Experts are promoting the concept of financial health as an alternative to “financial literacy.”
“Financial literacy is really what you know. Financial health is the outcome,” says Rachel Schneider, the center’s senior vice president at the Center for Financial Services Innovation. “You might know what to do, but the gap between knowing and behavior is huge.”
The concept of financial health also acknowledges the forces beyond our control. Just as physical health is a combination of behavior, genes and access to good medical care, financial health is a result of personal decisions and abilities, the economy and access to good, unbiased financial services and advice.
Financial health typically means:
- You can manage your day-to-day financial life
- You can absorb a financial shock
- You’re on track to meet your financial goals
How do you get there? These behaviors can help:
You spend less than you earn. This is the foundation for financial health. You can’t get out of debt or save for the future if your expenses eat up all your available income.
You pay bills on time. You manage your cash flow and meet your regular financial obligations. Missing payments costs you money in late fees, hurts your credit and causes stress.
You’re on track with retirement savings. How much you need will vary by age and circumstance, but you’ve done the calculations and are setting aside money regularly to get there. If you have other goals, such as buying a home, you should be saving toward those as well.
Your debt load is sustainable. The Center for Financial Services Innovation recommends that mortgage payments consume no more than 28 percent of your pretax income and that all debt payments, including a mortgage, should be less than 36 percent. An even simpler gauge is whether your debt keeps you up at night.
You don’t routinely carry credit card or other high-rate debt. Mortgages pay for homes that can increase in value, and student loans provide an education that can help increase your income. But there’s typically nothing good about credit card debt.
You have good credit scores. Good credit is a safety net when you need it. Bad credit can increase your insurance premiums, prevent you from getting an apartment and force you to pay larger deposits for utilities.
You’re appropriately insured. You want to be protected against financial shocks that could wipe you out, including medical bills, lawsuits, natural disasters or the death of a family member. Health insurance is a must, and so is homeowners or renters insurance. If you have a vehicle, you need auto insurance with liability limits at least equal to your net worth.
A decent emergency fund is a part of financial health. “Decent” varies according to your circumstances. Many experts would like to see everyone have six months’ worth of living expenses set aside. But as little as $250 can be enough to save a low-income family from a serious financial setback, according to a study by the Urban Institute, a policy research group.