Am I Financially Healthy

The only way to effectively reduce and eventually eliminate your debt, or to avoid debt accumulation in the first place, is to spend less than you earn. However, for many, this is easier said than done, and debt accumulation presents a real problem.

If you are worried about your debt, the first thing you can do is to decide where you stand now. Do this by calculating two things: your net worth (how much you are worth financially), and your debt-to-income ratio (how much debt you pay in comparison to how much money you earn).

To calculate your net worth, first total up what you have. This includes cash, insurance policies, cars, homes, boats, retirement savings, and all investments, among other things. Next, tally up your liabilities, such as debts, loans, taxes owed, mortgages, etc. Finally, subtract your liability total from your asset total. A positive number indicates financial health, while a negative number indicates that you have some work to do.

One problem that might be contributing to your negative result is your debt-to-income ratio. High debt will contribute significantly to financial unhealth. To determine your debt-to-income ratio, total up all your debts (credit debt, debts to banks in the form of loans and mortgages, car debt, student loan payments, and child support payments). Next, total up your income (paychecks, investment interest, and all other income). Calculate these on a monthly basis. Finally, divide your total debt by your total income. This is your debt-to-income ratio.

If your debt-to-income ratio is less than 30 percent, then good for you! If your debt-to-income ratio is between 30 and 36 percent, you are still doing well, but you might want to consider bringing it down. Anything above 36 percent is not desirable, and if your debt-to-income ratio is above 40 percent, you could be in real trouble. Consult a financial advisor to help you lower your debt.

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Dr. David Babbel Professor Wharton School

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