Five Rules to Improve Your Financial Health
What is Financial health?
Just like maintaining a fit body and mind is important for our well-being, our financial health is equally important to maintain a healthy lifestyle. The meaning of good financial health does not solely mean having a lot of money in the bank or the ability to understand complex financial ratios. Your financial health depicts a comprehensive picture of your combined wealth, your financial capacity, and where you stand currently in terms of a liquidity point of view.
Good financial health includes one or multiple steady sources of income, a low spending percentage on your total earning, low debt levels, a good number of diversified investments, and a healthy growth rate of your invested corpus. All these factors collectively make you financially strong. Now that you have understood the meaning of financial health, the question remains, how to improve it?
How to improve your financial health?
Before we get into the key points which will help you to improve your financial health, it is crucial to know where you stand financially. To identify this, you need to precisely calculate your total net worth, and then proceed with the following points.
Here are the 5 rules which will help you to improve your financial health
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Optimize your investments and make periodic adjustments
Making any long-term plan involves various factors which can change during the course of the journey. Hence, it is important you analyze your investments and make the necessary adjustments so that you stay on the right track. With the passage of time, your disposable might increase, or your risk appetite might change. Therefore, it is essential to make the necessary adjustment in terms of asset allocation and diversification that fits your current needs. For example, if you wish to take on less risk, you can allocate more money into more conservative instruments like Government Securities, Treasury bills, debt funds, etc. Further, you can reduce your allocation in small/mid-cap stocks. In the following way, you can rebalance your portfolio once a year so that it stays in line with your expectations and plans.
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Make a regular savings plan
Saving and investing regularly is a key to long-term wealth creation, as a result, you should take this extremely seriously. To improve your financial health, you should make an investment plan and stick to it religiously. The best way to accomplish that is to set up automated investment instructions in your brokerage account and start monthly SIPs. By implementing these, you will not only be consistent in investing but also benefit from dollar-cost averaging in the long run. Another effective way of building a financial discipline is to set up a separate savings account that will be responsible solely for all the investments. Make sure to deposit a determined percentage of your income into this account which shall be only used for investments.
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Build and maintain an adequate budget for your spending
Saving and investing is the most critical part of your financial health. Your total income does not matter as much as your savings rate. Because the more you are able to save, the more you can invest and allow it to grow. Therefore, you need to have a monthly as well as a yearly budget which will include the list of necessary and non-essential expenses. Once you recognize the areas where you are spending the most amount of money, you can easily cut back on the extras so that you are left with more. A general rule of thumb is to typically allocate 40-50% of your total income for necessary expenses, 20-30% for recreation, and the remaining 20-30% for your investments. In addition, make sure to invest at least 10% for your retirement. Making a sound budget and faithfully adhering to it regardless of any increase in your income will protect you from lifestyle inflation and will ultimately lead to better financial health.
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Bring down your debt levels
Although including some debt can help leverage your investment growth. But an increased proportion of debt can result in a negative net worth, which is disastrous for your financial health. Because of this, ensure your EMI payments are below 20-30% of your monthly income and you don’t utilize more than 50% of your total credit card limit. There are two effective methods to bring down your total debt. One is the ‘Avalanche method’ where you start paying off the loan with the highest interest and gradually move down with the one with the least interest rate. The ‘Snowball method’ is the opposite where you start with the lowest yielding loan and eventually move up to the highest.
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Set up an emergency fund
Your financial health is incomplete unless you are prepared for an unexpected event. The recent pandemic has taught us to be prepared for any unforeseen events that might take place in the future. One of the best ways to protect yourself is by obtaining insurance. But you should also protect your investments, and the best way to do that is by building an emergency fund. This emergency fund will be used in times of a distressed financial situation so that you don’t have to redeem your long-term investments. Therefore before investing elsewhere, your goal should be to securely invest 6-8 months of your ordinary expenses in a safe and liquid asset that will act as insurance in distressing times.
Bottom line
Similar to a growing child, whose nutrition requirements change over the years, the needs of your financial health change as you grow older. Because of this, it is important to know the finance basics, keep a track of your investments and re-balance them frequently so that your goals are aligned with them. By following the above-mentioned rules diligently, you will make sure to achieve all your short and long-term goals and also gain financial freedom in your life.