Financial literacy is the ability to understand and effectively use various financial skills, inclusive of personal financial management, budgeting, and investing. Financial literacy equips us in today’s world with the knowledge and the skills that we need to manage money properly and effectively. Another major part of financial literacy is paying yourself. The value of paying yourself will help to build up a nest for emergencies. Without these skillsets, one’s ability to make effective financial decisions will be difficult. Many people do not prioritize this aspect as much as they should.
Here are the 5 Key Components of Financial Literacy:
Revenue – Make Money
Budget – Expense
Planning/Raining Day Fund – Save
Credit Utilization – Credit Score
Protect & Guard
Revenue – Make Money:
The first start to financial planning and literacy is understanding how much one earns on a bi-weekly or monthly basis. If your income is the same dollar amount each payroll, then this is easy. If your income varies with each payroll, whether it is due to overtime earnings, commission, etc. the breakdown will be more challenging. We will need to take a deeper dive into estimating.
Your net pay (after taxes) is what you will need to know the exact amount of income. Once you have determined your net pay, you will be able to move forward to the next component.
Budget – Expenses
Creating a budget helps to achieve one’s financial goals. Budgets help you to plan your spending and holds one to timeframes of which such spending is allowed. It is recommended to create your budget in Excel so that you may calculate your numbers easily. To create a monthly personal budget, you will need to track your expenses over a monthly timeframe, breaking your expenses by categories and by due dates. This monthly budget should be reviewed each time that you receive your paycheck. Items paid from your budget should be noted on the spreadsheet with either a date of payment or the letter “P” for paid.
Planning/Raining Day Fund – Save
Saving is an intricate part of determining your financial goals. However, everyone will have their own unique situation, which will determine what their financial goals are. Whatever the unique situation is, your financial goals should include the following:
Rainy Day Emergency Fund – You should work to put aside three to six months of basic living expenses in an emergency fund. If you can afford more, then that would be exceptional. If you have secure employment and are working a salaried position, at minimum, you should have at least six months of basic living expenses in an emergency fund. This will give you some peace of mind should any unpredicted situations occur (e.g., layoff, illness, etc.). This will also help you to prevent major financial setbacks and frustrations.
Plan for retirement – Are you thinking that you are too young to plan for retirement? Not at all! The earlier you start, the better position you will be in later. To begin planning for retirement, set aside a minimum of 10% of your take home pay each month for retirement savings in an IRA, 401(k), or both.
Paying off personal debts – Loans and high interest rates could take a huge chunk of your take home pay. In a normal world, most people have debt. That is a concern! Whether credit cards, student loans, car loans or all three, always re-investigate your interest rates on loans. There may be opportunity to even lower your rates. Always remember that if you pay your loan off early, you could save thousands of dollars in interest.
Saving for a future purchase – You may have a goal to purchase a home, pay for furthering your college education or maybe even buying a new vehicle. Start saving now! This way, when you are ready to make that purchase or finalize that decision, you will either have less to save for, and perhaps even all the money that is needed to pay for the expense upfront.
Credit Utilization – Credit Score
Monitoring your credit utilization and credit score is a major part of maintaining financial stability.
Check the Annual Percentage Rate (APR) on your cards. The lower your APR is, the less interest you will pay overtime. If you have a high credit score, then you are more likely to pay less interest. You should never keep an ongoing balance on your credit card as this is an easy way to rack up debt, increase your utilization rate and decreasing your credit score. Keeping your credit utilization rate at 10% or under is extremely healthy. Paying your credit cards on time and/or before the due date will also help build a healthy credit portfolio.
Protect & Guard
Now that you have set yourself up with a prosperous and stable financial future, you are now able to protect and guard your finances moving forward. This means reconciling your bank accounts and credit cards monthly, safeguarding your accounts, passwords, documents and making sure that when using the internet, you are protecting yourself and information. Lastly, take a stab to understand and secure the type of insurance protection that you may need to protect yourself and your finances.
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