August 21, 2023
I cannot speak for your experience, but I know my own. I grew up in a suburban school system that provided no real world application or experience with financial literacy. My school did teach basic mathematical concepts including those of Algebra and Geometry. However, when it came to Financial Literacy, I entered into adulthood with very limited knowledge of how to succeed financially. I only knew what my parents shared with me. I was lucky to be able to write a check. I can recall teaching one of my friends how to accomplish this very task. As the child of a factory worker and a homemaker, my parents were not financially savvy. My father’s best advice was to save my money when possible and my mother encouraged a good education so that I would be able to make a lucrative income. Both of these messages were good pieces of advice; however, financial literacy is a topic that should learned and understood similar to Algebra and Geometry that are required mathematical courses.
Financial literacy, much like reading or writing, is a fundamental skill we all need. It's the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing. Today, we’ll walk you through some of the basics in your journey toward financial independence.
Understanding Money: A Simple Guide to Explaining Abstract Financial Concepts
To become financially literate, you must understand definitions of financial terms. Like this, you have a strong comprehension of the basics of the topic.
Currency: This is the medium we use to exchange for goods and services. Different countries have different currencies - from the US Dollar to the Euro to the Japanese Yen.
I can still recall when I discovered there was a whole market that determined the value of the currency and that the value of currency actually fluctuates just as rapidly as stock values fluctuate within the stock market. My concept of money growing up was strictly that you were able to use it to purchase what you needed or wanted. If I wanted to use my $2.00 allowance for an ice cream cone that cost $1.25, I would. It is so much more in depth than this. The Foreign Exchange Market (FX Market) has trades currencies around the world. Some currencies hold more or less value than other currencies. Imagine if I used my $2.00 allowance in a different country that had a different value to their currency. When I exchange my currency, I gain $.50 in the transaction. Therefore, now I automatically have $2.50 to spend. If the ice cream is still valued at $1.25 per cone, I am now able to purchase an ice cream cone for a friend too!
Inflation: This is the rate of increase in prices over a given period of time. Imagine your same ice cream cone that cost $1.25 this year. Due to inflation, which is the rise in prices over time, that same ice cream might cost $1.35 next year. Essentially, your money's value decreases over time due to inflation. This is an important topic to understand going towards the retirement years. If you have a certain amount of money saved for retirement, you need to understand that the worth of your savings may not be what it was when you earned it.
Importance of Saving: The Power of Compound Interest
It is so very important to start saving your money early. I took my father’s advice to start saving my money as soon as I entered into the workforce. He was definitely right about this. I created a 401K and allotted 6% of my income to this account. At this point, my retirement profile sates that I have met 100% of my saving goals for retirement and I am only in my 30’s. This is due mostly to the power of compound interest. Think of compound interest as “earning interest on interest”. Let’s say you invest $100 at a 5% annual interest. The next year, you'll earn interest on $105 (your initial amount plus the interest you earned). Over time, this compounds, and your savings grow at a much faster rate. This is why starting early makes a huge difference!
Debt Management: Good Debt vs. Bad Debt and the Importance of Timely Repayments
Debt is something that is owed or due; whereas credit is a sum of money that is added to an account. It my be a fabrication to say that I knew the difference between a debit and credit in high school. I was also unaware of the difference between good debt and bad debt. All debt is not created equal! What? How is it possible that debt is not equal. Let’s check into it a bit more!
Good Debt: This type of debt typically has a lower interest rate and can increase in value or generate long-term income, like student loans or mortgages. Let’s explore both of these examples! If you take a student loan, you are investing in yourself. For example, if you want to become a physician, at the end of your education, your income could reasonably be $250,000 per year straight out of medical school only to increase rapidly as you gain experience and evolve within your role. This means that if you borrowed a similar amount to pay for school, that you would be able to rapidly pay it off after you are gainfully employed. In the case of borrowing money for a mortgage, real estate typically appreciates money over time. For example, if your purchased your house in 2018 for $150,000, the value of your property could easily be $300,000 by present time. Therefore, you made $150,000 just by being the owner of the property. Of course, you will need to subtract out interest paid, but no doubt you will still be in the green on a transaction like this.
Bad Debt: This type of debt often comes with high-interest rates and doesn't increase in value or generate income. This can be like credit card debt from unnecessary spending. You must be aware that the credit card companies want you to not be able to pay off your monthly balance. Like this, they are able to charge you an insane amount of interest. Plus, if you are late paying the bill, they are happy to tack on a late fee. You must be a responsible spender for a credit card to make sense for you.
Let’s further the idea of being responsible with your money! It is so important to not only avoid bad debt, but to understand what your monthly income is compared to your expenses. You should try very hard to try to save some money each month! We provided the briefest example of budgeting to help you to succeed financially!
Basic Budgeting: How to Track Expenses and Set Savings Goals
Budgeting is your financial roadmap. To start:
Track Your Income: Note down all sources of income, whether it's from a job, rental income, or even a side hustle.
List Your Expenses: Keep track of where your money goes every month. This includes rent, utilities, groceries, and entertainment.
Set Savings Goals: Aim to save at least 20% of your income. This can be for an emergency fund, vacation, or retirement.
Remember, always make repayments on time to avoid extra charges and a dip in your credit score.
Financial literacy is a journey, not a destination. Start by understanding money, budgeting, saving, and managing debt. This article has not even explored beyond the tip of the iceberg on financial concepts. By grasping these basics, you're laying down a strong foundation for financial independence. Remember, every financial expert started as a beginner. Now it's your turn. Take that first step!