The Five Basics of Financial Literacy
Financial Literacy Month is celebrated annually in April to promote awareness and education about financial management and decision-making. The goal is to improve financial well-being by addressing topics such as budgeting, saving, investing, debt management, and retirement planning. Financial Literacy Month serves as a reminder of the importance of fostering financial literacy to support individuals in achieving their financial goals and building a secure future.
Here at hemming& Wealth Management, we consider the following Five Basics a good starting point for building your financial literacy. The more you understand financially, the easier it is to make a plan to reach your financial goals.
Credit and Debt
Understanding how credit and debt can work for you, and against you, is a key starting point towards expanding your financial knowledge. It’s not unusual to shy away from all credit or debt, but it can be useful in certain situations.
Debt
Debt is like any tool: when used correctly, it can be quite useful. When used incorrectly, debt can easily spiral out of control. Missing payments may negatively affect your credit score, and that can take years to recover from. Missed payments may stay on your credit report for seven years – which is why it’s important to have a consistent, doable plan in place to make sure your debt doesn’t overwhelm you.1
Credit Score
Your credit score is one of the factors lenders use to judge your trustworthiness and qualification for mortgages, auto loans, and other lending. Landlords and employers may also check your credit before renting or offering you a job.
Interest
Interest can work against you, but it can also work for you, too. When you take out a loan with an interest rate, the interest is working against you. But when you invest early and take advantage of compound interest, it’s working for you.
Compound Interest
Compound interest is good interest. When you’ve got an account that’s accruing interest, the interest earned gets added to the principal. Then, interest is earned on the new, larger principal amount, and the cycle repeats. Compound interest means your money can grow exponentially, as your principal grows your compound interest will grow, too.
The Value of Time
It’s never too early to start saving. In fact, the earlier the start, the better your result. By getting started with retirement savings sooner rather than later, you can leverage the value of time to your advantage.
Consider the case of Cindy and Charlie, who will each invest a total of $100,000. Cindy starts right away, depositing $10,000 a year at a hypothetical 6% rate of return. After 10 years, Cindy stops making deposits. Charlie, on the other hand, waits 10 years before starting to invest. He also puts away $10,000 a year for 10 years, at the same 6% hypothetical rate of return. After 20 years, who has more money? Shockingly, Cindy’s balance is nearly twice as large as Charlie’s, thanks to the extra time her investment returns had to compound.2
Inflation
Inflation has the potential to eat away at the purchasing power of your money. That means, with inflation, the dollar you earn today may not be worth a dollar in the future. Here are some things to keep in mind when thinking about inflation.
Cash in a Mattress
Keeping all of your cash under a mattress is not only unsafe, but it also costs you money. Assuming the rate of inflation is a hypothetical 2%, every dollar you squirrel away will shrink in value to just $0.98 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 6% rate of return over the last year, but inflation was 1.5%, your real rate of return was 4.5%.3
Identity Theft and Safety
In the modern world, identity theft is one of the biggest threats to financial and personal safety. A cracked password or misplaced Social Security number can have big consequences on your current and future finances.
Consider Using a Password Manager
The common wisdom is to use a unique password for each site and service you use. A password manager can make this easier by generating and storing strong passwords until you need to use them.
At hemming& Wealth Management we empower our clients through tailored financial planning and comprehensive wealth management solutions, guiding them towards abundance and fulfillment across all life stages. Our mission is to cultivate financial confidence in each client, equipping them with the knowledge to navigate money matters effectively, communicate about finances with clarity, and pursue their life's aspirations with assurance that their financial plan aligns seamlessly with their goals.
Sources
1. Experian, 2023
2. This is a hypothetical example of mathematical compounding. It’s used for comparison purposes only and is not intended to represent the past or future performance of any investment. Taxes and investment costs were not considered in this example. The results are not a guarantee of performance or specific investment advice. The rate of return on investments will vary over time, particularly for longer-term investments. Investments that offer the potential for high returns also carry a high degree of risk. Actual returns will fluctuate. The types of securities and strategies illustrated may not be suitable for everyone.
3. This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments. Past performance does not guarantee future results.
Citations
1. (2024). ChatGPT (3.5) [Large language model]. https://chat.openai.com