Financial literacy is the ability to understand and implement basic financial concepts. And since financial education is still working its way to the mainstream, often it’s the responsibility of each individual to figure out what personal finance concepts to learn. So if you’re looking to become financially literate, here are four concepts you should know.
1. The Importance of an Emergency Fund
An emergency fund is a simple financial tool that sets the scene for overall financial stability. An emergency fund is money set aside in a savings account to protect you from life’s little surprises. For example, if life hands you a flat tire, roof leak, or sudden emergency room visit, your emergency savings can give you a cash cushion to pay for the situation without needing to go into debt.
The general recommendation is to hold between three and six months of living expenses in your emergency fund. But that number may increase depending upon your income, job stability, and family size, with more savings needed for those in commission-based roles or with large families. It’s also important to put the emergency money into a savings account for safekeeping and easy access, not in an investment account where it could be tied up or lose value.
2. Budgeting Basics
Many people associate keeping a budget with sacrifice and want. But a budget, when done correctly, can help you find financial freedom. To create a budget:
Assess your current spending. Look at one to three months of historical spending to figure out how much you’re spending on essentials like housing, transportation, taxes, food, and non-essentials, like clothing, eating out, and entertainment.
Look at sources of income. Calculate how much you’re bringing in each month between your full-time job and any side hustles.
Decide on a reasonable budget for each category. Ensure your budget is less than your income and create appropriate budget categories based on historical spending.
3. Smart Debt Management
It seems like taking on debt is a fact of life, whether it’s a house, car, or personal loan. But before you take on debt, it pays to understand the types of debt and how to decide which debt is worth taking on.
Start by figuring out the difference between “good and bad debt” and the advantages and disadvantages of each. Once you know what kind of debt you hold, it will be easier to develop a debt management strategy to help you pay it off as efficiently as possible.
4. The Power of Compound Interest
Once people understand the concept of compound interest, they wonder why they didn’t start investing sooner. That’s because compound interest is powerful — so powerful, in fact, that it can grow your money without you making any further investments.
For a simple example of compound interest, let’s look at the impact of saving $10,000 in a savings account earning 1% compounded annually. In the first year, you’d earn $100 in interest. But in year two, you’d be earning interest on $10,100 — not the initial $10,000. That means in year two, you earn $101 in interest. By year five, you’d have a total of $10,511.
As you can imagine, as investments and interest rates increase, compound interest can have staggering impacts on the total amount in an account. And the earlier you begin to invest, the longer time compound interest has to work and make you more money.
The Bottom Line
Financial literacy is a lifelong journey. But the value it brings to your life cannot be measured. It’s best to start with basic concepts like establishing an emergency fund, creating a budget, managing debt, and earning compound interest through investing and saving wisely. Then, as you learn and grow, turn to new resources and higher-level concepts to keep progressing.
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About the Author: Brooke Joly is a freelancer who focuses on the financial wellness and technology sectors. She has a passion for all things wellness and spends her days cooking up healthy recipes, running, and snuggling up with a good book and her fur babies.
Photo Credit: stock photo
#2. HAVE a side hustle! So many people waste their time complaining they don’t have enough money and they waste their spare time which gives them more opportunity to spend money they don’t have. Get a weekend or night job as a waiter / waitress. You will generally get a free meal at the end of the shift, a good bit of exercise walking from tables to kitchen, and no opportunity to spend money because you are buy earning it. Rake your neighbor’s leaves, weed flower beds, walk dogs, open a part time cleaning service, do computer work for the non computer literate. Do not fall for “work from home” scams. Devote every dollar earned to paying down debt. Sell all your clutter on Facebook marketplace, craigslist or ebay. You don’t have to stop paid work after 40 hours.
Good article. I still live by those basic principles with a few others thrown in for good measure.