What Does Financial Literacy Mean?

Financial literacy is essential for lifelong success. Understanding how money works increases the likelihood of achieving your financial goals.

Now is the time to begin establishing good money habits. Educating yourself in the following areas helps you make effective financial decisions and attain your objectives:

• Banking

• Budgeting

• Saving

• Using credit

• Creating good debt

• Investing    

What Is Financial Literacy?

Financial literacy is the ability to understand and apply diverse financial skills, principles, and concepts, including the following:

• Personal financial management

• Budgeting

• Investing

• The time value of money

• Compound interest

• Debt management

Achieving financial literacy enables you to make good financial decisions, become self-sufficient, and attain financial stability. Key steps to financial literacy include:

• Creating a budget

• Tracking spending

• Paying off debt

• Planning for retirement

Educating yourself on personal finance topics involves diverse topics:

• Learning how money works

• Setting and achieving financial goals

• Becoming aware of unethical/discriminatory financial practices

• Managing financial challenges

Why Is Financial Literacy Important?

Individuals with higher levels of financial literacy are likely to do the following:

• Make ends meet

• Spend less of their income

• Create a three-month emergency fund

• Open a retirement account

For example, because few employees receive pensions, many are offered the option of participating in a 401(k) or 403(b) plan:

• Employees must make decisions about contribution levels and investment choices.

• Contributing to a 401(k) or 403(b) plan alone might not be enough to afford a comfortable retirement.

• Employees without an employer-sponsored retirement plan must open individual retirement accounts (IRAs) and other tax-advantaged retirement accounts.

Personal Finance Basics

Personal finance is where financial literacy translates into individual financial decision-making. Examples include how you manage your money and which savings and investment vehicles you use.

Personal finance is about creating and attaining your financial goals. Examples include:

• Owning a home

• Planning for retirement

• Supporting family members

• Saving for your children’s college education

• Supporting the causes you care about

Personal finance topics include:

• Banking

• Budgeting

• Using credit

• Handling debt

• Investing

1. Introduction to Bank Accounts

A bank can hold and build the money you'll need for major purchases and life events. The following information on bank accounts clarifies why they are essential for creating a stable financial future.

Why Do You Need a Bank Account?

Putting your money in a bank account is safer than holding cash:

• Assets held in a bank are harder to steal.

• U.S. bank assets generally are insured by the Federal Deposit Insurance Corporation (FDIC).

• You always have access to your cash.

Many financial transactions require you to have a bank account to:

• Receive your paycheck from your employer

• Earn interest on your money

• Use a debit or credit card

• Use payment apps like Venmo or PayPal

• Access your money through an automatic teller machine (ATM)

• Write a check

• Buy or rent a home

Which Type of Bank Can You Use?

The two common types of banks include:

Retail banks

Retail banks are for-profit companies that offer the following:

• Checking accounts

• Savings accounts

• Loans

• Credit cards

• Insurance

• Other financial services

Retail banks have the following characteristics:

• The banks can be accessible in buildings, online, or both.

• The online technology tends to be advanced.

• The banks often have more nationwide locations and ATMs than credit unions.

Credit unions

Credit unions are not-for-profit companies owned by their members that offer the following:

• Checking accounts

• Savings accounts

• Loans

• Credit cards

• Insurance

• Other financial services

Credit unions generally have the following advantages over retail banks:

• Lower fees 

• Better interest rates on savings accounts 

• Better interest rates on loans

• More personalized customer service

Which Types of Bank Accounts Should You Open?

There are three main types of bank accounts that you might want to open:

Checking account

A checking account is a deposit account at a bank or other financial institution that allows you to make deposits and withdrawals:

• Money can be deposited at banks and ATMs, via direct deposit, or through another electronic transfer method.

• Account holders can withdraw funds via banks and ATMs, by writing checks, or using debit cards linked to their accounts.

• The accounts earn little to no interest.

• Some checking accounts have monthly fees.

• There might be charges for overdrafts or using an out-of-network ATM.

Savings account

A savings account is an interest-bearing deposit account held at a bank or other financial institution:

• Savings accounts typically pay a low interest rate.

• Safety and reliability make the accounts a sensible option for short-term savings.

• Savings accounts might limit the number of withdrawals.

• The accounts are ideal for saving for short-term goals, like buying a car or going on vacation, or storing extra cash that you don’t need in your checking account.

High-yield savings account

A high-yield savings account typically pays a much higher interest rate than a standard savings account. This type of account usually requires a bigger initial deposit, a larger minimum balance, and higher fees than a regular savings account.

2.   Introduction to an Emergency Fund

An emergency fund can help you handle financial hardships, such as car repairs, medical bills, or job losses:

• Set up a separate savings or money market account for your emergency savings.

• The account should eventually cover at least three to six months’ worth of expenses.

• Emergency fund money should be off-limits for paying regular expenses.

3.   Introduction to Credit Cards

A credit card is an account that enables you to borrow money from the issuer and pay it back over time:

• You will incur fees if a payment is late or if you exceed your spending limit.

• If you don’t pay back the loan, you will be charged interest on the remaining balance.

• Aim to pay off your credit card balance monthly to avoid incurring debt.

What’s the Difference Between Credit and Debit Cards?

A debit card has the following characteristics:

• A debit card takes money out of your checking account.

• Because you can’t borrow money with a debit card, you can’t spend more cash than you have in the account.

• A debit card won’t help you build a credit history and credit rating.

In contrast, a credit card has the following characteristics:

• A credit card allows you to borrow money.

• The card does not pull cash from your bank account.

• A credit card can be helpful for large purchases.

• Using a credit card wisely and paying your credit card bills on time helps you establish a credit history and a good credit rating  

What Is an APR?

APR stands for annual percentage rate, which is the amount of interest that you’ll owe the credit card issuer on any unpaid balance. A higher number can cost you hundreds or even thousands of dollars if you carry a large balance.  

Which Credit Card Should You Choose?

Your credit scores have a big impact on your odds of getting approved for a credit card. Understanding the range your score falls in can help you narrow the options as you decide which cards to apply for. Beyond your credit score, you’ll also need to decide which perks best suit your lifestyle and spending habits.

If you have a fair to good credit score, you can choose from a variety of credit card types, such as:

• Travel rewards cards: These credit cards offer points redeemable for travel, including flights, hotels, and rental cars, with each dollar you spend.

• Cash-back cards:  Every month, you’ll receive a small portion of your spending back, in cash or as a credit on your statement.

• Balance transfer cards: If you have balances on other cards with high interest rates, transferring your balance to a lower-rate credit card could save you money, help you pay off balances, and help improve your credit score.

• Low- or No-APR cards: If you routinely carry a balance from month to month, switching to a credit card with a low or no APR could save you hundreds of dollars per year in interest payments.

4.   Introduction to Creating a Spending Plan

A spending plan helps control your spending, saving, and investing. Tracking your income and expenses helps you understand where your money is going. Then, you can set goals to decrease your expenses, increase your savings, and reach your objectives.

How Can You Create a Spending Plan?

Use a budgeting app, Excel sheet, or pen and paper to track your monthly income and expenses:

• Income: List the dollar amount of all monthly sources of money, including paychecks, investment income, alimony, settlements, side jobs, and other projects, such as selling crafts.

• Expenses: Use your bank, credit card, and other statements to list your monthly purchases, split into fixed expenses and discretionary spending. Fixed expenses are your monthly purchases with fixed amounts, such as your rent or mortgage payments, loan payments, and utilities. Discretionary spending is your spending on restaurant meals, shopping, clothing, travel, and other unnecessary expenses.  

• Savings: Record the amount of money that you’re able to save each month in cash, a bank account, an investment account, or a retirement account, such as a 401(k), 403(b), or IRA.

Subtract your total expenses from your total income to get the amount of money you have left at the end of the month. Now that you have a clear picture of money coming in, money going out, and money saved, you can identify which expenses you can cut back on.

If you don’t already have one, put your extra money into an emergency fund until you’ve saved at least three to six months’ worth of expenses. Don’t use this money for discretionary spending. The key is to keep it safe and grow it for times when your income decreases or stops.

5.   Introduction to Investing 

Once you have enough savings to start investing, you’ll want to learn the basics of where and how to invest your money. Decide what to invest in and how much to invest by understanding the risks and potential rewards of different types of investments.

What Is the Stock Market?

The stock market refers to the collection of markets and exchanges where investors buy and sell financial securities, such as stocks, exchange-traded funds (ETFs), corporate bonds, and derivatives based on stocks, commodities, currencies, and bonds. The leading US stock exchanges include the New York Stock Exchange (NYSE) and NASDAQ.

How Can You Invest?

You must use a broker to buy stocks. There are three basic categories of brokers for new investors:

1. A full-service broker who manages your investment transactions and provides advice for a fee.

2. An online or discount broker that executes your transactions and provides advice depending on how much you have invested. 

3. A robo-advisor that executes your trades and can pick investments for you with little human assistance.  

What Should You Invest In?

Which securities you purchase, and how much you buy, will depend on the amount of money that you have available for investing and how much risk you’re willing to take to try to earn a higher return. The following are the most common securities to invest in, listed in descending order of risk:

Stocks: A stock, also known as shares or equity, is a type of investment that signifies partial ownership in the issuing company:

• A stock certificate entitles the stockholder to a proportion of the corporation’s assets and earnings.

• Owning stock gives you the right to vote in shareholder meetings, receive dividends that come from the company’s profits if and when they are distributed, and sell your shares to somebody else.

• The price of a stock fluctuates throughout the day and can depend on many factors, including the company’s performance, the domestic economy, the global economy, the day’s news, and more.

• Stocks can rise in value, fall in value, or even become worthless, making them more volatile and potentially riskier than many other types of investments.

ETFs: An exchange-traded fund, or ETF, consists of a collection of securities, such as stocks:

• The fund often tracks an underlying index.

• ETFs can invest in industry sectors or use various strategies.

• When you buy shares of an ETF, you’re buying a metaphorical slice of a pie containing slivers of the securities inside.

• You can purchase a variety of stocks at once with the ease and convenience of one purchase.

• ETFs are similar to mutual funds because they both offer instant diversification and are professionally managed.

• ETFs are listed on exchanges.

• ETF shares trade throughout the day just like ordinary stocks.

• Because there are many securities inside the ETF, investing in ETFs is considered less risky than investing in individual stocks.

• If some of the securities inside an ETF decrease in value, others might remain steady or increase in value.

Mutual funds: A mutual fund is a type of investment consisting of a portfolio of stocks, bonds, or other securities:

• Mutual funds give individual investors access to diversified, professionally managed portfolios at a low price.

• There are many categories of mutual funds, representing the kinds of securities they invest in, their investment objectives, and the returns they seek.

• Mutual funds charge annual fees, called expense ratios, and in some cases, commissions.

• Most employer-sponsored retirement plans invest in mutual funds.

• Investing in shares of a mutual fund is different from investing in individual shares of stock because a mutual fund owns many different stocks or other securities.

• Unlike stocks or ETFs, which trade at varying prices throughout the day, mutual fund purchases and redemptions occur only at the end of each trading day and at a fund's net asset value (NAV).

• Similar to ETFs, mutual funds are considered less risky than stocks because of their diversification.

Bonds: Bonds are issued by companies, municipalities, states, and sovereign governments to finance projects and operations:

• When an investor buys a bond, they’re effectively lending their money to the bond issuer and promising to repay the loan plus interest.

• A bond’s coupon rate is the interest rate the investor will earn.

• A bond is a fixed-income instrument because it traditionally pays a fixed interest rate, although some bonds pay variable interest rates.

• Bond prices inversely correlate with interest rates: When rates go up, bond prices fall, and vice versa.

• Bonds have maturity dates, which are the times the principal amount must be paid to the investor in full or the issuer risks default.

• Bonds are rated by how likely the issuer is to pay you back.

• Higher-rated bonds, known as investment-grade bonds, are viewed as safer and more stable.

• Investment-grade bonds receive AAA to BBB- ratings from Standard and Poor’s and Aaa to Baa3 ratings from Moody’s.

• Investment-grade bonds are tied to publicly traded corporations and government entities that boast positive outlooks.

• Bonds with higher ratings typically pay lower interest rates than those with lower ratings.

• U.S. Treasury bonds are the most common AAA-rated bond securities.

*This information is for educational purposes only.

Let me know in the comments which personal finance topic you would like to learn about next!