Six Questions to Help Determine Your Financial Health

Many people, when thinking about their financial health, focus on a single indicator, such as whether they are saving enough for retirement or carrying too much student-loan debt. If personal finances were limited to–or fixed by–a single line item in the balance sheet, that approach would be fine.

But they aren’t.

During an annual physical exam, it is not possible to assess how well a patient is doing simply by checking the heart rate or blood pressure. Rather, a more comprehensive series of evaluations are needed. How well is the patient managing his or her health? Is the patient taking medicines as prescribed? Is the patient exercising and eating well?

The same is true of financial health.

Fortunately, there is a short financial checkup that effectively predicts what I think of as the key components of financial health–including short-term and long-term savings, management of financial products and financial literacy. The six-question test, which is based on a body of national and international research, evaluates four key areas: 1) ability to make ends meet, 2) advance planning, 3) management of financial products and 4) financial knowledge. (More in-depth questions from a national survey on financial capability, now in its third wave, are available online.)

Taken together, the questions below–and their answers–provide a starting point for people to better understand and improve their personal finances.

1. How confident are you that you could come up with $2,000 if an unexpected need arose within the next month?
– I am certain I could come up with the full $2,000.
– I could probably come up with $2,000.
– I could probably not come up with $2,000.
– I am certain I could not come up with $2,000.

This first question of the test assesses financial fragility–or the ability to mobilize resources when facing a shock. It is a rich measure that goes well beyond availability of or access to liquid assets, taking into consideration that one could deal with a shock by borrowing, by relying on the help of family and friends, by selling possessions or through other strategies. Moreover, it is a summary measure of the balance-sheet situation (not just assets) even as it addresses how one manages resources. Research links the lack of resources or the inability to access them when facing a midsize shock (specifically, answering this question with either of the last two responses) with indicators of financial distress.

2. Have you ever tried to figure out how much you need to save for retirement?

This question measures advance planning by examining the longer-term horizon and whether one has made plans for the future. While simple and intuitive, the question looks yet again at the state of personal finances and, in particular, at the steps taken to accumulate retirement savings, which can take many forms, including keeping within a budget. Academic research shows that those who answer affirmatively to this question have up to three times the amount of wealth as they near retirement as those who have not made any plans.

3. On a scale from 1 to 7 (where 1 = strongly disagree and 7= strongly agree), how strongly do you agree or disagree with the following statement: I have too much debt right now.

The third question turns to the liability side of the balance sheet. There are many opportunities to borrow and a multitude of options for doing so. Many young employees today start their working life in debt. The answer to this question reveals both the extent of the respondent’s debt burden and his or her management of finances. Those who choose value above the median (value 4 ) are found to carry not only several forms of debt, both short term and long term, but also to use high-cost methods of borrowing, such as payday loans.

The next three questions measure understanding of the ABCs of personal finance. They apply to the many financial decisions people have to make and that, ultimately, shape their finances and ability to achieve financial security in the short and long term. The questions address fundamental concepts–interest compounding, inflation and risk diversification–that underlie financial decisions, from day-to-day money management, to saving and investing for retirement, to borrowing.

Those who correctly answer the three questions reported below (the correct answers are the end) are not only less likely to be financially fragile and over indebted, but they are also more likely to plan for the future and to engage in many other behaviors conducive to higher retirement savings.

4. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow?
– More than $102
– Exactly $102
– Less than $102
– Don’t know

5. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, with the money in this account, would you be able to buy…
– More than today
– Exactly the same as today
– Less than today
– Don’t know

6. Do you think the following statement is true or false? Buying a single company stock usually provides a safer return than a stock mutual fund.
Rather than looking at a single behavior–an approach that usually is inadequate for evaluating how someone is doing financially–this test provides an encompassing measure of financial capability. It also identifies the areas where help may be needed. Even more, it allows individuals to compare their results to those of the average American.

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