Top 12 Indicators Essential for Financial Health

Financial Health

Top 12 Indicators Essential
for Financial Health

Table of Contents

Financial Health Indicators

There are several ways to measure your financial health. The following are the some of the top indicators of personal financial health I‘ve come across and which I use to measure my progress towards FI.

Use them like a dashboard and update them regularly to check whether you’re on track for financial independence.

Indicator 1 - Emergency Fund

An emergency fund is a pool of liquid money set aside for unforeseen expenses like becoming seriously ill or losing your job. 

Having an emergency fund is a safety net in that it can be the difference between a small bump in the road or a major car crash.

Usually an emergency fund is a stash of 3-6 months easy to access cash, e.g. in a high interest savings account.

Another great benefit of having a robust emergency fund is that it gives you a psychological advantage.

A peace of mind knowing that you can lose your job or fall sick for 6 months and still be able to manage, and focus on your health and getting back to work.

So, do you have an emergency fund? If not go to my post clicking the link below to learn how to get started on your Emergency fund today.

Related Post: Jumpstart an Emergency Fund in 3 Simple Steps

An Emergency Fund insures against life's unexpected misadventures!

Indicator 2 - Total Debt

Debt is bad! There really is, no good debt. Having said that, not all forms of debt are created as bad as other forms of debt. So for the purposes of explaining debt, it is worth categorising debt into three groups:

Level 1 – So so Debt: Investment Loans (e.g. Investment Property Mortgages, Margin Loans on stocks, Business loans etc)

Level 2 – Bad Debt: Student debt (HECS/HELP etc.) and Home Property Mortgage debt (i.e. your actual home loan)

Level 3 – Terrible Debt: credit card debt, personal loans, car loans, furniture and appliance loans etc etc.

If you’re in debt, your first priority is to get out of debt. It’s amazing how quickly you can get out of debt once you focus on it and apply some simple strategies.

I was able to crush my credit card and student loan debt in less than a year! I was able to do this because I created a strategy of how to destroy debt.

To learn my debt destroyer method and crush your debt in a shorter period of time that you thought, go to my post by clicking the link below.

Related Post: Debt Destroyer Method – Debt Free in 5 Steps

Indicator 3 - Debt-to-Income Ratio

Do you have a low debt-to-income ratio?

To calculate your debt-to-income ratio, add up your total recurring monthly obligations (such as mortgage, student loans, auto loans, child support, and credit card payments) and divide by your gross monthly income (the amount you earn each month before taxes and other deductions are taken out).

For example, assume you pay $1,200 for your mortgage, $400 for your car, and $400 for the rest of your debts each month.

Your monthly debt payments would be $2,000 ($1,200 + $400 + $400 = $2,000).

If your gross income for the month is $6,000, your debt-to-income ratio would be 33% ($2,000 / $6,000 = 0.33).

If your gross income for the month was lower, say $5,000, your debt-to-income ratio would be 40% ($2,000 / $5,000 = 0.4).

So how do you improve your ratio? Basically, there are three ways to lower your debt-to-income ratio:

  1. Reduce your monthly recurring debt
  2. Increase your gross monthly income
  3. Use a combination of the two.

It’s also worth noting that your debt-to-income ratio does not directly affect your credit score. This is a good thing. And the reason is because the credit agencies do not know how much money you earn, so they are not able to make the calculation.

Financial Health
Indicator 4 - Budget

Do you have a budget?

Budgeting is the process of creating a plan to spend your money. This spending plan is called a budget.

Creating a budget allows you to see in advance whether you have enough money to do the things you need or want to do.

Budgeting is basically balancing your expenses with your income. If they don’t balance and you spend more than you make, you have a problem.

Many people don’t realize that they spend more than they earn and slowly sink deeper into debt every year.

If you don’t have enough money to do everything you would like to do, then you need a budget.

And funnily enough, one of the more highly recommended budgeting tools in the FI Community is actually called YNAB (short for, You Need a Budget). 

Check it out here: YNAB – You Need a Budget

One of the top skills in becoming Financially Independent is knowing that every single one of your dollars is doing what you want it to.

Indicator 5 - Backup/Primary Active Income Ratio

Do you have a backup source of active employment income?

Whether it be a new position, a new industry, or self-employment or a a steady side hustle, having multiple sources of income gives you the psychological advantage and financial freedom to experiment in your life and career.

There are so many people I know who hate the job they’re in, but can’t quit because they have no other source of income, so they are stuck.

Don’t be average, gain the psychological and financial advantage that comes from hustling for a while until you have built a stable secondary source of active income.

 The ratio that you want to watch over time is the ratio between your backup income source vs your active income source. That is, if you are earning $100,000 per year from your primary source of income and $12,000 from your backup source of income, then your backup/primary active income ratio is 12%. Your goal over time would be to increase this ratio, to build in more resilience to your career and options. 

No bullshit though, a secondary active side hustle income source takes a significant effort and time to achieve. Especially, if you are someone like me, i.e. still working full time, has a family, a passion project and other normal life to-do’s. 

Indicator 6 - Passive/Active Income Ratio

Do you have passive income?

Passive income is something you have previously invested money or a large amount of up-front sweat equity into, and it is now providing a financial return to you with zero or minimal effort on your part. 

Some examples are:

  • Rental income from investment properties
  • Royalties from digital products
  • Dividends from equities

Ok, so you are creating some passive income, Awesome! 

Now you want to measure the ratio between passive income and active income. 

That is, if you are earning $100,000 per year and $1,000 per year passive income, then you have a 1% passive income ratio. Your goal would be to increase this over time. 

Passive income or passive cash flow is the next level of the FI ladder. It takes you to the level of Financial Freedom (or FIFREE).

To learn about the different levels of FI go check out my post on it by clicking the link below:

Related Post: The 5 Little-Known Levels of FI Revealed

Indicator 7 - Freedom Fund

Do you have a freedom fund?

A freedom fund is the big pool of money that you are saving outside of compulsory superannuation. It is specifically designed to set you up for an early retirement. 

The reason you need a freedom fund in Australia is because legislation stipulates that you cannot access your compulsory superannuation money until you are 65 (soon to be 67).

The freedom fund is also a separate pool from the emergency fund. The emergency fund is about 3-6 months of expenses to cover for emergencies.

The Freedom fund should be 25 x your annual expenses. So if your annual expenses are $40,000, then you need $1,000,000 in your freedom fund, if you spend $50,000 per year then you need $1,250,000 in your freedom fund, etc.

Check out my post on how to kick-start your freedom fund by clicking the link below:

Related Post: 4 Secrets Guaranteed to Kick-Start Your Freedom Fund

Indicator 8 - Net Worth

Do you know your current net worth?

To calculate your net worth, simply subtract the total liabilities from the total assets. 

In other words, your net worth, is the figure you get, when you add up everything you own, from the value of your home, to the cash in your bank account, then subtract from that, the value of all of your debts. 

Debts may include a home mortgage, car loan, student loan, or even credit card balances.

It doesn’t matter how big or how small the net worth number. It doesn’t necessarily matter if the number is negative. Your net worth is just a starting point to have something to compare against in the future.

Indicator 9 - Liquid Assets

The other important measure is the ratio of liquid assets to Net Worth. 

So essentially, it tells me what is the portion of assets I have available that can actually sustain me with an income now if I needed to retire.  

This means it excludes my home, investment properties, business assets and Superannuation. 

This for me is a more accurate measure of how close I am to my retirement number.

Indicator 10 - Annual Expenses

Do you know your annual expenses figure?

This is how to calculate it:

  1. Add up all of your fixed-monthly housing expenses. This includes your rent or mortgage payments, electricity, water, gas, phone and cable. Some of these might fluctuate slightly from one month to another, but use estimates of the average cost.
  2. Add your monthly transportation costs. In most cases, this will be your car payment and insurance, and average gas expenditure. If you pay your car insurance premiums less frequently, save them for the annual expenses section.
  3. Add your health costs. This includes gym memberships, health insurance, doctor co-pays and the cost of any medications you take.
  4. Add estimates of how much you spend on food each month. Food costs include groceries, meals at restaurants and other food and beverages purchased outside the home.
  5. Add your monthly spending money. Purchasing clothing, electronics, books and housewares falls into this category. Personal care items should be included here if they are not in your grocery category. Also include estimates of how much you will spend on entertainment each month.
  6. Add any additional monthly expenses. If you have other debt, such as student loans or credit card debt, include the monthly payments on these. If you are saving for retirement, an emergency fund or another big purchase, add the amount that you save toward these each month. Other potential monthly expenses include child care costs, child support, alimony and monthly charitable giving.
  7. Multiply your total estimated expenses for each month by 12 to find your baseline annual expenses.
  8. Make a list of all of the things that you pay for less frequently than monthly. This might include car registration, vacations, gifts, magazine subscriptions, car maintenance and repairs, property taxes and any type of insurance you do not pay monthly.
  9. Estimate how much you spend each year in each of the categories. For example, you might spend $120 per year for oil changes on each of your vehicles. Include each estimate on the list.
  10. Add all of the annual expenses to your baseline annual expenses to get your estimated annual living expenses.
Indicator 11 - Annual Savings

Do you know your annual savings figure and rate?
This is how to calculate your annual savings figure:

  1. Calculate your annual income (after tax) for a specific period. Include employer superannuation contributions
  2. Calculate your spending for the same period.
  3. Subtract your spending from your income to figure how much you’re saving, then divide this number by your income.
  4. Multiply by 100 to get the annual savings rate.

When calculating your saving rate, it’s important to note that it should include your income after taxes, because you’ll over-estimate your savings otherwise.

Indicator 12 - Years to FI

Once you figure out your savings rate, you can get a sense of how close you are to financial independence. 

This varies according to your personal goals but experts typically recommend having $1 million set aside in your freedom fund to retire by 60 to 65.

However, if you want to kick back earlier, many early retirees rely on the “four percent rule.” The idea behind that is, if you can safely withdraw four percent a year from your freedom fund, you have enough in the bank to quit your job.

Flipping the four percent rule can help you figure out how big your portfolio needs to be, or what’s called your “magic number.”

Simply divide your annual spending by 0.04 (or multiple it by 25) to get your target.

Using the four percent rule, for example Person A will need $750,000 ($30,000 / 0.04) in the bank to retire comfortably.

Once you know your magic number you can calculate how long it will take to get to FI. 

Alternatively, you can get a quick 5 second overview by viewing the post I wrote about this, to view, click the link below.

Related Post: Years Until Retirement – 5 Simple Seconds to Calculate

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The EntreFIneur
The EntreFIneur

EntreFIneur is a passionate frugalist, FI enthusiast, experimenter, ideator and entrepreneur. He's also a family man and when he has time, an active fitness fiend and outdoor hobbyist.

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