While most of us handle money in some shape or fashion on a daily basis, not all of us have an in-depth understanding of the fundamentals of financial literacy. Working with a trusted financial professional can help you better strategize and prepare to meet your financial goals. Below we’ve detailed some financial basics everyone should know. Understanding these important concepts can serve as a basis for your financial standings.
Debt & Credit Scores
Credit can work for or against you, and it is vitally important to understand how credit works. This should serve as the foundation of your financial knowledge. First and foremost, you should not completely avoid credit or debt out of fear or intimidation. Instead, it’s important to have a firm grasp on your financial standing and have a plan for tackling debt responsibly.
When used correctly, debt can be very useful. It is easy to spiral out of control quickly when misusing debt. Interest accrues on missed payments and oftentimes penalties are assessed. This may impact your credit score in a negative way. 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.
Your credit score is a major factor lenders use to judge your trustworthiness and qualification for mortgages, auto loans and other lending opportunities. Landlords and employers may also check your credit before renting to you or making an offer of employment. Your credit score is dependent on a number of factors including previous credit history, current debts, history of payments and more.
Interest can be a tricky concept to grasp because there are two sides to it - interest accrued on debt and interest accrued on savings.
When you take on debt (such as credit card, auto loan or mortgage debt), you’ll be responsible for paying back both the principal amount plus the interest accrued on the loan. The interest is how a lender makes money on the loan and creates incentive for the borrower to pay the loan back in full and on time.
When you have a savings or money market account that accrues interest, the interest earned gets added to the principal. Then, interest is earned on the new, larger principal, and the cycle continually repeats. This is called compounding interest, and it can be an integral part in growing your retirement savings - as the longer the interest has to compound, the greater the savings will grow.
As a general rule of thumb, it’s never too early to start saving. This goes for retirement, homebuying, a child’s education or whatever else could be coming down the line. The earlier you start saving, the more you’ll be able to tuck away over time - especially when you consider the power of compounding interest. This leverages the value of time to your advantage.
Inflation has the potential to eat away at the purchasing power of your hard-earned money. Due to inflation, the dollar you earn today may not be worth a dollar in the future. Below are two important concepts to remember with regard to inflation.
Bury it in the Yard
Keeping all your cash buried in the backyard or stuffed 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, where it doesn’t earn 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 inflation adjusted rate of return was 4.5 percent.
Identity Theft & Safety
Due to COVID-19 the shift to doing everything virtually picked up speed. During this change, identity theft remained 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. Remembering all those passwords can be a daunting task, but a password manager can make this easier by generating and storing strong passwords automatically.
While this is just a brief overview of some important financial basics, it could be helpful for you 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.