Are You Financially Literate? Answer These 5 Questions to Find Out
Understanding how to manage money will make a big
difference for your financial stability.
“Money is a very powerful thing, which you hardly notice
when it goes right, but which can create havoc when it goes wrong.” –Milton Friedman
A major study conducted by the Financial Industry Regulatory Authority demonstrated that
people with higher levels of financial literacy are more likely to find
financial security or stability.
Financial literacy means the scaled ability to
competently understand what money is, how to raise money, and the various ways
of effectively managing money. Financial literacy does not guarantee financial
security, although financial literacy and security are strongly correlated.
People who understand finances have a higher chance of becoming financially
secure and wealthy. People who do not understand finances are much less likely
to establish financial security or acquire personal wealth.
Just as there is a scale to reading literacy and
comprehension, there is a scale to financial literacy. The more you read, the
better you will become at reading and comprehending. Similarly, the more you
study and practice finance, the likelier you are to improve your understanding
and implementation of financial principles and, hopefully, your financial
well-being.
How to Improve Financial Literacy
The first step toward improving financial literacy is to
understand what money is. For many people interested in finance and financial
literacy, it takes a while to understand what money actually means.
Unfortunately, there are many bad examples in the world. This has caused many
financial crises in people’s personal finances, as well as government finances
and monetary policy management and implementation. Money has become a
widely debated term, primarily for philosophical and political reasons. For
this article, we will use an Austrian School of Economics perspective and
definition of money.
Money is a socially derived, commonly agreed-upon,
sound, medium of exchange that measures the price of all other goods and
services.
Ways to honestly acquire money include producing something
people will purchase, providing a service that people will pay for, trading,
acquiring something for a lower amount and selling it for more, or receiving it
as a gift.
The second step in improving financial literacy is to
understand the five pillars of financial literacy: earn, save,
protect, spend, and borrow. Here are five questions you can ask yourself to
test your own financial literacy.
1. Do You Know How Much You Earn?
Understanding how much you make might sound simple, but
there’s a bit more to it than you might think. We’re talking about much more
than your annual salary or hourly wage.
Do you know what your health benefits are? Your retirement
plan? Does your company offer a reduced stock purchase (an ESPP)? Do you get a 401k match? Are you tracking any
non-primary forms of income you might have? (Various studies
have indicated that nearly 45 percent of Americans have a side hustle to
generate more income.)
These are all important questions to consider.
2. Do You Understand the Importance of Saving and
Investing?
You may have read the article, 5
Easy Steps For Improving Your Credit Score, in which I go over two super
easy options for saving:
- 70-20-10 Rule. Spend no more than 70 percent of your
after-tax income on living expenses, 20 percent towards debt, and 10%
towards savings.
- 50-30-20 Rule. Spend no more than 50 percent of your
after-tax income on living expenses, 30 percent towards debt, and 20
percent towards savings.
When you save your money, as opposed to letting it burn a
hole in your pocket every time you acquire some, you are ensuring a more secure
future with each dollar you save. Consider emergency savings for a car issue,
health concerns, in case you lose your job, your computer or cell phone breaks,
or a family crisis. Having money readily available is important for meeting
spontaneous needs as well as providing confidence and peace of mind when those
things do arise. Once you have a solid savings plan, you should start
considering investing.
Investing
is an important element in savings. Use portions of your savings to invest, as
opposed to storing money in savings accounts. By investing your money, you are
increasing your likelihood of greater returns later in life.
One strategy for investing is getting an investment app such
as Robinhood, Acorns, or WeBull, and then using
portions of your savings to invest in companies that you believe will do
increasingly well. The better the company does, there is an increased
likelihood that their stocks will rise, so if and when you sell your shares you
can make a profit. Be sure to put in the time and effort researching companies
before you make an investment. You can invest a few dollars or thousands, it is
up to you and your individual circumstances. You can either invest a percentage
each time you are paid, use gift money, or use your tax returns. But investing
a portion of excess income each can offer many advantages.
This is by no means the only way to invest, of course. One
can invest in gold, as
this family does, which can be an effective way to safeguard against
inflation. Land, silver, and even cryptocurrencies like Bitcoin are other
popular examples.
Investing carries risk, of course, so learning how to
develop the mindset of a trader is a good idea before taking the
plunge.
3. Do You Know How to Protect Wealth?
When you have money, you should safeguard it against losses,
theft, inflation,
deterioration, emergencies, and other costs that life brings with it. Putting
all of your money under your mattress or in a wall safe is not going to be the
best way to save money if all it takes to lose it all is a fire or a thief.
Protect your money with reputable institutions, insurance, and the right type
of safe if you insist on having some on hand. It is also a good idea to have a
credit and identity monitoring service, which many credit card companies and
banks offer for free.
Diversifying your wealth and portfolio is likened to the
saying, “Don’t put all of your eggs in one basket.” When you diversify, you are
ensuring that if there are losses in one investment, such as your 401k,
traditional or Roth IRA, or stocks, you will not lose all of your money at
once. In short, diversification
is a strategy to reduce portfolio risk, which is a way to protect your
wealth.
4. Do You Monitor Your Spending?
Watch what you spend your money on, and do as much price
checking as possible to ensure you get the best deal for your purchases. By
becoming price conscious, you will not increase your wealth, per se, but you
will save what you already have.
As an avid meal prepper and chef hobbyist, I thoroughly enjoy cooking
and I am constantly at a grocery store. One of the things I enjoy cooking is
steak, which is a more high-priced cut of meat than chicken, pork, or ground
beef. A decent steak is probably going to cost at least $15. However, I found
that if I search online with something like MyGroceryDeals, or Flipp, I can find the best prices
on steak or when they are expected to be on sale. This can sometimes save me 50
percent on one steak. Imagine the savings that could be for an entire family.
For larger purchases, it’s always a good idea to search
prices and conduct research before you make a purchase. You can use your
favorite search engine to see if the item is sold elsewhere for a lower price.
It is also a good habit to see if it can be bought new or used on Facebook
Marketplace, Craigslist, eBay,
or Etsy. Websites like CamelCamelCamel help
track price drops on Amazon.
It is also important to remember that if you work a standard
job like most people, each dollar represents an amount of time that you will
have to work for in order to pay for something. So, if you earn $20 per hour,
and the meal you are about to eat costs $20, that is one hour of work you will
have to put in to afford that meal. Weigh your options to determine if that is
worth the time and amount spent within your budget. (If you don’t have a
budget, it’s not a bad idea to start
one.)
5. Do You Know the Dos and Don’ts of Borrowing?
Sometimes you have to borrow money for larger purchases.
Such things as college, a vehicle, or a house, have high costs and are not
easily afforded upfront for the vast majority of people. Keeping your credit
score high enables you to borrow money with ease. For many purchases, if you do
not have a good, or at least decent, credit
score, borrowing money will be difficult and expensive if even possible.
Borrowing, or acquiring debt, is not always bad—in fact, it’s often the case
that even quite wealthy people have debts. The key is knowing how to manage
debt and having a plan to attack it.
If you are going to borrow money, be sure to check for the
best interest rates and the amount of time to pay it off, and be sure you can
make your payments when they are due.
There is a lot to learn about financial literacy, far more
than that which was covered in this article. However, by taking proper action
with these key components in mind, you will begin making better financial
decisions and help prepare a better future for yourself and possibly your loved
ones.
Get Started Today
If you are ready to begin your financial literacy education,
be sure to check out more of the articles and work offered by FEE.
The sooner you start, the better off your life will be. Click here to start
now: Financial
Literacy 101
Joshua D. Glawson writes about politics, economics,
philosophy, and personal development. He has Bachelor's in Political Science
from University of California Irvine.
Image source: 123RF
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