Money is complex.
Investments, taxes, debt, long-term security – there are so many details and strategies to regularly keep track of that managing your money can sometimes feel like a full-time job you aren’t prepared for.
Think about it: before you started your career, you went to school or acquired training, gained relevant experience, and worked hard to develop the knowledge and skills needed to succeed.
But did you do the same thing with your money?
Most school systems leave financial literacy on the backburner, and money isn’t always a subject taught at home. These knowledge gaps have stoked a national crisis of playing financial catch-up that leaves people stressed about their money, unprepared for an emergency, and uncertain about their future.
When used wisely, money is a valuable tool that can help support your unique life and values. At this point, you may be asking yourself:
So, how can I take the stress out of money?
One big answer is by prioritizing financial literacy.
Financial Literacy in the United States
So what does financial literacy mean?
Financial literacy is the ability to effectively apply basic financial concepts and principles like investing, budgeting, debt, and personal financial management to your life. Historically, financial literacy hasn’t been an area where many people thrive.
In fact, only one-third of adults worldwide understand basic financial concepts. The same report noted that in the United States, four out of seven people, roughly 57%, are financially illiterate. As a nation, the United States ranks 14th for basic financial literacy.
This soft financial foundation can have serious long-term consequences on an individual and societal level. The National Financial Educators Council survey found financial literacy shortfalls cost Americans $351 billion dollars in 2021. Individual respondents said they felt their lack of financial knowledge cost them $1,398 annually.
Imagine what you could do with an extra $1,400 a year? Perhaps you could pay off high-interest debt, pad your emergency savings, increase your retirement nest egg, open an education fund for your child, or invest in other goals.
Becoming financially literate and improving your money knowledge can only help you use it more efficiently and effectively. When you understand basic financial concepts, there’s less fear and uncertainty surrounding such an enormous topic.
Gaining financial literacy doesn’t happen overnight, and it’s not a gold star you receive on a test. It’s an ongoing process of learning, discovering, and growing. Here are six core financial literacy categories to help take your money skills to the next level.
1. Know What You Earn
The first step to financial literacy is understanding exactly how much money you have and earn.
Assess Your Net Worth
Your net worth is the value of all your assets minus all your liabilities. Here’s an example.
Between her salary, investments, real estate, and cash, the total value of Malia’s assets equals $1 million dollars. But, Malia also has significant student loan and mortgage debt, topping out at over $350,000. This means Malia’s net worth is $650,000.
Why does knowing your net worth matter?
Net worth clues you into how well you manage your money and helps you identify areas of improvement.
Have you paid off your debt? Are you using debt wisely?
How much are you saving versus spending?
Think about your net worth as the big picture overview of your financial life: it’s the synopsis that recaps where you’re at financially.
You can grow your net worth by prioritizing long-term investments and keeping debt low. As you progress through your career, consider ways to boost your income like side-gigs, freelance work, or passive income streams. You may also have access to other sources of income like equity compensation, bonuses, and other advanced payment structures.
The key is to keep your expenses and debt low as you increase your income, and avoid lifestyle inflation.
Gross Versus Net Salary
Yes, you know your salary, but is that the number you actually take home every year?
Once you factor in taxes, deductions, deferrals, and more, the answer is likely no. It’s essential to know the difference between your gross income and net income.
You can find the difference between your gross and net salary by reading your paycheck.
- Gross salary represents your pay before taxes and deductions
- Net salary takes those taxes, deductions, and deferrals into account
Don’t be surprised if your jaw drops when you see these numbers!
Your gross salary is often far more than your net salary because this number represents your pay before federal and state taxes, plus payroll deferrals such as your 401(k) or HSA contributions.
The good news is you have some control over how much in taxes your employer withholds from your paycheck via your W-4. Your W-4 is a tax document you filled out during your first week on the job, so it’s no surprise if you don’t remember it, but the contents are meaningful.
Your W-4 notifies your employer how much of your paycheck you’d like to withhold for taxes. It details your filing status, dependents, planned deductions, and more. Correctly filling this out means you won’t over or underpay your taxes throughout the year, making tax time much simpler for you and the IRS.
2. Spend With Purpose
Once you know what exact funds are coming in, you must manage exactly what’s going out. An excellent way to keep track of this is with a budget.
While budgets aren’t the most glamorous financial tool available, they are a reliable way to help you manage your spending, saving, investing, and giving. If it helps, don’t call this process budgeting; call it a spending plan or cash flow management system – give it a name that’s meaningful to you that reminds you of why it’s important to keep track of your money.
No matter what you name the process, it helps you manage the money coming in via your paycheck, investment income, freelance work, and more, while showing what you’re sending back out like taxes, cost of living expenses, entertainment, investments, charitable donations, and the like.
Your budget shouldn’t leave you stressing over every purchase you make. Rather, you want to ensure your spending aligns with your larger financial strategy, goals, and values.
Analyzing your spending can actually be quite enlightening. You may not realize how much you’ve spent on airfare, new clothes, restaurants, or even groceries. Once you know, you can make intentional adjustments to spend more consciously and mindfully.
- Are you spending in ways that align with your goals and values?
- What buying habits keep you from reaching your goals?
- Does your spending prevent you from investing more in retirement, education, and the future?
- How can you reframe your spending to match your financial strategy?
When you look at your money from this perspective, you’re less likely to overspend consistently.
3. Save and Invest For Your Future
Our culture isn’t very future-oriented. We tend to prioritize what brings us happiness and joy today and not worry so much about tomorrow.
More than ever, people rely on every paycheck just to make ends meet. Salary Finance discovered in their research that 32% of Americans run out of money before their next paycheck, even those making $100,000 or more. Meaning, overspending and undersaving is a predicament many households face across income levels.
The propensity for instant gratification has also contributed to the lack of retirement savings across the country. Data from the Federal Reserve found the average nest egg was just over $255,000. Plus, only 36% of people are confident that their retirement savings are on track.
So what can you do? Start investing.
To begin with, there’s a significant difference between saving and investing. Saving represents financial protection, while investing opens the doors for financial growth.
When you save money, you store it in a safe and accessible place like a bank account so it’s there when you need it (for bills, a flat tire on the highway, or a leaky roof).
It’s often best to save for short-term goals and needs like an emergency fund, downpayment on a house, or a family vacation.
While savings won’t make your money grow that much – the average interest rate for savings accounts is about 0.6% – it’s okay because your savings serve a different purpose than your investments.
Investing takes on a bit more risk but lets your money grow long-term. Where you would earn less than 1% in a savings account, your investments could earn an average of 10% per year. There’s no guarantee for how your investments will perform, but rich historical data of long-term positive market performance supports the relative reliability of investing.
Investing is essential for building wealth over time. You can invest in several areas, like retirement (401k, 403b, 457), education (529 Plan), and other goals (brokerage account).
When you invest, you leverage the power of compounding interest. Here’s an example. Say you put $1,000 into a brokerage account. After that, you contribute $200 monthly. Assuming a 6% return over 5 years, your $1,000 could turn into over $15,000!
Be sure to get into the habit of investing regularly. How can you get started? Consider the following:
- Increase payroll deferrals to your employer-sponsored retirement account with every raise.
- Invest outside your workplace for retirement with an individual retirement account (IRA) (either traditional, Roth, or both).
- Think about your health. If you have a high deductible health plan, consider investing in a health savings account (HSA). If not, see if your employer offers a flexible spending account (FSA) to help pay for medical/health costs.
- Open a brokerage account for other future goals like helping out your adult children, caring for aging parents, or springing for a home upgrade.
4. Borrow Wisely
Debt can be a valuable financial tool, but it can also get you into trouble if you’re not careful.
Here’s a little secret: not all debt is bad.
It’s easy to think that debt only hinders your financial future. Still, you can use debt strategically throughout your life to set you up for success: building equity in a house you love, receiving a quality education that kickstarts your career, or starting a business you’re passionate about.
But without a strategy, debt can set you back. Overspending on your credit card, buying a car, house, boat, or material goods you can’t afford – when you overspend on a large scale, it can be challenging to dig yourself out.
An instrument that can be both beneficial and detrimental is a credit card.
The Dos and Don’ts of Credit
Credit can be fantastic when you use it appropriately. Building a strong credit history boosts your credit score, an important metric throughout your life. For example, banks run a credit report as part of a loan-qualification process, like buying a house or car, or taking out a personal loan. A healthy credit score can help you secure competitive interest rates on these loans.
But credit is not a magic money source, and misusing it can have serious consequences. Remember the power of compounding interest? While compounding interest is advantageous in investing, it’s adverse in debt.
If you don’t pay off your credit card bills every month, the debt compounds at sky-high interest rates. The average credit card interest rate for new cardholders is 18.26%, so even just one month of missed payments can make your remaining balance unmanageable.
How can you use credit wisely?
- Build credit early and consistently. Don’t be afraid to use your credit cards, just do so strategically. One factor that determines your credit score is the length of time you’ve been building credit. It usually takes about 10 years of building credit to be in good standing, so start early. It’s also important to use your credit cards, but not too much. Try to consistently use them but stay well under your credit limit each month (i.e. use no more than 30%).
- Pay off your account balance in full every month. This is the big one. Don’t charge something that you aren’t sure you can pay off. Paying off your credit cards in full every month is an excellent way to keep yourself out of debt. When you carry a balance, the interest rate starts racking up.
- Make on-time payments. Another key determinant of your credit score is making payments on time. While one late payment may not derail everything, a few can (especially in a row).
Create a Debt Repayment Plan
Remember, debt isn’t inherently bad, it’s all how you use it. A telltale sign of financial literacy is being able to create and stick with a debt repayment plan that works for you.
Whenever you take on debt, be sure you have a strategic repayment plan in place. Here are some ideas:
- Pay off high-interest debt first
- Consolidate loans for a better interest rate and smoother repayment process
- Refinance debt if it will help you pay your debt off faster with a lower interest rate
- Make on-time, consistent payments
5. Give Generously
Charitable giving is a meaningful part of many people’s financial and personal lives.
You might be wondering what charitable giving has to do with financial literacy? It’s an awareness of what you have and what you can offer others. Studies show that people who give their resources and time regularly are happier, more joyful, and report higher levels of overall satisfaction with their lives.
Take some time to consider how charitable giving, whether through financial contributions, volunteering, or other involvement, fits your financial and personal goals.
- What organizations and causes are important to you? How can you make a notable difference in these areas?
- What efforts are you currently making, and how can you make them even more targeted?
- Can you give more of your time and talents to causes you care about?
- How can you get your family and loved ones involved as well?
- Are you maximizing your giving by doing so tax-efficiently?
If you’d like to be more involved in charitable efforts, Abacus can help you create a plan.
6. Protect Your Wealth Long-Term
How can you protect yourself and your wealth over time?
Start by keeping your online information secure. There’s been a significant uptick in cybercrimes over the last several years, putting even greater emphasis on digital protection. Consider the following measures to help protect your identity online:
- Invest in an identity theft protection plan like LifeLock or Identity Guard
- Keep your technology (laptop, tablets, phones) up to date with software
- Use a secure internet connection
- Create strong passwords
- Watch out for phishing scams
Once you’ve taken steps to protect yourself, safeguard your wealth by conducting a thorough insurance review to protect yourself and your loved ones.
- Do you have enough life insurance to protect your family if you pass away? Even if you’re single with no children, a life insurance policy can provide loved ones with support on funeral costs.
- What type of disability insurance is right for you? Disability coverage protects your income if you can’t work.
- Are you on the best health/medical plan?
- Do you need additional personal liability insurance via an umbrella policy?
Finally, the last thing you can do to protect your wealth is build a comprehensive estate plan. While end-of-life considerations are tough to think about, doing so gives you control over what happens to your assets and personal property. Here are some thoughts to consider:
- Do you have a will?
- Would your estate benefit from a trust? If so, what kind?
- Have you decided who will help you carry out your wishes? Some examples include an executor, health care directive, financial power of attorney, guardian for minor children, a trustee, etc.
- Are your beneficiaries up to date? It’s best to review beneficiaries regularly, especially after a significant life transition like marriage, divorce, children, or a new job.
An estate plan is a gift you give to your loved ones. It clearly documents your wishes, streamlines the wealth transfer process, and alleviates stress for your family.
Financial Literacy is an Invitation to Lifelong Learning
Remember, financial literacy isn’t something that happens overnight; it’s an ongoing process that unfolds over a lifetime.
You won’t be an expert in every financial topic you’ll encounter, and that’s okay! What you can do is keep learning, growing, and making financial choices that put you on a successful path.
The best part is you don’t have to travel this journey alone. A trusted financial advisor can help you find confidence and clarity with your money. Abacus would love to help you discover all the incredible things your money can help you do.