Few things affect your quality of life more than financial literacy.
The basics go well beyond being able to open up a bank account or get a job. They entail knowing how to make a wide variety of financial decisions throughout your life. Understanding and applying these financial basics to the money you earn is likely to make you wealthy. Not having a grasp of them can leave you in a perpetual financial bind. Here are the 10 essential financial basics:
10. Credit Cards
In today’s world of credit, it’s vital to understand credit card basics. Credit cards can be an asset or a liability depending on how you use them.
Learning the basics of how credit cards work — and how you can use them to your advantage, while not using them when they aren’t to your advantage — is one of the most important financial lessons that you can master to ensure that your finances stay in order.
9. Compound Interest
To grasp the full potential and power of investing, you need to understand how compound interest works and what it can do over time. Save $150 a month (approx $5 a day) without compound interest, and in 30 years you’ll have $54,000.
Save the same amount with a return of 9% compounded interest and you’ll have nearly $275,000 after the same 30 years. When you understand the fundamentals of compound interest and time working together, you see how saving even small amounts for your retirement years can have a huge effect.
When it comes to finances and trying to grow the money you have, there will always be risk involved. Understanding that risk is part of investing, and you can greatly increase your wealty by taking calculated risks to correspond with different points in your. At the same time, being too risk adverse or taking huge risks with your money in an attempt to get rich quick will likely leave you retirement-poor.
7. Retirement Vehicles
The government provides a number of retirement vehicles that allow you to invest with tax advantages to encourage you to save money for your retirement. These include 401(k)s and IRAs, which can mean the difference between not being able to retire and retiring in the lifestyle you desire. Understanding how these tools work to your benefit and taking advantage of them to save money tax-free is an essential part of basic financial literacy.
6. Index Funds
When it comes to investing, the first and most basic strategy you need to understand is stock index funds. Over time, you will need to learn many other aspects of investing, but understanding stock index funds is the first fundamental part of using the stock market to grow wealth.
It is a simple and cost-efficient way to get into the stock market when you may not have a lot of money or time to spend on investing, but it allows you to take full advantage of the compound interest discussed above.
5. Housing and Mortgage
It is important to understand the basics of housing and how mortgages work. For all of those who have been caught in the subprime mortgage crisis, this is one crucial financial lesson that they had not learned.
As the number of different mortgages available to borrowers increases, understanding how these new mortgages work becomes even more essential. It’s important to remember that housing prices don’t always go up, and that you need to make sure that mortgage debt is not only affordable on a monthly basis, but also affordable over the life of the mortgage loan.
4. Depreciating Assets
Not everything you purchase is an investment, and it’s therefore important to understand the difference between an appreciating asset and a depreciating asset.
Many of the things that people buy, such as cars, will decrease in value over time. That does not mean that they are bad purchases to make, as they can be an important factor in your overall earning potential. However, it does mean you should be purchasing these at the best price you can and not buying more than you actually need.
By understanding whether a purchase is likely to appreciate or depreciate over time, you can use this information to your advantage by buying a three- to five-year-old used car, for example.
3. Emergency Fund
Life will always throw unexpected curves into even the best laid plans, and realizing that this is likely to happen and being prepared with an emergency fund is an essential part of your financial literacy.
Unexpected financial losses can occur, and having an available resource for these emergencies can be the difference between remaining financially healthy and finding yourself financially struggling.
Although they can seem completely overwhelming and incomprehensible, understanding the basics of how taxes work is important. By understanding the basics, you can make moves in your daily life that will actually save you money over the long term. It will also help you determine what documents and receipts you need to keep track of that can reduce your taxes over time.
There isn’t anything more important than knowing where the money that you earn is going. How you budget is not nearly as important as that you actually keep track of what you earn and where you spend that money in some way or form.
Until you understand where you spend your money and ensure that you are spending less than you earn, you are not in a position to use any of the other financial information that you have gained as part of your financial literacy.
Jeffrey Strain owns and runs SavingAdvice.com.