5 Basics of Financial Literacy

by | Mar 9, 2021 | Financial Planning

April will be here before we know it, and April is Financial Literacy Month.  Raising the overall level of financial literacy in the US is so important.  Being able to fully understand the basics of personal finance can help so many Americans make better financial decisions.  What are some of the basics?  We’ve outlined five of the most important ones below!

The Basics of Financial Literacy

#1: Debt & Credit Scores

Understanding the ways in which credit or debt can work with or against you should serve as the foundation of your financial knowledge. Credit and debt are necessary factors in establishing a healthy financial life.  Avoiding credit and/or debt altogether because you don’t fully understand it is not an option.  Every financially literate adult should have a firm grasp on how credit and debt can impact their finances. 

Debt

When used correctly, debt can be useful. But when misused, it can spiral out of control fast. Missed payments can accrue interest or penalties and may impact your credit score in a negative way. Debt that is managed responsibly can help you reach important goals like buying a car, purchasing a home, going to college, starting a business and more. 

Credit Score 

Your credit score is one of the factors lenders use to judge your trustworthiness and qualification for mortgages, auto loans and other lending opportunities. Landlords and employers may also check your credit before renting to you or offering you a job. Your credit score is dependent on a number of factors including previous credit history, current debts, history of payments and more.

#2: Interest

Interest accruing can be either a good thing or a bad thing.  It’s important to know the difference between interest accrued on debt and interest accrued on savings.

When you take on debt (like credit card debt, an auto loan or mortgage), you’ll be responsible for paying back both the principal amount and the interest accrued on the loan. The interest is how a lender makes money on the loan and provides the borrower with an incentive to pay the loan back in full and on time. Letting interest accrue on debt is a bad thing.

When you have a savings account that accrues interest, the interest earned gets added to the principal. Letting interest accrue on savings can be a good thing. Then, interest is earned on the new, larger principal, and the cycle repeats. This is called compounding interest, and it can be an integral part in growing your retirement savings – as the longer the interest has time to compound, the greater the savings will grow.

#3: The Value of Time

It’s never too early to start saving – for retirement, homebuying, a child’s education or whatever could be coming down the line. The earlier you start saving, the more you’ll be able to tuck away over time – especially with the power of compounding interest. This leverages the value of time to your advantage.

#4: Inflation

Inflation has the potential to eat away the purchasing power of your money. That means, with inflation, the dollar you earn today may not be worth a dollar in the future. Below are two important concepts to remember regarding inflation.

Keeping all your cash under a mattress is not only unsafe, it literally costs you money. Assuming the annual rate of inflation is a hypothetical two percent, every dollar you keep under your mattress and not earning interest would shrink in value to $.98 next year.

Because inflation erodes the purchasing power of your money, any returns you earn on your accounts may not be the “real” rate of return. If your account earned a hypothetical six percent rate of return over the last year, but inflation was 1.5 percent, your real rate of return was 4.5 percent.

#5: Identity Theft & Safety

Especially as the world shifts to doing everything virtually, identity theft remains one of the biggest threats to financial and personal security. A cracked password or misplaced Social Security number can have big consequences on your current and future finances.

The common wisdom is to use a unique password for each site or service you use. A password manager can make this easier by generating and storing strong passwords automatically.

While this is a brief overview of some of the important basics of financial literacy, it’s important to work with your trusted financial professional to explore these topics further. Remember to reach out if you have questions about any financial basics, and take this month to reevaluate your current financial knowledge as you identify potential areas for improvement.  If you have any questions for us, we would be happy to help!  Click here to schedule an initial call with our team.

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