5 Core Concepts of Financial Literacy
Financial literacy is the knowledge and ability to understand and make sound financial decisions. It involves various financial skills, from personal financial and debt management to investment and wealth accumulation.
Increased financial literacy is a crucial element in achieving not only financial health but also overall well-being. Specifically, it leads to greater resilience during expected and unexpected life events, leading to monetary stability and a stress-free life.
To be financially literate, here are five principles you should remember to help you get started.
Budgeting
Money can be used in four main ways: spending, saving, investing, and giving away. Striking the right balance among these categories is crucial, and a budget is a helpful tool to achieve this balance.
A budget can help you plan how much money goes into each category, ensuring you manage your finances wisely and meet your financial goals. Aim to be as detailed as possible to avoid underestimation that may lead to budget overrun.
When making a budget, cover and keep track of four essential elements: your income, savings goals, fixed expenses, and flexible expenses. Ensure you include all aspects of your lifestyle expenses and other financial components to ensure your budget is effective.
There are many ways to budget, usually depending on your goals. Start by thinking about what you want to achieve with your money in the short and long term. It could be saving for a big purchase or paying down debt. By listing your goals, you create a baseline for your budget.
Wealth Planning
Before diving into investments, it’s crucial to have a well-thought-out plan. Investing without a plan can lead to unnecessary risks and potential financial setbacks. Like in budgeting, start by defining your financial goals.
When deciding on goals, consider your wealth stage. Note that your financial situation is closely tied to your life stage, which impacts your current and future financial picture. Generally, people go through three main wealth stages:
- Early Savers is where you start your career, buy a home, get married, or start a family. For example, it’s when people ask for real estate or look for Medicare quotes online. The key goals are to earn money, save, and grow your assets.
- Mid-Life Accumulators where you likely have a stable career, own a home, and are starting to think about retirement and estate planning. The key goal is creating a balanced portfolio that preserves and grows wealth.
- Preservers/Spenders where you’re already retired or working less. For example, people use their accumulated wealth to generate income as a salary replacement and protect wealth to transfer to the next generation. The key goals are minimizing risk, generating income to replace a salary, and managing wealth wisely, especially regarding income tax.
Make sure the goals you make are realistic enough that you can confidently work towards achieving them. Then, assess your risk tolerance. Understand why you’re investing, whether it’s for long-term wealth growth, retirement, or specific short-term objectives.
Lastly, establish a clear investment strategy that aligns with your goals and risk tolerance. Don’t forget to determine your investment time horizon (i.e., how long you plan to keep your money invested) and adjust your strategy accordingly.
Taxation
Including taxes, as inevitable expenses, in budgeting and financial planning is crucial. Knowing it helps you meet your tax obligations, fulfill your legal responsibilities, and prevent unexpected financial and legal burdens.
A solid understanding can also help you optimize your financial strategies. This includes taking advantage of available tax deductions, credits, and incentives. By making informed decisions, you can legally minimize tax liability while keeping more of your income.
Credit and Credit Scores
Understanding credit is crucial for responsible debt management. Since your credit scores directly impact the interest rates and terms offered by lenders, knowing them helps you make informed borrowing decisions, avoid excessive debt, and effectively manage debt.
Moreover, nowadays, some employers consider a person’s credit history part of the hiring process, especially for positions involving financial responsibilities. The same goes for rental properties. Many landlords often check the credit history of potential tenants.
Most of the time, a positive credit history can make it easier to secure a job or rental property, while a poor credit history may lead to difficulties in finding both. Hence, learn more about credit to career opportunities and suitable housing.
Estate Planning
Estate planning is making a detailed plan for what happens to your assets before and after death. It involves creating important documents, such as a Will (a legal paper that says what should happen to your things after death) and other plans for managing your assets.
The goal is to ensure your wishes are followed, your loved ones are taken care of, and your belongings are passed down smartly, especially when it comes to taxes. It’s a good idea to start doing state planning, even if you’re still young. This helps make things easier for your family and avoids complicated legal processes, such as probate.
Final Thoughts
Financial literacy is one of the indispensable skills in today’s world. Whether it’s through self-study or with the help of others, there are countless ways to have it, so there should be no excuse for you not to be financially literate. Start having a more stable and secure financial future now.
