Working with a trusted financial professional is important when it comes to strategizing and preparing to meet your financial goals. But as most of us handle money on a daily basis, it’s important to have an in-depth understanding of the fundamentals of financial literacy. Below we’ve broken down eight financial basics everyone should know. Understanding these important concepts can serve as a basis for your financial standings.
Basics #1: Debt & Credit Scores
Understanding how credit or debt can work with or against you should serve as the foundation of your financial knowledge. First and foremost, it's not wise to avoid credit or debt altogether out of fear or intimidation. Instead, it’s important to have a firm grasp on your financial standings and a plan for tackling debt responsibly.
When used correctly, debt can be useful. 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.
But when misused, debt can spiral out of control quickly. This is especially true, and a particular risk when using consumer credit cards. Missed payments can accrue interest or penalties and may impact your credit score in a negative way.
Your credit score is one of the key factors lenders use to judge your trustworthiness and qualification for mortgages, auto loans, and other lending opportunities. Landlords may also check your credit before renting to you. Your credit score is dependent on a number of factors including previous credit history, current debts, history of payments, revolving credit utilization, and more.
To build up a strong credit score, make regular payments on or before the due date. Try to keep your revolving utilization around 20% of your total credit. Keep your oldest account active and don’t close any credit accounts unless you need to. If you have a great credit score and teens who need to build their credit, you can give them a jumpstart by adding them as an authorized user to your account.
Basics #2: Interest & Dividends
There are two sides to interest that can make it a tricky concept to grasp - 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.
When you have a savings account that accrues interest, the interest earned gets added to the principal. 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 of growing your retirement savings - as the longer the interest has to compound, the greater the savings will grow!
Along the same lines as the benefit of compounding interest, it’s important to understand the value of dividend-paying stocks. Dividend-paying stocks provide a payout for shareholders based on the organization’s performance for that time period. Much like compounding interest allows your money to grow exponentially, you can reinvest dividends earned to do the same in your investment portfolio. Outside of the potential for exponential growth, dividend-paying stocks have a long history of outperforming stocks that don’t pay dividends or have cut dividends. Learn more about our unique investment strategy.
Basics #3: The Value of Time
As a general rule of thumb, 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.
Did you get a late start on saving for retirement? Explore these strategies.
Basics #4: Emergency Savings
Your first — and most critical — savings goal should be to put away 3-6 months of expenses in an account that you only pull from in an emergency. The recent COVID-19 pandemic has shown many people just how important it is to have an emergency fund.
When you lose your job, have emergency surgery, or total your car, an emergency fund can help carry you through. Without emergency savings, those same events could cause significant financial strain, forcing you to add to credit card debt or pull from a retirement account. After the emergency, you should always work to replenish your fund so it’s there the next time you need it.
Basics #5: 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.
Cash in a Mattress
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.
Rate of Return
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.
Basics #6: 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.
Basics #7: Removing Emotions from Your Finances
Finances can be incredibly emotional for most people. You work hard to earn a living and it can be stressful to constantly worry about money. Unfortunately, when emotions come into play, they tend to get in the way of logical decision-making. Making emotion-fueled financial decisions is never a good idea.
Instead, work with a financial advisor. Since they’re removed from your situation, they can evaluate what’s going on based on facts and make logical decisions, with your best interest in mind.
Basics #8: The Media & Market Portrayal
Even though they’re supposed to share news, media companies are in the entertainment businesses. As a result, stories and market scenarios are often dramatized for clicks and views. Don’t buy into the hype, and resist the urge to make decisions based on what you hear. Always be sure to check your sources and proceed with caution.
While this is a brief overview of some important financial basics, 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.
Investors should be aware that investing based upon a strategy or strategies does not assure a profit or guarantee against loss.