Michele Carby gives a crash course Financial Literacy 101 to introduce the tools you need to transform your life.
They didn’t teach us about money when I was at school. Even as a student, it struck me as a little strange that we did not have lessons about managing personal finances. My little niggle of doubt at the age of 16 has grown significantly over the years into a major concern because so many people have a poor grasp of managing money effectively.
Things are a little better now. In the UK, schools do some work on personal finance in Personal, Social, Health and Economic (PSHE) lessons, and the subject is increasingly popping up on the curriculum in South Africa and many other countries. However, there is still a significant financial literacy deficit that harms both individuals and society as a whole.
A report last year by Bank Leumi found that 93% of Brits feel uneducated regarding personal finance, and literacy testing by Freetrade found 48% of subjects failing a basic literacy test and a whopping 80% failing a test on pensions. Results from many other countries are similar and these figures really should set alarm bells ringing.
Low financial literacy leads to making poor financial choices. For most of us, money is the oil in our daily lives that makes everything else in our lives work. Making bad choices reduce the oil that keep the wheels moving. The friction, stress and complications that arise can negatively impact every single aspect of our lives.
Finance Literacy 101 – what you need to know
Incomes & Outgoings
Everyone should have a clear picture of their income and regular outgoings. This is the most fundamental building block on which financial planning and management need to be based.
Everyone should understand how to draw up and operate on a budget. I have known many people who don’t engage in even the most basic budget planning. If they are short at the end of the month, they stick purchases on the card, a surefire way of building a mass of high-cost debt in no time.
Once you know your incomes and outgoings, draw up a budget to guide your spending throughout the month. Many people see setting a budget as a cage for themselves and fight it for that reason, but actually operating to a budget is a liberator because it gives you control over your spending. That control gives you the freedom to make choices based on your personal priorities.
Debt is where many people come unstuck, getting caught in a cycle of repayments that take an ever greater percentage of their income and squeezing both their finances and choices.
Of course, not all debt is bad. Taking out enabling loans can be an investment in your future. A mortgage can help buy you a home and an asset, a car loan can increase your mobility or a business loan opens the door to financial and life opportunities.
On the other hand, funding an unaffordable lifestyle through bank overdraft or credit cards is often a recipe for disaster and getting caught in a debt spiral. Credit cards charge exorbitant rates of interest that can rise as high as 40% APR. Build up a big balance on these and you can get in trouble very quickly.
When you take on any debt, ensure you understand the interest rates and other terms and conditions to ensure that your budget can comfortably support the payments.
Growing wealth & investment
Anyone savvy with personal finance should seek to grow wealth in the long term. This means understanding how savings and investments work, at least at the basic level. The essential concepts you should understand are risk, diversification and volatility. It will also help if you know the differences between asset classes including, stocks, mutual funds, commodities and other key investable assets.
The rise in the average lifespans means that most people will have to support themselves for many years after stopping their working life. As a result, you must establish a pension if you want to maintain a reasonable standard of living. The ultimate goal is that the income on the pension pot you build throughout your working life will provide for your living expenses without depleting the capital value.
The best advice with pensions is to start as early as possible. That allows you to benefit from the compound growth from the savings themselves, which, over the decades, will grow your pension significantly.
As you grow assets and wealth, it is essential to protect them. To do that you first need to understand the risks you face. For example, a severe medical issue is a problem for your wealth and finances. Time off work, treatment and other consequential costs can quickly overwhelm your budget. However, an insurance policy can offset those losses and leave you to concentrate on getting well.
Insurance can cover all kinds of risk, some simple, some complex. The financially literate person understands the risks they take and insures themselves accordingly.
Poor financial choices can be very costly, even catastrophic, so my last advice in Financial Literacy 101 is when making a financial decision to do your due diligence. Whenever you make a major decision, look closely at the solution before you understand the terms and conditions and the potential ramifications. Finance today can be very complex, so if you don’t understand, take advice from a relevant professional, financial planner, accountant or lawyer.
Make sure you are fully informed and then make your choices.
The power of financial literacy
I have just sketched out the basics here, but even arming yourself with the knowledge above will make a big difference to your financial affairs. They will help you master money rather than struggling with it and that will empower you to take control of both your money and your life.