Financial health has become a bit of a buzz term. Ask any financial professional if they think financial health is important, and you’ll be hard-pressed to find someone who says, “No.” But is there a firm standard way to define someone as financially healthy? How is it measured? Who is doing the measuring? This is where it becomes a little murky. It’s sort of like cash flow planning - most people agree it’s a good thing, but just over two decades ago, when I went looking for standards and tools, there was nothing to be found. There is a little more substance to the existing take on financial health, but is it accurate?
The Financial Health Network (FHN) seems to have the most established methodology to measure financial health. They’ve even built a financial health tool kit, complete with a survey and methodology for scoring answers to questions on their eight key indicators of financial health. The indicators fall into four categories: spend, save, borrow and plan.
Spend
1. Spend less than income
2. Pay bills on time
Save
3. Have sufficient liquid savings
4. Have sufficient long-term savings
Borrow
5. Have manageable debt
6. Have a prime credit score
Plan
7. Have appropriate insurance
8. Plan ahead financially
This seems like a logical approach. The problem is, humans aren’t logical. Their scoring system assigns points based on the answer selected in a survey. Unfortunately, the questions are mostly confidence-based and, as humans are known to be overconfident, the results can be heavily skewed.
Example question: Thinking about your household’s longer term financial goals, such as saving for a vacation, education, retirement, or starting a business, buying or paying off a home, or making retirement funds last. How confident are you that your household is currently doing what is needed to meet your long-term goals?
The answer options for the question above are:
- Very confident
- Moderately confident
- Somewhat confident
- Slightly confident
- Not at all confident
This question doesn’t give the survey respondent any objective measures to help them answer accurately. A better question might be: How much retirement income are you on track to receive? The options could be a percentage of pre-retirement spending per month. While some of the questions are a little more objective, they are still easily impacted by other tendencies, like social desirability bias. This means that even when surveyed anonymously, humans tend to pick answers that make them seem smarter or better.
One of the questions on debt asks the survey respondent if they have no debt, a manageable amount of debt, a bit more than a manageable amount, or far more debt than is manageable. What does that even mean? Debt is an amount. It’s numerical and how it relates to other aspects of our finances, like income, is how it should be measured. Someone up to their ears in credit card debt may still technically feel it’s “manageable,” and this provides a very inaccurate read of their financial health.
Some time ago, CacheFlo was able to examine health scores based on this methodology, and compare those self-reported scores against individual Winton profiles. We saw people who ranked their spend management capability as high, despite carrying credit card debt that was more than 20% of their income. We also saw people who scored themselves as low on planning, when they actually had retirement savings equal to 10 times their current income.
Confidence scores only measure confidence, which may or may not be related to reality. If we’re to measure financial health in an effective way, we need to ensure it’s based on data, and that those figures are measured against other financial factors. One person with $500,000 of debt could find this manageable, while another person could find this devastating.
Here are some possible ways to more objectively measure your client’s financial health across FHN’s eight financial indicators.
Spend
1. Spend less than income
- Your client is saving every month towards their goals and isn’t growing their debt.
- You can identify monthly free cash flow for your client, and they've committed to funding their short- and long-term goals with that money found.
2. Pay bills on time
- Committed and spendable cash flow should be separate accounts. Their money found should be positive, indicating it’s possible to spend less than their income and cover their bills on time.
Save
3. Have sufficient liquid savings
- Your client has emergency savings available that is approximately 4-6x their committed and spendable expenses.
4. Have sufficient long-term savings
- The client's retirement income needs are based on their projected committed and spendable expenses, measured against existing or future assets.
Borrow
5. Have manageable debt
- Your client's debt payments are below 50% of their committed cash flow.
6. Have a prime credit score
- Their credit score is above 760, which is considered excellent by Equifax.
Plan
7. Have appropriate insurance
- Your client's insurance is in force, and the face amount is equal to 100% of their outstanding debt plus their income, as well as their committed and spendable expenses for a determined number of years.
8. Plan ahead financially
- Your client has a written financial plan (modular or full), including a written cash flow plan, and is managing their spendable account.
Not sure how to calculate committed and spendable cash flow? Check out our 30-day free trial of the CCS program and take a whole class on these unique and powerful cash flow categories!
Watch our webinar, Measuring your client’s financial health, to learn more about how you can quickly measure your client’s financial health as part of your regular review process.
About CacheFlo
CacheFlo is a financial education company that builds eLearning and tools to help financial professionals and individuals make behaviour-based changes, which allow them to get more life from their money. We want to make it easier for people to predict the impact of their financial choices before they make them.
About the Certified Cash Flow Specialist (CCS) program
CCS professionals go through enhanced cash flow-based training to develop the skill set to deliver behaviour-based cash flow advice. They start the financial planning process with a cash flow plan to genuinely help their clients get more life from their money.
