Your income is the greatest asset you have. With it you not only take care of your and your family’s current needs, but you also have the power to secure your financial future by building wealth. To make sure you’re using your income wisely, use this simple method for completing a financial health check and identifying any possible red flags.
Use this article to:
- Figure out how much you’re spending in each main category
- Compare your spending to the guidelines for each category
- Spot potential financial problems for each category
- Make goals to address the potential problems
Simple financial health check steps
Here are the 06 steps to quickly check the health of your finances:
Step 01
List your take-home annual income. Make sure to exclude PAYE, ACC, KiwiSaver and Student Loan deductions.
We’ll use Hone and Jen as an example:
Hone is a software engineer and makes $95,000 per year, but after PAYE, ACC, and KiwiSaver is deducted, his take-home pay is $68,493.00.
Jen works part-time as teacher and makes $49,000 per year, but her take-home pay is $35,766.76 because she is still paying off her student loan in addition to the other deductions.
Hone and Jen’s total take-home pay is $104,259.76.
For the purposes of this example, we’ll round up to $104,260.
Step 02
Total your annual needs, wants (and priorities), savings (and investments) and giving in your annual spending plan. If you’re unsure which items in your spending plan are in each category, find out about each category here: 04 Types of Spending and How Much Each Should Be
Tip: After you think you have your annual totals for each type of spending, check that they all add up to your annual take-home income.
Based on our example, Hone and Jen’s annual totals might be:
Needs – $70,540
Wants – $21,754
Savings – $11,750
Giving – $216
Simple Financial Health Check Steps
Step 03
Calculate the percentage of your income for each category.
Use the following formula: category total/annual take-home income
Hone and Jen’s percentages would be as follows:
Needs – $70,540/$104,260 = 68%
Wants – $21,754/$104,260 = 21%
Savings – $11,750/$104,260 = 11%
Giving – $216/$104,260 = .2%
Step 04
Compare your percentages to the target percentages for each spending type. Be sure to familiarise yourself with the target percentages in the article, 04 Types of Spending and How Much Each Should Be.
Our example couple, Hone and Jen, haven’t received mortgage debt reduction advice from Futurebound, so they still have 30 years to pay on their mortgage. Their target percentages for each category would be:
Needs – 50%
Wants – 30%
Savings – 10%
Giving – 10%
Step 05
Analyse each category and how it compares to the target percentages. Take note whether your percentages are higher or lower than the targets and why.
Based on the percentages we calculated for Hone and Jen, their Needs (68%) are much higher than the target (50%) due to them buying their first home in the last 3 months and not having a mortgage debt reduction plan. However, they’re happy they don’t have any car loans or it would be much higher.
Their Wants at 21% of their income is low compared to the target, but they’ve had to cut back to buy their home.
They’ve managed to keep their Savings at a good level (11% compared to the 10% target), and they’re putting it into a revolving credit to offset their mortgage and be used for an emergency fund.
Giving for Hone and Jen is very low due to focusing on getting into their first home.
Step 06
Create financial goals based on your analysis. Now, that you have an overview of how you’re doing financially, note some possible financial goals that can help you reach financial freedom.
For example, Hone and Jen might decide to save up an emergency fund of 03 months of their needs instead of 06 months of their needs, since they have secure jobs.
They might also get some mortgage debt reduction advice, try to pay down their mortgage in under 10 years, and use the equity in their home to invest in property.
Over time, it would decrease their Needs, increase their Savings, and make it possible to increase their Wants and Giving too.
Jen volunteers at their local food bank, so she might plan on making regular financial donations once they free up some cash.
Identifying red flags
One of the benefits of doing this simple financial health check is that is makes it easy to identify possible problems in your finances.
Here are some red flags to pay attention to:
Needs – If your Needs is higher than the target, it’s probably due to having a large mortgage and car loans. If you’re working toward financial freedom, this is slowing you down because you have a lot less to put toward building wealth with investments.
Wants – If your Wants are higher than the target coupled with low Savings and/or Giving, it could be because you’re living beyond your means and are paying too much in short-term debt repayments.
However, if your Wants are low with no or low Savings and Giving, this is likely due to being “house poor”. This means your housing costs are so high that you don’t have much money to do anything else.
Savings – If your Savings are low, that means you’re not building wealth and you probably have an insecure financial future.
Giving – If your Giving is low, you might not have discovered the secret to living a fulfilling life is to contribute to others. Giving is an important category to your wellbeing and making a difference for your family, community and world.
Keep in mind this article is providing general information and not individual financial advice.
If you’d like a review of your situation and customized advice for building wealth to reach financial freedom and live a fulfilling life, please book a free 15-min chat.
