The lack of basic financial literacy in America is incredible. I am a huge believer that everyone needs to have this skill, however most Americans (2/3) can’t pass a basic financial literacy test according to FINRA. The majority of families have very little (if any) emergency savings, and Americans are well under funded when it comes to retirement. They also have excessive credit card debt, do not know what compounding is and have many other financial challenges. Many of these issues could be solved (or at least not as impactful) if Americans had some basic financial literacy skills.
We have written about how important it is to teach financial literacy to kids. But even though the schools are failing us in this capacity, young adults and even anyone of any age can start to learn about (and importantly practice) financial literacy.
I noted how my mom encouraged us/pushed us towards college. Another thing she did when I was young/teen is talk about money. She was arguably too focused on it (as it was so tight after I was 11 or so). But her focus on money, and talk of finances, sparked me to try to better understand it, such as budgets, income, living within means, investing, and more. This led me to invest, save when I was young (as that is when it most matters due to compounding) and keep my finances in line, and all this helped me achieve the goal of being a millionaire by mid 20s and multi-millionaire after that.
My keys to financial literacy
I think there are some main parts of financial literacy, and they include the following.
Someone else will always have more or better things
This is not something you may commonly read on other financial literacy skill sites, but I think it is the most important. As nothing else really matters if you do not realize this. What this means is that you have to get out of the mindset of keeping up with the Jones. My mom stressed this, and I think it stuck with me when I was younger.
Someone will always have more and/or better stuff….someone will always have more money, nicer clothes, a newer car, bigger house, etc. Financial literacy is realizing and accepting this fact, and not spending money to try to get “better or more stuff” then someone else. Be content and live simply.
Live within means – Budgeting
You need to understand your income (after taxes) and expenses. This includes income from every source as well as every expense your family has. This is another core financial literacy skill. One key I think is after and pre-tax income, and I think this is critical to know and it is noted below.
Not some people are very disciplined and very good with numbers, so they do not need to write their budget down on paper (or into a spreadsheet on a computer). But this is not common – most people should document it.
Once done, you can look at it as often as you want, but I recommend at minimum at least one time per month. Reconcile your budget to actual bills you paid and income that came in the door. If you need to update the budget to make it more accurate or realistic, do it. Do that weekly if need too…make it accurate. Live within your budget, and live simply (see below). If your budget does not account for lavish items, then be sure to stop and smell the roses as you live simply, and enjoy things like dogs, nature, and simplicity.
Compound interest on both investment and debts
I think may be the most important piece of knowledge to have. It is one of the main reasons that I am probably where I am today, as it is all about making your money work for you when it comes to investing. About 2/3 of Americans do not know what compound interest is. This is so critical to know, and Einstein called it the eight wonder of the world. To be financially literate, you need to know this.
At its most simple form, compound interest means the interest you earn on interest (for investments). Or it is the interest you pay on interest (for debts/loans). So, the interest rate itself grows year after year. Now that may sound confusing, but we wrote an entire blog entry here on what compound interest is.
I started investing as a teenager. So, the investments/interest had time to compound and grow. This is a big reason why I crossed the million mark in my 20s and just went from there.
We put this as a financial literacy skill to stress its importance. But it is not a skill or knowledge in as much as just it just needs to be done. Have an emergency stash, as most people think they are indestructible and will never miss work, lose their job, etc. While I have always had adequate savings, I too though I was indestructible.
Pre and after tax income
It is critical to know this as part of any financial literacy. Sometimes someone may say I make 100K per year, so I can spend 100K per year. No!! You pay taxes on that 100K gross income, and the rate will depend on many factors such as if partner has income, if kids, deductions, etc.. But the point is that 100K (or whatever the salary is) will not be how much you take home that year. You need to understand your income tax bracket and how they work.
Not sure what to call this financial literacy skill, but the official definition is “the loss of potential gain from other alternatives when one alternative is chosen.” What does this have to do with financial literacy? A lot, and this is another one that I think is key. We will add an entire blog about this as well.
An example would be if you are working and have kids in day care. Maybe you make say 40K pre-tax and are paying say 18K a year for day care. Now ask yourself is it worth it? As you will not really be grossing 40K (it may be closer to low 30s when factoring in taxes). So, then you are working full time to basically pay for day care. As working comes with its own expenses too, such as transit, extra or nicer clothes, maybe more meals out, etc.
Where is your time better spent, and what is the opportunity cost? Is it worth it to work to in effect just pay for day care? Or is it better to leave the job, take care of the kids on your own and take that approach.
Anyhow, we could go on and on about this topic, but those are some of the key financial literacy skills we think everyone should have. At the very least it would be a start!