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Learn the Importance of Financial Literacy

financial literacy

Do you want to improve your financial game? Getting a better understanding of your finances may, in fact, put you ahead of approximately 66% of Americans. In fact, 4 in 7 Americans may be financially illiterate. The foundation to developing a personal financial strategy begins with developing a retirement plan. In order to improve your odds of success, you need to start with the basic concepts of financial literacy; budgeting, saving, debt/spending, and financial management.

What is financial literacy?

According to the U.S. Strategy for Literacy 2020, “financial literacy describes the skills, knowledge, and tools that equip people to make individual financial decisions and actions to obtain goals.” In practical terms, it’s the ability to understand financial concepts that allow for an individual or business to have financial stability. If you’re a small business owner, financial literacy is a requirement. You cannot run a business with out the fundamental financial concepts. For individuals, it becomes a useful tool to help  manage a financial strategy for retirement. Below are the essential concepts that will be foundational to your financial literacy.

1) Budgeting

Definition:

Budgeting is the process of creating a plan to spend your money. This spending plan is called a budget. Creating this spending plan allows you to determine in advance whether you will have enough money to do the things you need to do or would like to do. Budgeting is simply balancing your expenses with your income.

Learning to budget your money is an essential concept for financial security. In fact, it’s one of the most basic planning tools in financial literacy.

If you run a small business, then budgeting helps you make sound financial decisions. It’s particularly useful when considering the purchase of big-ticket items, and creating a reserve saving to manage through the tough seasons. By budgeting, you will gain a greater appreciation for and understanding of income generated from work and the expenses for running your daily life.

For certain, technology has made budgeting much easier for individuals and businesses alike. Today, you can create create and maintain a budget through apps, software, calculators, and websites. If you want to improve your understanding of the theories and strategies of budgeting and how to incorporate budgeting into your daily life – of for retirement planning – you should seek out the assistance of a financial planner. You can start with theses examples of you want to perform some online research: The Actual Expense (single and dual budget) Method, and/or Modern Retirement Theory by Branning and Hud.

2) Saving

Definition:

Savings refers to any income that we do not spend and put aside – we put the money away. It is the portion of our disposable income that we do not spend on consumer goods, but accumulate or invest.

Saving money can be a real challenge. How challenging? Well, according to a recent Federal Reserve report, 39% of Americans don’t even have $400 on hand to help with a sudden emergency. Moreover, a Transamerica study conducted in 2020 found that only 17% of Americans believe they have enough money for their retirement.

Ultimately, the goal is to grow your savings so that you can fund a suitable retirement. However, a basic rule-of-thumb is that you should have between three (3) and six (6) months of living expenses tucked away. Depending on your age, your savings can be utilized for different purposes. For example, if you’re younger you may want to use savings for a large purchase. For others is may be more sensible to pay off debt, or retirement planning.

Savings can be held in bank accounts, investment accounts, or employer sponsored accounts such as 401(k)s. However you hold your savings, make sure you budget enough to reach your planned financial goals.

3) Debt and Spending

Definition:

Debt is anything owed by one person to another. Debt can involve real property, money, services, or other consideration. In finance, debt is more narrowly defined as money raised through the issuance of bonds. A loan is a form of Debt but, more specifically, is an agreement in which one party lends money to another.

For many of us, spending money is an emotional experience. It’s frequently the balance of some immediate gratification and some future goal. We are constantly challenged with the want of consumer items like watches, cars or even buying a home. That want is balanced with our need to save more money. The battle is eternal.

One way to mitigate against spending savings money is by obtaining debt. One can issue debt for spur-of-the-moment purchase like a new car, or planned expenditures like a new home. Regardless, while debt does delay the immediate outlay of your saved money, it is an expense that needs to be repaid.

It is wise to be cautious and understand the interest attached to each debt obtained and the impact monthly loan servicing will have on your budget. Will you still be able to save money? A study by Northwestern Mutual shows that of people who carry debt, 33% of their monthly income is dedicated to debt servicing – this was exclusive of mortgages. If you don’t manage your use of debt and spending, it will make it difficult to budget correctly for emergency savings and retirement.

4) Personal Financial Management

Definition:

Personal finance is a term that covers managing your money as well as saving and investing. It encompasses budgeting, banking, insurance, mortgages, investments, retirement planning, and tax and estate planning.

This is were the rubber hits the road and you put all your tools in action. If you develop a sufficient degree of financial literacy, it help provide the foundation of knowledge needed to make smart decisions with money. As you construct you plan, or consult with a financial advisor, here are the items you need to make sure are considered:

  • Strategies for creating a budget.
  • Plans to create an emergency savings fund.
  • Goals to pay off debt.
  • Diversified use of retirement savings tools (eg. employer-sponsored 401(k), IRAs (Roth or traditional, investment accounts).
  • Begin to consider your legacy plan.

The bottom line

So why is financial literacy important? Simple answer: it helps you manage today, prepares you for tomorrow, and can assist in planning for your twilight years.

We highly recommend that you don’t simply read articles like this and consider yourself prepared. You need to consult an expert, ask questions, and execute a fully developed plan. If that plan includes life insurance, as it should, we are happy to be helpful in getting you just a bit closer to achieving your goals.

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