How health and finances are linked

Health and Finances are very similar in nature. Both have a long term impact and ironically, often neglected by most people. It may be because the impact is not always so severe before it starts affecting your life. Let’s look at some examples from both fields.

When you are young, you may not exercise or even have bad habits like smoking.
When you are young, you may not be saving money as you just want to enjoy your income.

Is there any short term impact? Possibly no, unless you are hit by a bus or a job loss.

When you do not eat right and take shortcuts to fast foods and sugary drinks.
When you do not have patience to save up but buy things impulsively with debt.

The key here is the shortcut or the impulsive behavior. And this continues for many years till it really hurts one day. Even kids today are victims of both the junk food and immediate gratification culture.

On the other hand, let us look at some good habits.

When you are eating healthy and exercising regularly, the benefits are seen only in the long run.
When you are saving and investing regularly, the magic of compounding and reduction of debt play only in the long run.

The key here is the patience, discipline and doing the right things over a long time that matters.

Nothing complicated, yet health and finances are the two most difficult areas in many people’s lives.

And so the healthcare and insurance industry came up with the concept of Health checkup.

And we decided to define a similar Financial Health Checkup.

How do you define a good Financial Health?

No to Low debt, especially consumer debt.
Savings equivalent to several months of expenses.
Reasonable size of home or housing expenses.
Assets more than liabilities.
Living within your means.

These are all common sense, but can we quantify them as in a health checkup report?

A comprehensive Financial Health checkup dashboard may look like this:

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With a minimal amount of data from the user, a number of ratios can be calculated. These ratios are nothing but a numerical form of your current financial situation.

Let us look at some of the ratios and how they are used to define the Financial Health.

Debt to Income ratio

This is a very simple ratio and is also used by Lenders, calling it the DTI ratio. It simply indicates what percentage of your net income goes towards debt payment.

Anything more than 30% could be a red flag, unless it is due to some special situation.

Lenders will be more liberal in that:

They accept up to 40-45% in some cases.
They use gross income instead of net income.

The reason lenders use a more relaxed constraint is they have a business to run and do not care about your overall financial health as long as you can pay their bills.

Health Analogy: You could be drinking and partying, but too much of it is going to impair your life. Your employer will care about your performance at job, but this can affect your career and relationships much more.

Expense coverage ratio (ECR) by savings

This is a form of Emergency Fund or Contingency Fund. It is the ratio of the savings that you have compared to the monthly expenses, including debt and housing payments. This is a very important metric as it directly measures your financial ability to survive an unemployment or income loss.

When converted to a simple ratio, it says how many months your savings can last without affecting your lifestyle. A ratio of 3 to 6 (300%-600%) is considered healthy, as that is typically the time taken to get a new job.

A higher value then signifies your Financial Freedom number, for example, if you are thinking of changing careers or launching a business, it could be as high as 18-24.

Health Analogy: Your fitness level will define how many days you can go without food or endure difficult living conditions.

Assets / Liabilities (A2L) ratio

This ratio depicts the coverage of all your liabilities by your assets. There are two ways to look at this.

Net worth = Assets – Liabilities. So an A2L ratio > 1.0 indicates a positive net worth.
In a dooms day scenario, if the ratio is > 1.0 your assets can be liquidated to pay off all your debts.

Thus this is a very important Financial metric and often used by financial advisors to track progress.

A ratio of 2.0 (200%) or higher is considered safe, which means after paying off debt you are still left with something substantial.

Health Analogy: It is like going to the gym or exercising to improve your stamina and having enough power to do hard manual work, when needed.

Assets / (Rent + Debt) (A2RD) coverage

This may sound similar to the ECR but it covers only obligatory payments like Rent and Debt. This is important for the following reasons.

You can control your expenses but not the rent and debt payments, without making signifiant changes. You need a place to live and you do not want to pay penalties or trash your credit history.
Lenders look at your assets due to this since they want their payment by selling your assets, if necessary.
Your savings can still cover your discretionary expenses as seen by ECR.

In short, the more assets you have, the better you can continue with your obligations and not have to declare bankruptcy or similar. This covers a longer term and more doomsday scenario than ECR.

Health Analogy: This is your body immunity or timely access to vaccinations to fight against virus and diseases.

Housing Cost Ratio

Cash Poor, House Rich. Analyze finances for most Americans and you will find this trend. Large mortgages and the misconception that home is an investment, have caused this expense to be a major part of household income.

The Housing cost ratio simply measures what percentage are you spending every month towards having a roof over your head. It could be just the rent or sum of mortgage, taxes, insurance if you own.

Anything above 25-30% is considered risky since it can derail your other financial goals.

Health Analogy: I hope you will see this as comparable to obesity or diabetes, which are also problems in affluent societies.

Slack

I love this number. This means that after taking care of all your expenses, debt payments, home costs, you have surplus money. This really defines your future and is a powerful financial weapon to build your freedom.

You can either consider this an absolute number or measure it as a savings ratio (slack / income), provided you are actually saving or investing this amount.

The larger this number, the better it is since it accelerates your Financial Freedom and gives you more options. And the earlier you put this to work towards your goals, the better it will serve you.

How?

$100 invested every month at 7% per annum grows to $113,353 in 30 years.
$500 invested every month at 7% per annum grows to $588,000 in 30 years.

However if you do not save now, and wait for 10 years, then invest the same total amount.

$150 invested every month at 7% per annum grows to only $76,560 in 20 years.
$750 invested every month at 7% per annum grows to only $382,804 in 20 years.

Health Analogy: How healthy and fit you will be in your old age will depend on when you start exercising and how consistent you have been. It is due to the consistency part that Yoga or Running are often considered easier than hitting the gym.