A friend recently forwarded an article to me that profiled the following statistics:
- 70% of adults in the U.S. said they care more about their physical health than their financial health;
- 49% of men, and 38% of women, said they care more about how much they weigh, than how much debt they carry; and
- 72% of Americans said they would prefer to keep their current amount of debt, rather than increase their weight by 25 pounds and be debt-free.
The trade-off between physical health and financial health is obviously a false one: People can be both physically healthy and financially healthy. They can also be both physically ill and financially ill.
More important, though, is the fact that financial health can influence physical health, and vice versa. For example, a physically healthy person can become sick as a result of being in financial distress. Similarly, someone who is physically ill could become healthy following a relaxing vacation, which they can easily afford.
How, then, should we think about the above statistics? It is important to first put them into context: The debt-load of the average American family has been estimated between $100,000-to-$250,000. The reason for such a wide range pertains to the difficulties of accounting for all of the various sources of personal debt, such as mortgages/home equity loans, car loans/leases, credit cards, etc., across the nation.
Whatever the actual “average debt-load” is, it is very large, especially when compared to the average American family income of approximately $54,000. Total debt of two-to-five times annual income is not indicative of long-term financial health.
Financial health can be assessed along three dimensions:
- The difference between how much a person owns and how much they owe;
- The amount of fixed and discretionary expenses that are funded by earnings; and
- The amount of savings that are set aside for a “rainy day” and retirement.
Consider each of these dimensions in turn: First, the difference between how much a person owns and how much they owe is particularly important with respect to property such as homes and automobiles. A common property financial measure is the Loan-to-Value (LTV) Ratio, which compares the current amount of a loan to the value of the property securing it. A low LTV Ratio is a sign of financial health.
Second, fixed monthly expenses (such as rent/mortgage payments, food, utilities, etc.) and discretionary monthly expenses (such as cell phones, cable television, restaurants, etc.) can be compared to monthly earnings to calculate an Expense Ratio. An Expense Ratio of less than one means that total monthly expenses are less than monthly earnings, which is a sign of financial health.
Finally, there is savings. In general, a savings rate of 5-10% of annual income is indicative of financial health. However, this can be a very steep threshold for many families. Fortunately, there are ways to stimulate savings, such as through the income tax code.
Almost everyone is required to file an annual income tax return, which many (most) of us do not like to do. However, included in the income tax code are a variety of credits, such as the “earned-income tax credit,” which can be used by some people to legally increase tax refunds. Such refunds can, and should, be used to start or add-to savings accounts to the extent possible.
The above may seem relevant to only lower income families, but it is not. Many mid-to-higher income families are also in need of financial health awareness and advice. In fact, everyone needs to continuously work on both their physical health and their financial health. Being “in shape” physically and financially facilitates a healthy, responsibly funded life.
Check out FINRA Investor Education Foundation’s 6 keys for financial fitness Act Now
Written by Joseph Calandro, Jr.