Financial Literacy: The Key to Confidence with Money

Summary:

• The Key Concepts of Financial Literacy
• The Basics of Investing
• Setting Goals
• Risk Management
• Pitfalls to Avoid
• The Emotional Factor

It’s financial literacy month and we’re going to review some basic tools to boost your knowledge.

Many of us navigate financial decisions without the tools to fully understand them. Most people have bits and pieces of information about budgets, debt, and saving, but may not have a full enough understanding to feel confident about their money. We’ll start with the basics, and show you how they support your bigger financial picture.

Understanding the Basics:

We’ll get to investments and insurance later, but let’s start with the following core concepts:

• Cashflow: Money comes in (income/earnings) and money goes out (spending/expenses). Positive cashflow means you’re bringing in more money than you’re spending, and negative cashflow means that your expenses exceed your income. A lot of people start examining their cashflow on a monthly basis. You can also look at your cashflow on an annual basis, to get a big-picture look even things vary from month to month.
• Debt (and credit): Debt is money that you borrowed to cover an expense and owe back to the person or institution that lent it to you, like a bank. There are a lot of different reasons you may have debt, you could have student loans, a mortgage, credit card debt, a car loan, or a combination of various debts. Different types of debts come with different repayment terms, including the timeline by which you’re expected to repay the money, and the interest rate. Which brings us to our next concept…
• Interest: Interest is extra money charged or earned on top of an initial amount of money, defined by an ‘interest rate’ which is expressed as a percentage. Here are two examples:
  • Interest on Debt:
    • Let’s assume you have a $1,000 credit card balance with a 20% annual interest rate.
    • If you don’t pay back any portion of that $1,000, the interest adds $200 in the first year, increasing the balance you owe to $1,200.
    • If another year goes by and you still don’t pay back any portion of the now $1,200, another 20% is added, this time in the amount of $240 for a new total of $1,440. This is an example of interest compounding.
  • Interest on Savings/Investments:
    • Let’s assume you deposit $1,000 in a savings account with a 5% annual interest rate.
    • If you don’t remove any funds from the savings account, the interest adds $50 in the first year, growing your balance to $1,050.
    • If another year goes by and you still don’t remove any funds from the account, another 5% is added, this time in the amount of $52.50 for a new total of $1102.5. This is an example of interest compounding.
  • Saving: The last key basic concept is saving money. This means setting money aside for future use. You can set it aside in various ways, for example in a savings account or an investment account. There are many ways to set aside money, and each way comes with its own level of risk and growth potential.

The Basics of Investing

Now that you understand these four key concepts, let’s zoom in on another topic: investing, and see how these four key concepts come into play.

We mentioned that there are many ways to set aside money, and that each way comes with its own level of risk and growth potential. There are retirement investment accounts, Roth retirement accounts, and non-retirement accounts, and while each comes with its own taxation treatment, they are vehicles for investing the money you’re setting aside with the hope that it will grow by accruing interest.

Very importantly, that hope for growth comes with risk. That risk is the loss of the money that you initially invested/saved. There are types of investments that have historically been riskier than others, and those investments have historically also offered potential for higher growth over time. The inverse is also true historically speaking, that less-risky investments offer less potential for growth over time.

How does investing relate to our key concepts?

• Cashflow: Your ability to invest depends on your cashflow. If you regularly have positive cashflow, you have funds available to invest.
• Debt: If you have debt that is growing faster than your investments, those investments will never outpace your debt.
• Interest: Investments grow via interest. While some investments offer fixed interest rates, others change day-to-day.
• Saving: Not only are you saving money for future use, but you’re investing that money to turn into more money for future use.

Setting Goals and Planning Ahead

Financial decisions are never only about money. Our finances impact nearly every aspect of our lives and recognizing the role your finances play in achieving your goals is a key component of financial literacy.

You might have short term goals like going on a vacation or buying a new car, and you might also have long term goals like retiring by a certain age. Your goals might also not be driven by big purchases, for example you could have a goal to pay off debt or build an emergency fund. You can have multiple long and short term goals simultaneously!

Let’s see how our key concepts fit into goal setting and planning ahead:

• Cashflow: Your cashflow will guide what goals are realistically achievable. How much money is leftover after living expenses each month sets the limit for how much you can save for any goal, short or long term.
• Debt: The compounding cost of any debt you may have can influence how you prioritize paying off that debt alongside your other goals. If you have debt with a high interest rate, paying it off before saving for other goals may be a good priority. If you have debt with a low interest rate, you may still be able to put your money to work elsewhere while you pay down that debt simultaneously.
• Interest: We talked about investments in the previous section, and how more volatile investments can offer more potential for growth while less volatile investments may offer less growth potential but more stability. A short term goal may require more stability at a lower rate of return, while a long term goal may be able to weather the storm of volatility for a potentially higher rate of return.
• Saving: Remember that saving is setting aside money for future use. When you set goals, you’re determining what that future use will be.

Risk Management

Earlier we mentioned that saving can help prevent taking on more debt when life happens. There’s always risk in life, you might have an unexpected car repair or medical bill, or you could lose a source of income unexpectedly. A basic example of managing this risk is saving an emergency fund that can cover unexpected expenses or loss of income. How much to have on hand for emergencies is very case by case!

But there are other ways to mitigate risk, such as insurance. There are so many types of insurance that may apply to your lifestyle, we’ll save that deep dive for another day.

Pitfalls to Avoid

We all try to do our best with our finances, and there are easy ways to avoid common financial pitfalls. Related to our key concepts:

• Cashflow: Losing track of your budget is common! A monthly check-in can save you headaches to make sure you’re maintaining a positive cashflow. Subscriptions that go unchecked can prevent progress toward your goals by accident!
• Debt: Ignoring debt while it grows is a quick way to lose control.
• Interest: Underestimating the impact of interest can hurt you two ways:
  • High interest debt can grow out of control,
  • And ignoring your opportunities to invest can lead to missed opportunity.
• Saving: Many people wait until they have “just a little more” to start saving, but even small steps are real progress!

There are other common traps you can easily avoid:

• Fraud and scams: Check out our recent blog on fraud prevention!
• Analysis paralysis: Feeling like you need to have everything figured out before you can make a move can hold you back.
• Avoidance: Ignoring finances altogether can lead to unnecessary problems in the future.

The Emotional Factor

Even if you understand these basics, financial decisions aren’t purely logical, they’re emotional! How we spend, save, and think about money is often shaped by our experiences, habits, and our upbringing. This can lead to stress, avoidance, or even over-confidence.

The important thing to recognize is that these feelings are normal. Building financial literacy can help shift your relationship with money, regardless of where you’re starting.

Who Can Help

While these basics can help, you might still find yourself wondering what to actually do to improve your financial situation. We can help.

For more information on financial literacy, check out any or all of some of our favorite books:

• The Psychology of Money by Morgan Housel
• The Millionaire Next Door by Thomas J Stanley
• The Richest Man in Babylon by George Samuel Clason
• Think and Grow Rich by Napolean Hill
• Rich Dad Poor Dad by Robert Kiyosaki and Sharon Lechter
• The Intelligent Investor by Benjamin Graham
• The Art of Spending Money by Morgan Housel
• Die with Zero by Bill Perkins
• The One Page Financial Plan by Carl Richards
• Simple Wealth Inevitable Wealth by Nick Murray
• Stocks for the Long Run by Jeremy Siegel