Understanding how to manage money will make a big difference for your financial stability.
“Money is a very powerful thing, which you hardly notice when it goes right, but which can create havoc when it goes wrong.” –Milton Friedman
A major study conducted by the Financial Industry Regulatory Authority demonstrated that people with higher levels of financial literacy are more likely to find financial security or stability.
Financial literacy means the scaled ability to competently understand what money is, how to raise money, and the various ways of effectively managing money. Financial literacy does not guarantee financial security, although financial literacy and security are strongly correlated. People who understand finances have a higher chance of becoming financially secure and wealthy. People who do not understand finances are much less likely to establish financial security or acquire personal wealth.
Just as there is a scale to reading literacy and comprehension, there is a scale to financial literacy. The more you read, the better you will become at reading and comprehending. Similarly, the more you study and practice finance, the likelier you are to improve your understanding and implementation of financial principles and, hopefully, your financial well-being.
How to Improve Financial Literacy
The first step toward improving financial literacy is to understand what money is. For many people interested in finance and financial literacy, it takes a while to understand what money actually means. Unfortunately, there are many bad examples in the world. This has caused many financial crises in people’s personal finances, as well as government finances and monetary policy management and implementation. Money has become a widely debated term, primarily for philosophical and political reasons. For this article, we will use an Austrian School of Economics perspective and definition of money.
Money is a socially derived, commonly agreed-upon, sound, medium of exchange that measures the price of all other goods and services.
Ways to honestly acquire money include producing something people will purchase, providing a service that people will pay for, trading, acquiring something for a lower amount and selling it for more, or receiving it as a gift.
The second step in improving financial literacy is to understand the five pillars of financial literacy: earn, save, protect, spend, and borrow. Here are five questions you can ask yourself to test your own financial literacy.
1. Do You Know How Much You Earn?
Understanding how much you make might sound simple, but there’s a bit more to it than you might think. We’re talking about much more than your annual salary or hourly wage.
Do you know what your health benefits are? Your retirement plan? Does your company offer a reduced stock purchase (an ESPP)? Do you get a 401k match? Are you tracking any non-primary forms of income you might have? (Various studies have indicated that nearly 45 percent of Americans have a side hustle to generate more income.)
These are all important questions to consider.
2. Do You Understand the Importance of Saving and Investing?
You may have read the article, 5 Easy Steps For Improving Your Credit Score, in which I go over two super easy options for saving:
- 70-20-10 Rule. Spend no more than 70 percent of your after-tax income on living expenses, 20 percent towards debt, and 10% towards savings.
- 50-30-20 Rule. Spend no more than 50 percent of your after-tax income on living expenses, 30 percent towards debt, and 20 percent towards savings.
When you save your money, as opposed to letting it burn a hole in your pocket every time you acquire some, you are ensuring a more secure future with each dollar you save. Consider emergency savings for a car issue, health concerns, in case you lose your job, your computer or cell phone breaks, or a family crisis. Having money readily available is important for meeting spontaneous needs as well as providing confidence and peace of mind when those things do arise. Once you have a solid savings plan, you should start considering investing.
Investing is an important element in savings. Use portions of your savings to invest, as opposed to storing money in savings accounts. By investing your money, you are increasing your likelihood of greater returns later in life.
One strategy for investing is getting an investment app such as Robinhood, Acorns, or WeBull, and then using portions of your savings to invest in companies that you believe will do increasingly well. The better the company does, there is an increased likelihood that their stocks will rise, so if and when you sell your shares you can make a profit. Be sure to put in the time and effort researching companies before you make an investment. You can invest a few dollars or thousands, it is up to you and your individual circumstances. You can either invest a percentage each time you are paid, use gift money, or use your tax returns. But investing a portion of excess income each can offer many advantages.
This is by no means the only way to invest, of course. One can invest in gold, as this family does, which can be an effective way to safeguard against inflation. Land, silver, and even cryptocurrencies like Bitcoin are other popular examples.
Investing carries risk, of course, so learning how to develop the mindset of a trader is a good idea before taking the plunge.
3. Do You Know How to Protect Wealth?
When you have money, you should safeguard it against losses, theft, inflation, deterioration, emergencies, and other costs that life brings with it. Putting all of your money under your mattress or in a wall safe is not going to be the best way to save money if all it takes to lose it all is a fire or a thief. Protect your money with reputable institutions, insurance, and the right type of safe if you insist on having some on hand. It is also a good idea to have a credit and identity monitoring service, which many credit card companies and banks offer for free.
Diversifying your wealth and portfolio is likened to the saying, “Don’t put all of your eggs in one basket.” When you diversify, you are ensuring that if there are losses in one investment, such as your 401k, traditional or Roth IRA, or stocks, you will not lose all of your money at once. In short, diversification is a strategy to reduce portfolio risk, which is a way to protect your wealth.
4. Do You Monitor Your Spending?
Watch what you spend your money on, and do as much price checking as possible to ensure you get the best deal for your purchases. By becoming price conscious, you will not increase your wealth, per se, but you will save what you already have.
As an avid meal prepper and chef hobbyist, I thoroughly enjoy cooking and I am constantly at a grocery store. One of the things I enjoy cooking is steak, which is a more high-priced cut of meat than chicken, pork, or ground beef. A decent steak is probably going to cost at least $15. However, I found that if I search online with something like MyGroceryDeals, or Flipp, I can find the best prices on steak or when they are expected to be on sale. This can sometimes save me 50 percent on one steak. Imagine the savings that could be for an entire family.
For larger purchases, it’s always a good idea to search prices and conduct research before you make a purchase. You can use your favorite search engine to see if the item is sold elsewhere for a lower price. It is also a good habit to see if it can be bought new or used on Facebook Marketplace, Craigslist, eBay, or Etsy. Websites like CamelCamelCamel help track price drops on Amazon.
It is also important to remember that if you work a standard job like most people, each dollar represents an amount of time that you will have to work for in order to pay for something. So, if you earn $20 per hour, and the meal you are about to eat costs $20, that is one hour of work you will have to put in to afford that meal. Weigh your options to determine if that is worth the time and amount spent within your budget. (If you don’t have a budget, it’s not a bad idea to start one.)
5. Do You Know the Dos and Don’ts of Borrowing?
Sometimes you have to borrow money for larger purchases. Such things as college, a vehicle, or a house, have high costs and are not easily afforded upfront for the vast majority of people. Keeping your credit score high enables you to borrow money with ease. For many purchases, if you do not have a good, or at least decent, credit score, borrowing money will be difficult and expensive if even possible. Borrowing, or acquiring debt, is not always bad—in fact, it’s often the case that even quite wealthy people have debts. The key is knowing how to manage debt and having a plan to attack it.
If you are going to borrow money, be sure to check for the best interest rates and the amount of time to pay it off, and be sure you can make your payments when they are due.
There is a lot to learn about financial literacy, far more than that which was covered in this article. However, by taking proper action with these key components in mind, you will begin making better financial decisions and help prepare a better future for yourself and possibly your loved ones.
Get Started Today
If you are ready to begin your financial literacy education, be sure to check out more of the articles and work offered by FEE. The sooner you start, the better off your life will be. Click here to start now: Financial Literacy 101
Original: https://fee.org/articles/are-you-financially-literate-answer-these-5-questions-to-find-out/
