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Why Financial Literacy is Important

| March 05, 2019
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April is Financial Literacy month. Before we got there, I wanted to create a post about what makes up financial literacy and why it’s important.

Financial Literacy

Being financially literate means you have the knowledge and the skills to make informed decisions with regard to your financial life.

This involves certain areas, including budgeting and tracking expenses, saving for the future, investing, and credit, among others.

Scary Statistics

To help illustrate how important being financially literate is and how poor of shape we are in as a society, I’m going to provide you with some statistics.

  • 44% of Americans don’t have enough cash to cover a $400 emergency
  • 45% of student loan borrowers are not making payments
  • 38% of households have credit card debt (average over $16,000)
  • 33% of American adults have nothing saved for retirement
  • 16% of people aged 18-26 are optimistic about their financial future
  • 54% of millennials are worried they won’t be able to pay back student loans
  • 63% is the average score for all age groups on a financial literacy test

Stats provided by Forbes and Financial Educators Council.

Budgeting

One of the most important parts of financial literacy is being able to effectively budget. Specifically, it’s being able to give your money direction and tracking your expenses.

When you have a plan of attack for your money, you can make great strides in achieving your financial goals. Similarly, when you can track your expenses, you can make adjustments by cutting waste and designating more funds to save or paying down debt.

Here are simple steps for budgeting.

  • List your income
  • List necessary expenses (mortgage/rent, utilities, food, transportation, debt, savings)
  • Compare your total monthly income to total necessary expenses
  • Adjust if expenses are higher than income
  • Review last few months worth of expenses to see where your money is going
  • Cut unnecessary excess as needed
  • If it turns out that after you cut down on the excessive discretionary spending, that you have money left over, save it or reward yourself for sticking to your budget.

To learn more about budgets, click here.

Saving

There might not be a better predictor of financial success than your money saving habits. And I believe that getting started is the hardest part because some people don’t have any extra money to save.

My advice is the same no matter what. Just start with a little. $20 per month to a savings account. 1% of your salary to your employer-sponsored retirement plan. If you don’t have one of those, contribute $50 per month to an IRA.

The key here is to start. After some time, you’ll be used to that extra $20, $50, or $100 per month not being there. When that happens, bump up the amount you save a little bit.

Investing

Saving your money isn’t enough. It’s important to put that money to work on your behalf.

*Investing, specifically in the stock market has been the most effective way for one to increase their wealth over the long-term.

There are a few important rules of thumb you should follow.

  • Keep it simple - It doesn’t take fancy schemes or complex strategies to invest effectively. Pick a few index funds and let compound interest do the rest.
  • Keep fees low - Pay attention to the “expense ratio” of those funds. Ideally, you want it below .10%.
  • Keep your behavior in check - During times of distress (when the market declines) it’s human nature to want to sell what you have to stop the bleeding. Most often, this actually hurts you. Stick to your plan, and you’ll do okay in the end.

*Past performance does not guarantee future results. Profits cannot be guaranteed in a declining market.

To learn more about investing, click here.

Credit

Having a good credit history is so important nowadays. It impacts loan opportunities, interest rates, housing, and even employment.

Here are the five factors that impact your credit score (ranked by importance).

  • Payment history (35%)
  • Credit utilization (30%)
  • Length of credit history (15%)
  • New credit (10%)
  • Credit mix (10%)

Make sure all of your payments are on time or early, keep your credit utilization (total outstanding balance divided by available credit) below 30%, the longer the history the better, and use a variety of credit accounts if possible (loans, credit card, etc.)

If you want to learn more about credit, click here.

Interest

Understanding interest and how it affects your money is important. It works in two ways.

  • You pay interest - Your credit cards, student loans, and other debt have interest rates tied to them. You pay that rate when you have an outstanding balance. The higher the interest rate and/or the higher the outstanding balance, the more you will pay towards interest.
  • You’re paid interest - Savings accounts, CDs, and bonds. You “lend” the institution money and are paid an interest rate as a result.

Conclusion

The stats show how bad of shape we are actually in. Money is not the end all, be all in life, but understanding how to use it to your advantage can help set you up for a life well-lived, instead of worrying.

I left out debt because I’ve written about that topic ad nauseam, so if you want to learn more about that, click here.

If you'd like to learn more about anything discussed here, drop me a line.

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