5 Ways To Improve Your Financial Health

Whether you’re saving to buy your first home, trying to avoid debt, or eyeing a comfortable retirement, every decision you make can have an impact on your overall financial goals. Just like your physical health, your financial health needs to be nurtured.

Let’s discuss five key strategies that can help you secure your financial future: calculating your net worth and budget, avoiding lifestyle inflation, differentiating between needs and wants, starting to save for retirement early, and building an emergency fund.

Key Takeaways

• Calculating net worth and maintaining a budget are critical to financial health.
• Avoiding lifestyle inflation is crucial for sustainable financial growth.
• Differentiating between needs and wants helps guide mindful spending.
• Saving for retirement early leverages the power of compounding.
• An emergency fund is essential for financial resilience against unexpected events.

1. Calculate Your Net Worth and Budget

Instead of taking a passive approach to your finances, carefully evaluate your present financial health to help you determine how to reach your short-term and long-term financial goals.

To start, determine your current net worth: the difference between the value of your assets versus the amount of money you owe. You can calculate your net worth by making a list of what you own (your assets) and what you owe (your liabilities). Then, subtract the liabilities from the assets to get your net-worth figure.

Your net worth represents where you stand financially, and this figure can fluctuate over time, so it’s smart to calculate it at least yearly. By tracking your net worth, you can see your financial progress, set goals, and identify any areas that might require improvement.

Creating a personal budget is just as important as knowing your net worth. Maintaining a monthly budget can help you effectively plan for costs down the line, save for life’s milestones, reduce wasteful spending, and prioritize where your money is going.

There are many ways to create a personal budget, and the income and expense categories you include can change. Here are some common income categories:

• Salaries and wages
• Tips
• Bonuses
• Social Security
• Retirement income
• Disability benefits
• Interest and dividends
• Rents and royalties
• Alimony
• Child support

Some common expense categories include:

• Housing (mortgage, rent, HOA fees, maintenance)
• Utilities (electric, gas/oil, water, phone, internet)
• Food (groceries and dining out)
• Medical and health care (doctor visits, dentist appointments, prescription medications)
• Insurance (health, home/renters, auto, life)
• Personal (hair care, skin care, cosmetics, gym, clothing, professional dues)
• Transportation (gas, tolls, parking, taxis, public transit)
• Savings (emergency fund, retirement, education, vacations)
• Debt payments (credit card, auto loan, student loan)
• Giving (birthdays, holidays, charitable contributions)
• Childcare/eldercare
• Education (tuition, books, supplies)
• Entertainment and recreation (games, sports, hobbies, books, movies, DVDs, concerts, subscriptions like streaming services)

After calculating your projections, subtract your total expenses from your total income. If you have money left over, you have a surplus, which you can choose to spend, save, or invest. However, if your total expenses exceed your total income, you’ll need to modify your budget by either finding a way to earn more money or by reducing your expenses.

2. Avoid Lifestyle Inflation

The majority of individuals tend to spend more money if they have it at their disposal. Typically, as you move up in the workforce and start earning more money, there’s a correlation between higher income and an increase in spending. This is what’s known as “lifestyle inflation.”

While having more money may mean you can pay all your bills and have extra money left over, lifestyle inflation can be damaging in the long term since it limits wealth accumulation. Try hard not to give in to a “keeping up with the Joneses” mentality—if you start spending more money every time you start earning more money, there may not be any extra left over to save or invest for your future. 

Important

More spending today means having less money in retirement, and just because you’re earning more money now doesn’t mean you’ll have a higher income for the long term.

Spending more money on certain things may be justified, such as purchasing a bigger home as your family grows or hiring a cleaner if you don’t have much free time outside of working hours. As you move through life, it’s smart to continuously evaluate your budget to determine your needs and your wants.  

3. Differentiate Between Needs and Wants

Understanding the differences between needs and wants is key to maintaining financial health. Simply, needs are things that are necessary for survival. They may include housing, food, clothes, health care, a reliable means of transportation such as a vehicle, etc. After all your needs are met, it’s important to put money away in your savings, too.

Meanwhile, wants are things that aren’t necessary for survival. They may include your morning coffee run on the way to the office, multiple streaming services, dining out, going on vacation, etc. Needs should always be your top priority, and wants should always come second, only if you have discretionary funds left over. Carefully differentiating between needs and wants can help you create a balanced budget.

4. Start Saving for Retirement Early

It’s never too late to start saving for retirement. However, saving early and often is important. The earlier you’re able to start consistently saving for retirement, the more financially secure you’ll likely be during your retirement years, thanks to the magic of compounding interest.

Compounding is when an asset’s earnings, like dividend payments from stock ownership or interest earned from your savings account, are reinvested and begin to earn additional income over time.

Here’s an example: assume you want to save $2,000,000 by the time you turn 62, and you expect to earn 6% interest each year (compounded daily).

• If you start saving when you are 20 years old, you would have to contribute about $875 a month—a total of $454,562 over 42 years—to reach this goal by the time you turn 62.
• If you start saving when you are 40 years old, you would have to contribute $3,646 a month—a total of $991,820 over 22 years.
• If you start saving when you are 50 years old, you would have to contribute $9,485 each month —a total of $1,407,507 over 12 years.

As you can see from the figures above, starting to save in your 20s versus in your 30s or 40s can make a world of difference in your retirement savings growth. 

Important

Starting to save at a young age means you can save less each month and contribute significantly less overall to achieve the same goal.

5. Build an Emergency Fund

An emergency fund is pretty self-explanatory. It’s money saved for emergency purposes only, and this fund is meant to help you pay for expenses that you might not have room for in your normal budget. These may include an unexpected home or car repair, or a surprise medical bill. Additionally, an emergency fund can help bridge the financial gap if you lose your income due to a layoff or an accident that temporarily puts you out of work.

Most experts advise saving at least three to six months’ worth of living expenses in cash. However, saving more is advisable if possible, given the uncertain economic climate. 

Don’t forget that establishing an emergency backup fund is an ongoing process. Consistent contributions over time are key to growing your fund to a healthy level. If you need to withdraw from your emergency fund, be sure to start replenishing it as soon as possible.

The Bottom Line

Following these five steps can help you achieve long-term financial success. Monitoring your net worth, adjusting your budget, saving, and avoiding a “keeping up with the Joneses” mindset can all improve and help you build upon your financial health.