Financial Wellness

Published on: 04/02/22

What is it really?

Financial Wellness is a broad term often used in the financial industry to indicate how healthy your current financial situation is. It doesn’t mean just feeling good about your finances. Financial wellness is overall financial health, which includes income, debts, and spending. For example, though your income may be steady and you have investments making stellar returns, if debts and spending offset these gains, you wouldn’t be considered financially well. Similarly, if your income is steady and you have more than enough to offset your debts and spending, you would generally be considered financially well.

The 4 Elements of Financial Wellness

The Consumer Financial Protection Bureau (CFPB) has identified four main elements that lead to financial wellness. First, financial wellness isn’t simply about how healthy your finances are today, but also your projected financial well-being in the future. Today’s financially healthy person will have control over daily expenses and is financially free enough to live life without undue worry over money. But to be truly considered financially healthy, one should also have the ability to address future financial challenges, like a lost job, or unexpected health expense. This often means the creation of an emergency fund, and a plan for its use. One should also be on track to meet future financial goals. And this of course assumes a financial plan and trajectory has already been developed. Only when both current and future financial needs are met, would you be truly considered financially well.

Improving your Financial Wellness

To improve your financial wellness, you should first understand where you currently stand. Do a quick financial health check. Gather all your bills, and whatever else makes up your monthly expense, and create a budget. In your budget always include your full income and expenses so you have an honest appraisal of how much you have to spend each month, and importantly, how much will be left over. Often the presence of a budget can identify weaknesses in your current or future financial state that you wouldn’t normally see without a budget. Sometimes there are expenses that can be easily reduced, like money spent on eating at restaurants or cancelling unused subscriptions or memberships. But sometimes too, there isn’t an easy way to reduce spending. If the majority of your expenses are for mortgage or debt payments that can’t be put off, then your opportunities for improving your financial wellness through a reduction in spending are limited. It’s important, then, to be organized and honest about your current and future financial state and needs. If your current income is only barely covering mandatory monthly payments, then it’s probably not prudent to be investing.

Emergency Funds

Before Investing, you should always have an emergency fund on hand in case of unexpected expenses. It’s tempting to jump into investing, especially if you have free cash flow to invest each month. However, if you do not have an emergency fund first, when financial challenges present themselves, you may be forced to sell your investments at in inopportune time, or you may sell and have to take losses. Having an emergency fund would have ensured you don’t have to make rash investment decisions when confronted with unforeseen expenses. Each month you should try and set aside some money for your emergency fund so that you can weather at least 2 to 3 months of being without steady income. Some financial advisors would say that you should have more money on hand, roughly 6 months of income. In any case, setting aside money for an emergency fund each month is critical for your long-term financial well-being. Even setting aside small amounts like $50 or $100 a month will get you in the habit of saving. Once you have an emergency fund buffer, then consider what other expenses can be reduced, particularly high-interest debt from personal loans and credit cards.

Become Debt-Free

Becoming debt free can feel like an impossible task, especially if your debt payments take up a significant portion of your disposable income. However, it’s a goal that should be high on your priority list, since it’s often impossible to materially change your financial state if you have large amounts of high-interest debts, with large monthly payments.

One strategy to tackle repayment of high-interest debt that has been deployed by many investors over the years, is simply to double the amount of debt payments you make each month, or at least, to double the minimum payment being paid each month. Credit cards are especially notorious for setting minimum payment amounts so low that if you only paid the minimum each month, it would take decades to pay off. Just doubling minimum payments each month reduces the decades it would take to pay off a large credit card debt to under 5 years. The difference in interest alone in this one example is staggering and should encourage you to pay off your debts as quickly as possible.

Another popular way to tackle high-interest debt is simply to pay off the card or loan with the highest interest rate first. For example, if you had multiple high-interest debt payments you would choose the debt with the highest interest rate and pay off the most each month you are comfortably paying. Then you can keep payments to the debts with lower interest rates small. This is an ideal way to both reduce debt and interest expense. Another strategy is to pay off the smallest debt first regardless of interest rate. Doing this can give you a sense of accomplishment, and also give you an attainable goal. Once the small debt is paid, then the next largest debt would be paid in order.

There is no one right way to pay off debt. As long as you have a plan in place and stick to it, you will be debt-free eventually. But it’s important to pay off the highest interest rate debts first as quickly as possible to free up funds for savings and investment.

Saving and Retirement

After you have set aside enough money for your emergency fund you can begin saving in earnest. Savings are not simply for retirement but can be for big ticket items, a down payment on a home, or for travel. Whatever savings are being used for, like with the building of your emergency fund, set aside money each month even if it is a small amount.

Many advisors suggest saving 10% of your monthly income for retirement, and some recommend as much as 25%. If this is too much for you to do comfortably, then invest the most that you can. Maybe start with one percent of your paycheck and keep increasing as your salary grows. If your employer offers some kind of retirement program with matching funds, try to save enough each paycheck to qualify for matching funds. For example, if your company matches retirement contributions in a 401k up to 6%, try to contribute the maximum. Make it a goal to capture all of the matching amount. Of course you may contribute or save more than that, but taking advantage of an employer match is one of the easiest ways to save, and can add significant returns to your savings over time.