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3 Critical Steps to Check Your Financial Health

Use these three crucial steps to check your financial health and avoid a money malady

If you hadn’t been to the doctor’s office for years…maybe ever, what would be the first thing to do when trying to assess your health? You’d go in for a checkup, right?

So if you’ve never assessed your financial health or haven’t in a long time, you need to start with a financial checkup.

Our daily lives are so busy just trying to pay the bills that most people never sit down to really check up on where their finances are and if they are on the right track.

It’s like only going to the doctor when you get sick. You might be able to cure the colds and little complaints but sooner or later, something big is going to catch up to you. Staying healthy means getting those regular checkups and catching it in time.

There are three critical steps you need to take for a financial checkup that will keep you financially healthy and help meet your goals!

Does Net Worth Equal Financially Healthy?

Net worth isn’t just something millionaires talk about while sipping mimosas on their yacht. It’s an important financial concept for everyone, measuring what you own and what you owe.

Finding your net worth is a starting point in your financial checkup to see how much you have in savings, investments and how much debt might be dragging you down. Knowing where you’re starting from makes it a lot easier to plan where you’re going.

steps to check financial healthFinding your net worth starts with adding up all your assets. These are just the things you own like your home, investments, cash in bank accounts and any cash value on life insurance.

  • Money in the bank
  • Investments including personal accounts, retirement accounts, pension and 401K
  • Cash value of insurance policies
  • Anything that has a value of more than a few thousand dollars

A lot of people tell you not to include your home as an asset for finding your net worth. I think this is silly. For most people, their home is their largest asset. It’s a real source of value and shouldn’t be excluded.

I don’t include cars in assets unless they are really expensive or collectors’ antiques. Most cars lose their value quickly and it’s use as a financial asset is very limited.

You next add up all your liabilities, the debts and other obligations you owe.

  • Credit card balances owed
  • Car loans
  • Student loans
  • Mortgage
  • Anything you owe and that will take more than a few months to pay off

Finding your net worth is easy, just subtracting your total amount of assets by everything you owe.

What Does Your Net Worth Mean?

So many people are a little surprised and scared to find they have a negative net worth. This has nothing to do with your worth as a person and doesn’t mean you’re a financial train wreck.

Most younger adults have a negative net worth, they owe more than they own, because of student loans and other payments. Maybe you’ve only been working a few years and haven’t had a chance to build up your assets.

You’ll find all kinds of advice on how much your net worth should be by age. There is a huge problem with comparing your net worth against an average or following these overly-simple guidelines.

  • They usually don’t take into account where you live or your cost of living
  • They don’t account for your circumstances like family size and age
  • They separate your financial planning from your financial goals

Your net worth is nothing but a starting point from which to get your finances on the right path. It means nothing until you understand your long-term financial goals and how much you need to meet those goals.

As an example, imagine two people:

  • Sally has a net worth of just $5,000 because of student loans and a mortgage. She’s 26 years old and is saving money regularly.
  • Jake is 38 years old and has grown his net worth to $80,000 by investing and paying down debts.

Which is the better off? You can’t say until you know how much each person needs to meet their financial goals, how much they are investing and other factors.

If Sally estimates her retirement goal at $720,000 by the time she reaches 65, she only needs an annual return of 5% and savings of $6,000 a year to reach her goal. Conversely, if Jake estimates he’ll need $3 million during retirement to cover expenses then he would need to invest $10,000 annually and earn 7% to meet his goal. On this, Sally looks like she’s in better financial health even though she has a lower net worth.

There is something to learn from finding your net worth beyond just an exercise to start financial planning. It’s the idea that your financial health comes from owning assets rather than owing debts.

What’s the one thing that all rich people have that the poor lack? It’s not intelligence or hard work. There are smart people that are poor just as there are lazy people that are rich.

The one thing that separates rich and poor is owning rather than owing! It seems obvious, it’s the very definition, but is something that people don’t think about.

Concentrate on buying assets that have value and will make you money, i.e. investments and your home, rather than spending money on things that will force you into debt.

Give Yourself Some Credit for Your Financial Checkup

Next in your financial checkup is reviewing your credit reports and credit score.

Your credit report is a record of all your debts and payment history from when you first started using credit. Whether you want to be debt free and don’t plan on using credit cards, your credit report is still extremely important to your financial health and affects more than you may know.

  • Insurance companies are allowed to charge higher premiums to people with bad marks on their credit report and low credit scores
  • Potential employers may look at your credit report before offering you a job, gauging your financial responsibility
  • Landlords will look at your credit report and may deny your rental application if you have a shaky financial past

Of course, if you ever need a loan then your credit report will not only mean the difference between getting the loan or not but will also determine if you can afford the loan.

You actually have three different credit reports, not just one. There are three companies that collect financial information about your debts and credit payment history. Each of these puts everything together into a report which is then used by lenders during a loan application.

Checking your credit report is easy and you have the right to look at each of the three reports for free once a year. When you check your credit reports, you’ll see all the loans you have outstanding as well as some of those you’ve had in the past.

Information doesn’t stay on your credit report forever, usually only from a few years but up to 10 years for a bankruptcy. Despite the fact that bad marks and missed payments eventually drop off your credit report, it can feel like an eternity because interest rates will be higher until they do.

When you check your credit reports, you are looking for any errors that might have been reported. There might be payments that were reported as missed or late and even debts that shouldn’t be on your report at all. It might even show if someone has stolen your identity and is taking out loans in your name.

Not all lenders report to all three credit reporting companies so your three credit reports may be different. That’s why it’s important to check all three credit reports at least once a year to catch any errors or identity theft as soon as possible.

You can also use a credit monitoring service like TransUnion to keep track of your credit report and catch identity theft quickly. The service will monitor your credit and send email alerts when something changes, as well as offer tips on how to improve your credit.

Take advantage of this trial offer from TransUnion, get your credit score and report for $1

While your credit reports will show all your credit history, they don’t include your credit score. This is a number usually between 300 and 850 that lenders use to determine whether to give you a loan and at what rate.

good credit score and financial health

Understanding what affects your credit score will help you deal with bad credit and improve your score to get better rates on loans.

  • Most of your credit score comes from your payment history (35% of your score), whether you make payments on time and if you’ve defaulted on loans
  • The total amount you owe versus how much credit you have available is another big factor (30% of your score)
  • The length of your credit history, how many years you’ve had access to credit accounts for 15% of your score
  • Applications for new credit and new loans account for 10% of your score
  • Types of credit used, whether you have a lot of credit card debt or other types of debt, is another 10% of your score

Because your credit reports and scores can affect so many areas of your life, beyond just whether you get a loan and the interest rate, it’s important to review for your financial checkup. Reviewing your credit report can even help you better understand your spending and financial habits by looking at the credit accounts you’ve opened.

A bad credit score or marks on your report is not the end of the world but you do need to work on improving your credit score before trying to get a loan. Improving your credit score just a little can mean several percent lower in interest and thousands in savings each year.

Are You a Financially Healthy Investor?

The final part of your financial checkup is to check your investor policy statement and investments.

An investor policy statement (IPS) is a road map that describes your financial goals and how you are going to get there. Instead of investing blindly and hoping you have enough money for retirement, an IPS helps you customize your investing for your needs and makes sure you are going in the right direction.

Putting together an IPS starts with understanding how much you have invested now, how much you can invest regularly and how much you’ll need for expenses in the future. That’s all pretty basic investing stuff but the IPS goes further to explore how much risk you’re comfortable taking with investments.

Understanding that risk tolerance is crucial and too often missed by investors. Without it, investors just invest in stocks and chase stock market returns. When the next crash comes, they freak out and panic-sell at the worst possible time.

Putting together an investor policy statement is about understanding how much risk you can take before freaking out and making bad investment decisions. You’ll be able to invest for the highest return while still being able to sleep at night.

These are the three critical parts of a financial checkup. In a coming article, we’ll look at how to put all the information together and use it to reach your financial goals. Just as with your health, it’s important to schedule regular financial checkups to catch problems before they get out of hand and to keep yourself financially healthy.

Joseph Hogue, CFAAbout Joseph Hogue

An investment analyst by profession, I run two blogs (Crowd101 and PeerFinance101) in personal finance, peer lending and crowdfunding. I've been on both sides of the table as a lender and a borrower and am excited to be a part of the peer movement. With the power of the internet, people are helping other people manage debt and raise money in ways never before possible.

A veteran and Iowa-native, I now live in Colombia with my wife and son. Like so many people, I was once trapped into the money myth and what it means to be successful. After taking control of my finances and learning how to make money in a job I love, I found a level of financial freedom that just has to be shared.

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