Financial Literacy For Beginners – 5 Basic Components

What is financial literacy? Financial literacy is budgeting, saving, understanding credit, interest, debt management, and investing. But first, let’s start with your relationship with money.  How do you see yourself? Are you a hoarder, Spender, or a Money worrier? Test yourself with the Hesta Quiz.  Learning how we view and interact with money leads to financial freedom. However, it starts with Financial Literacy For Beginners – 5 Basic Components

First, understand you can be taught to manage your money to become and stay debt-free.  Second, ordinary people have become millionaires in their lifetime. Third, so can you.  However, this is not a get-rich-quick scheme. It requires consistency, time, and money.

Financial Literacy For Beginners Starts With The Money

Starting with the job – this is your main source of income.  It can be boosted with other sources of income from gig work, side jobs, your own business, passive income, and of course investment opportunities. 

What can we do with our income?  We can spend it or save it.  But, how to spend it and stay out of trouble. The importance of understanding how finances work is the road to Financial Literacy for Beginners:  Basic Components are outlined below.

Financial Literacy For Beginners – Basic Component #1 – The Budget

A budget is designed to help you spend your money most profitably.  It is the spending plan for your income. It helps you keep track of what is going in and what is going out.  The first step is looking at your income and then your expenses.  Set up checking accounts to pay your bills and for personal spending. Set up savings accounts for paying yourself first, saving for vacation, holidays, and emergencies.

Your checking and savings accounts are the engines that drive your budget. Learn how they work together with your budget by reading Checking and Savings Accounts.  Make sure to set up direct deposit to your checking account for your paycheck.  This will help you save on checking account fees.  Then set up auto bill pay so that you can pay your bills on time and build a credit history.  For your savings account set up automatic transfers to pay yourself first. Each paycheck auto-deposit funds for your emergency fund and any other savings account for special purchases and holidays. i.e., sinking funds. More about sinking funds is below.

Living off less than you make so you can get out of debt and save.  Decide that you will save at least 10% of your income.  Secondly, set aside the amount you need to live on.  Finally, set aside funds to pay off any debt you have accumulated.  You should pay off debt as quickly as you can so that you can have financial freedom.  This is when you can spend your money based on your budgeting goals. Which should include saving for emergencies, the things you want, investing for your financial security. This is how you manage your income and live the plan you have created for your life.

Component #2 – Understanding Interest Rates

Interest Rates are how you and the bank can generate revenue.  It is how your money works for you via savings or investment accounts. The bank makes its money by loaning money to consumers in the form of interest rates.  For every dollar you save you earn money and for every dollar you borrow you pay the banks for the use of their funds. 

What exactly is Interest paid to the banks? Interest is the monetary charge for the privilege of borrowing money, typically expressed as an annual percentage rate (APR). It is the amount of money a lender or financial institution receives for lending out money.  In simple terms, it is the cost of borrowing money.  The fee is paid to the lender and is money paid by the borrower.

What are debts? Money paid by you to the lender is debt. It takes the form of credit card balances, car notes, personal loans, student loans, and mortgage payments. In some cases, having multiple types of debt can lead to overextending your finances. Avoiding debt will help you live within your means. If you need help with debt start with a budget, decide to get out of debt, and make a plan.  To learn more about budgeting and how it can help you get out of debt read What is the Purpose of a Budget?

Your Money Working for you – Compounding Interest

On the flip side. Interest is also the amount of money paid to you to loan the bank money in the form of a savings account or money market.  Yes, when your money is in a savings account you are allowing the bank to borrow your money. This loan is insured by FDIC so that there is no risk to you. In turn, the bank makes money off of your money by reinvesting it. The interest paid on these types of accounts is very small.  I suggest that once you reach about $1,000 in savings move your money to a high-yield interest savings account. Here is a list of the best high-yield savings accounts from Bankrate. Please note some of these are online financial institutions.

This is where you should keep your Emergency Fund account. In a high-yield savings account your emergency fund will earn the maximum amount of interest but also remain available should an emergency happen.  To learn more about the importance of this type of savings account read Emergency Fund Savings.

Component #3 – Savings Is An Important Part of Financial Literacy For Beginners

Let’s define saving. Saving is the amount of money you should pay yourself first before spending and other financial obligations that have to be subtracted from your income. These funds are placed in an account that typically has a low rate of return.  In other words, it is the process of setting aside a part of your income for some future use i.e., emergency, college, special purchase

How to save. You have to start with the means of savings.  This would be your income where you will pay yourself first. I suggest 10% of your net income.  If this is not possible start with $5 per pay period until you reach $1000. Start reducing your expenses to increase this amount.  Then begin paying off your debt.  The key to savings is learning to save for the things you want rather than using any form of credit or borrowing.  This type of savings is classified as sink funds.

What are Sinking Funds?

Sinking funds are used for planned expenses. For personal finances, a sinking fund is a great financial tool. They keep you out of debt, on budget, and your personal financial goals on target. An example of a sinking fund that we have is a Vacation Sinking Fund. This account is responsible for all the expenses associated with our next big vacation or multiple weekend trips.

Your Emergency Funds is different from your sinking fund as it is for unexpected and not tied to a specific purchase.  Where the sinking fund is expected and is for a specific purchase. Typically, an emergency fund is for 3 to 6 months of living expenses.  It is for loss of wages due to a layoff, illness, etc.  It can also be for unexpected expenses such as a car repair. 

Financial Literacy For Beginners and Investing

Ordinary people are millionaires. 22 million adults in the U.S. have enough assets to fit in the definition of a millionaire per the Global Wealth Report 2020. I bet a few of your neighbors can be classified as millionaires.  These are ordinary people who built wealth over time paycheck by paycheck. Using the long game of compounding interest, where you can see small amounts of money invested over time can grow into millions in 15 to 20 years.  It depends on how much you save, how consistently you save and how much time you have to save.  For example, saving $25/week for 40 years with 5% interest will net you $144,959.73.  Use this handy Compound Interest Calculator from Investor.gov.  Play around with this calculator to see how you can reach your million-dollar or more goal.

Financially Literate People Know Their Net Worth

Calculating your net worth is super easy.  It is how much you have in the bank or in investments, and all your assets minus how much you owe to financial institutions or others.

Assets are Checking Accounts, Savings Accounts, Retirement Savings, Real Estate, and Autos

Liabilities are Credit Card Debt, Personal Loans, Student Loans, Mortgages, Auto Loans, or any other money owed to others.          

Here is a quick but very simplistic example:

Assets

Money in the bank: $10,000

Investments: $4,000

Liabilities

Credit Cards Balance $2,000

Student Loan: $8,000

Net Worth = Assets minus Liabilities

$14,000 – $10,000 = $4,000 Net Worth

For a more comprehensive way to calculate your net worth using the above lists of Assets and Liabilities use this Net Worth Calculator from Kiplinger.

Component #4 – Understanding Credit and Debt

The interest that enslaves you comes from the interest that is charged by financial institutions that you are obligated to pay when you borrow.  Based on your credit rating or the discretion of the financial institution the interest can range from 0% to 26% or higher.  When you borrow to make a purchase, you are tying up current and future cash.  This is the true meaning of debt. Therefore, if you wish to make a purchase today you may not have cash available to meet this need.  Hence, you have to borrow yet again.  If this pattern continues the debt will become harder to shoulder.  Especially if you are playing the minimum payment game. This is thinking you are okay as long as you can afford the minimum payment and still have enough to pay your other monthly bills. 

It is easy to get into debt but much harder to get out of. That is why it is important to understand your relationship with money. If you are more of a spender then you need to understand how your spending patterns have the potential to lead you down a road that could potentially enslave you to the lender.  Which could lead you to become a money worrier or money avoider per Olivia Mellan. However, if you tend to be frugal you may tend to be a hoarder or an amasser.  This could have the potential of you not living a productive life.  The purpose of money is to acquire the things we want and need to live and survive today. Amassing money for the future is only one component of budgeting. A budget designed for your lifestyle should include spending, saving, and investing.

Financially Literacy for Beginners Component 5 – Protecting Your Credit

Data breaches have become far too common.  Those most responsible for being the gatekeeper of our financial data have contributed to Identity Theft.  I find it ironic that they also wish to sell us identity protection programs. The now infamous Equifax breach in September 2017 exposed the names, social security numbers, birthdates, telephone numbers, and email addresses of 143 million accounts in the United States and 400,000 in the United Kingdom.  Read more about the biggest financial data breaches from FinTech. Since the horse is already out of the barn, what options do we have today?

Freeze It!

I have opted to freeze my Credit Reports, with a credit score in the 800s I don’t want anyone opening up new credit at my expense.  If you can’t access my credit reports you can’t open up new credit.  I have tested this out on several occasions and it works. 

Another freeze option is to freeze your credit cards.  You can do this via your banking app on your phone or call your banking institution.  I especially like doing this for my debit card because I use it the least out of all my other cards. Besides, I don’t want anyone having direct access to my assets.  Even though it is just like a credit card where my financial institution will reimburse the money.  Why go through all that hassle of getting the funds back and dealing with any financial repercussions such as bounced checks due to insufficient funds.

Finally, there are monitoring services from various companies.  Some are free; however, others have a small monthly cost associated with them. Again, a few are offered by the credit bureaus that have been part of a data breach.  I use Credit Karma which is free but check out this list of monitoring services from the balance. You are bound to find the perfect program for your needs.

How To Start Financial Literacy For Beginners?

Now, that we have reviewed the 5 Components for Financial Literacy For Beginners, there is more to do to financially educate yourself.  You can read any of the top financial books.  I would start with The Richest Man in Babylon by Classon, Rich Dad Poor Dad by Kiyosaki, and The Simple Path to Wealth by Collins.  These are great starter reads with tons of information about budgeting, getting out of debt, money management, and building wealth. Read as many blogs and articles as you can find that will help you develop financial literacy. 

Finally, after your research take the Financial Literacy Quiz to see how much you now know by FINRA. Per FINRA, in the U.S., 34% of individuals can answer four or five questions on a basic five-question financial literacy quiz correctly.  You should be able to get them all right.

Financial Literacy advice From Family and Friends

Never take financial advice from broke people.  They are broke because they do not know how to manage their finances. I have witnessed them continue to make bad choices and to continue to try to pull others into their world.  They borrow, don’t want to pay back, and jeopardize the financial stability of many people that are just starting their financial journey.  Their advice is to not do what they have done with no clear advice on how to become financially independent is useless.

Find the person in your circle that always seems to have enough to live and help others in need. They have been good stewards of all that has been provided for them.  They use discernment and are wise in the ways of finances.  You will never see them borrowing and have paid for most of the things they own.  They live on a budget; they save and they invest.  When they speak about money it will always be in terms of budgeting, saving, and investing for their future.  Learn from them as they are well versed in finances from an ordinary person’s perspective.

Final advice: Take 30 minutes out of your day to educate yourself.  The lack of financial literacy cost Americans a total of more than $415 billion in 2020 per the National Financial Educators Council.  Learners are earners.

Here are additional resources:

Living Below Your Means

Wealth Accumulation

Being Financially Sound

Slave to the Lender

Let’s Budget, Spend, and Live!

Sabrina

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