Financial literacy is a key part of establishing a comfortable, secure lifestyle. But most 18-year-olds (and even older adults) are woefully undereducated on how to manage their money. Right now, only 17 states require financial education for their students, and it may not be comprehensive enough. When you consider how many Americans live paycheck to paycheck, have student debt or simply don’t understand the importance of credit, it becomes clear why financial literacy is so important.
Defining Financial Literacy and Its Importance
So what is financial literacy? Financial literacy is the basic knowledge of how to manage your personal finances. This includes establishing credit, paying off student loans and other debt, saving, planning for retirement, getting insurance, understanding real estate, budgeting, and dealing with income taxes. That sounds like a lot, but resources – including those from the government – are available to get you up to speed.
Why is financial literacy important? Well, think about the things you’d like to do in life, like owning a home, providing for your family, getting a college degree, traveling, and all the other dreams and goals you have. Plus, we bet you’d like to retire someday too! All require money in some regard. When you make poor financial decisions as an adult, you can open yourself up to unintended and far-reaching consequences, from becoming a victim of predatory lending to foreclosure and bankruptcy.
Knowing more about personal finance can also help you avoid identity theft, which is more prevalent than ever. When you’ve got a good foundation of financial knowledge, you’ll be much more likely to achieve monetary comfort and keep it for the rest of your life.
Financial Literacy Basics
Now that you know what financial literacy is and why it’s important, let’s start with the basics. Think of this as a crash course for beginners in financial literacy.
The No. 1 thing you can do to start your financial literacy journey is to create a budget. Can you cover your expenses each month, or do you find yourself relying on the credit card and dipping into your savings? It’s time to create a monthly budget and stay well within your means.
First, compare your current expenses with how much you’re bringing in. Then you can decide where to cut down. Can you spend less on groceries and eating out, or ditch cable for internet-based television? Ideally, your budget should have you spending less than you bring in, so you can contribute the rest to savings and retirement.
Credit vs. Debt
Building credit is a lot harder than losing it, which is why you need to understand how credit works. The top issues affecting your credit are late payments and large outstanding balances. It’s important to pay your bills on time, including rent, mortgages, auto loans, insurance, utilities and more. You can also open a joint credit card account with someone who has good credit.
As you pay your bills on time and keep low balances, you’ll build good credit. The better your credit, the better terms you’ll get on loans because banks and companies will know they can trust you to pay them back.
The Impact of Interest
Just as it’s important to pay your credit card bills each month, it’s important for you to understand how interest works. On the most basic level, the longer you take to pay off your loans, the more interest you accrue. With careful budgeting and savings, you should aim to pay off your debts as soon as possible. Some financial gurus advise that when you pay off one loan, you should take the amount you would have paid that month and apply it to another debt. You’ll be debt-free before you know it!
Of course, interest can work foryou – when you choose savings accounts with interest, your money will grow. And if you keep the interest in the account, your wealth compounds over time.
It’s time to get familiar with savings account options. From emergency funds to retirement accounts, you should know about different kinds of savings and be able to estimate how much you need to save to prepare for the lifestyle you want. Talk to your employer about their retirement plans and other resources that help employees plan for the future.
Financial Education Tips and Tricks
Alongside knowing the different aspects of debt and savings, having a grip on the fundamental cornerstones of financial literacy is important. Take a look at a few basic concepts that underlie financial responsibility…
Obviously, one of your main goals as a financially literate adult is to pay your bills in full and on time. You can’t plan for the future if you’re worried about keeping the lights on. Beyond that, think about your other goals, both long- and short-term.
Use Financial Management Tools
Websites and apps can help you see exactly how much money you spend and where, as opposed to how much you bring in. They’re great for that crucial first step of making a smart, achievable budget.
Have an Emergency Fund
If you got laid off today, would you have enough savings to keep you afloat until you find a new job? About 40% of Americans wouldn’t even be able to cover a $1,000 emergency, let alone pay for three to six months of living expenses. Start by saving a thousand dollars – and then keep going. Ideally, you should be saving at least $3,000 of your annual income per year.
Plan for Retirement
It’s never too early to think about retirement. At age 25, it seems far away, but every little bit counts. Learn about 401(k) and Roth IRA accounts and try to invest at least 15% of your annual income there. If that sounds impossible right now, invest what you can and make 15% your long-term goal.
Work on Becoming Debt-Free
If you’re constantly paying off debts (about 40% of Americans spend half their income on just that) you probably don’t have a lot of extra money to invest in your financial future. Although, with a good payment plan, you can become debt-free. Then you can save and make interest work for you rather than against you.
Consider Insurance Options
Insurance is a good way to protect yourself from future debt. You should not only have home, auto and health insurance but also consider life insurance, long-term disability and identity theft protection.
Strive to Be Financially Literate
Financial literacy might seem overwhelming at first, but the best thing you can do is become informed. We suggest tackling it one item at a time. Start with making a budget, then move on to the next most important thing for your lifestyle. When you’re financially literate, you’ll be better equipped to handle any of the curveballs life has in store.
For more financial insight, you can turn to Marc Lichtenfeld. In addition to being an Income Expert, he’s also on a crusade to improve financial literacy. You can find Marc’s recent articles here.