The 7 Components of Financial Literacy

1. Money:

Money is the bloodline of this world. It is the medium of exchange that allows for payment of goods and services. And in the same essence, that is what your earnings means for you. Your earnings help you to pay bills, make purchases, and set aside funds for you/your family’s future.

Therefore, the key thing to remember when it comes to your earnings is to ask yourself two questions: “Is your income enough to take care of basic household needs and emergencies?” and “Is your income enough to secure your financial future goals?”

Both questions are important as this will help you assess if you need to make more or reduce spending. The easier route is to reduce your household expenses/spending. This will allow you to keep more of what you make.

Conversely, you might discover there is a need to increase your earnings which more often than not, require a bit more action/planning. Some examples of how you can start taking steps to improve your financial situation might be through a pay raise with your current employer, higher compensation from a new job opportunity, or a side-hustle.

A hard truth is that your earnings will determine what you can and cannot do. It is the starting point to building your financial freedom. Therefore, take a moment to reflect on the questions above.

2. Savings & Investing:

At times, we may hear the term savings used exclusively to define overall savings. However, savings is separate from investing. And for the purposes of this post, savings is referring to your short-term funds.

Short-term savings are for funds that are typically used within three to six months and perhaps up to three years. An example of this would be building a 6-month emergency fund or saving for a major big purchase in the near future (i.e., car, house).

Short-term savings are beneficial as it helps you to avoid racking up credit to pay for emergencies, taking out loans, or borrowing from family/friends when you are in a pinch – which in some situations can change the dynamic of the relationship. In addition, having short-term savings on hand allows you to avoid dipping into your retirement or other long-term investment accounts.

Typically, your short-term savings should be accessible when needed but not too easy to access for frivolous spending. Remember, that your savings is to protect your plan for the near future. Therefore, try to avoid using it for unplanned spending splurges.

In regard to investing, these funds are held for longer periods of time. Think retirement or other investments such as real estate, mutual funds, ETFs, Cryptocurrencies etc. Investing is vital if you want to create wealth for you/your family’s future. The key to investing is starting, even if you are getting a late start.

Investing can seem daunting to some but it’s important to begin where you are regardless of the amount you can currently afford to do. As you make more money you can invest more!

A simple way to get started is through your employer. If your employer offers a retirement package, take advantage of the benefit and any matching contributions. And if you are currently contributing to your retirement but not sure if you are on the right track, consult with an investment representative to review your portfolio.

Remember, it’s good to make money but it’s even better when you learn how to make your money work for you!

3. Budgeting:

Based on various articles, the number of households that do not keep a budget seems to range from 30% - 55%. Although a pretty wide range, it shows enough plausible evidence that not all individuals/families are managing their money. According to a recent article by Credit.com, “Almost 30% of Americans don’t budget because they simply don’t think they need this tool.”

Budgeting is a needed tool.

You worked hard to earn that money and it’s important to know where each dollar is going at all times. This is why budgeting is the foundation to your money management. It allows you to track your income, expenses, and spending.

Budgeting Methods:

There are various types of budgeting methods such as the 50/30/20 method which aims at dividing your income into three categories; 50% needs, 30% wants, 20% savings. There is also zero-based budgeting; where all the money you have coming in equals the same amount going out. Then, there are such methods as monthly or per paycheck budgeting, which allows you to budget your expenses per month or per pay frequency.

Getting Started:

Just start. First determine which budgeting method works for you. Next, decide which vehicle to use in which to budget. You may prefer budgeting via pen and paper, excel spreadsheet, or via an app. Once you have this established, begin setting aside time either weekly, biweekly, or monthly to review your household budget.

Remember, you can’t manage what you don’t track! Starting budgeting today!

4. Protection:

Fraud Protection:

Identify theft is on the rise and it is imperative that you protect your personal data to keep your money safe. Below are some ways to ensure that you keep your account information secure.

- Safely secure passwords & do not share.

- Change passwords every 3 months.

- Create strong passwords.

- Check all accounts frequently for any suspicious activity.

- Check your credit report every year.

- Install antivirus and antispyware software (i.e. McAfree, Norton).

- Shred mail that contains personal information that need to be discarded.

FDIC Protection:

Assuming your funds are held in a bank, it’s important to understand what protections you have. The Federal Deposit Insurance Corporation (FDIC) protects depositors of insured banks in the U.S. against the loss of their deposits if an insured bank fails. The amount covered is up to $250,000 per account owner/ownership category per banking institution. For example, if you opened a savings account with $150,000 and then earned $6,000 in interest (assuming a 4% APY), you would be insured for $156,000.

FDIC insurance covers the following deposits:

- Checking accounts

- Saving accounts

- Certificate of deposits (CDs)

- Money market deposit accounts

- Outstanding cashier’s checks/interest checks

FDIC insurance does not cover:

- Stocks, bonds, mutual funds

- Other investments backed by U.S. government

However, not all banking institutions or types of financial accounts are insured by the FDIC. If you are unsure your account type is FDIC insured, contact your local bank or check online.

Avoid Oversharing:

Sometimes, sharing too much, online or in conversation, can put you at high risk for theft as well as fraud. When in doubt, only share your personal financial information with those who need to know.

You earned it. Now protect it!

5. Debt Management:

Sometimes, it may be necessary to borrow for big, ticketed purchases, such as purchasing a home or a car. And many individuals/families have credit card and student loan debt. Whatever your outstanding debts may be, it’s important to track your borrowing habits and take action to manage your debt. This is accomplished by having a debt management strategy.

Debt management is a way to get your debt under control through financial planning and budgeting. It can also refer to a credit counseling service that consolidates any unsecured debt into one monthly payment, which is sent directly to your creditors by the credit counseling service.

Debt Repayment Methods:

Snowball method - This debt-reduction strategy allows you to pay off your debt slowly from the smallest to largest balance. You make minimum payments on all bills except the smallest one. For the smallest one, you pay as much as you can. Once the smallest debt is repaid, you then roll that payment amount towards to the next bill. This method allows you to pace yourself and to give you a quick win as you are paying off those smaller debt amounts first.

Debt Avalanche method - With this strategy, you concentrate on paying off your highest-interest debt first, followed by the debt with the next highest interest rate. This method may be right for you if want to knock out debt faster and take the least expensive route. Keep in mind that by using this method, it could take longer to see significant progress and harder to stay motivated.

Note: If doing either the snowball or the avalanche method and you are still overwhelmed in credit card high interest rates, speak with a counselor regarding other ways to eliminate debt (i.e. 0% APR balance transfers, renegotiate interest rate). You can also accomplish this independently by researching online.

Having a debt management strategy allows you to manage your debts effectively and most importantly reduces stress.

6. Credit:

Having a good credit score indicates to lenders/creditors that you are responsible and practice good financial habits, like paying bills timely. There is more than one credit scoring model available and more than one range of scores. However, according to Equifax most credit score ranges are similar from 300 – 579 (poor), 580 - 669 (fair), 670 - 739 (good), 740 – 799 (very good), and 800 – 850 (excellent).

Credit score vs credit report:

While your credit score is a three-digit number that helps creditors determine your credit-worthiness, your credit report is an actual statement that contains all of your past and current detailed account credit activity.

Check your credit report with the three credit bureaus (Experian, Equifax, and TransUnion) at least once a year. Correct any errors you discover on your credit report and identify any signs of fraud. Report these immediately with the bureaus.

Please note: Checking your report with the three bureaus does not count against your credit score.

What % makes up a FICO credit score?

- Payment history – 35%

- Amounts owed – 30%

- Length of credit history – 15%

- New credit accounts – 10%

- Credit mix – 10%

Benefits of building credit:

- You get better approval rates. If you have a good credit sore, you’re more likely to be approved for credit products, like a credit card or loan.

- You get a lower interest rate based on a higher credit score.

Some general tips to maintain good credit:

1. Pay all bills on time.

2. Pay off your debts.

3. Continue to keep credit accounts, even if paid off.

4. Diversify your credit mix by having different types of credit.

5. Avoid having too many newly opened accounts.

Building credit takes time. With a bit of patience, you’ll get there. If you need more information about understanding credit, visit https://consumer.gov/credit-loans-debt/using-credit

7. Taxation:

If you have been diligently contributing to your retirement and taking advantage of your Employer match – GREAT! In addition, it’s important to understand the tax implications to your future income.

Qualified Distributions:

Qualified distributions for your retirement accounts (401K, IRAs, 403B plans) are allowed at age 59 ½. Any withdrawals before 59 ½ are subjected to an IRS distribution penalty of 10%.

Note: Refer to your company’s retirement plan document regarding qualifying events (i.e separation).

Withdrawals:

Once you start taking income from a traditional IRA, you will owe taxes on the earnings portion of those withdrawals at your regular income tax rate. However, for a Roth IRA, you get the benefit of tax-free growth of your contributions and earnings. Please note - the 2023 contribution limits for Roth IRAs are $6,500 ($7,500 if you are age 50 or older).

When you receive income from your 401K and 403B plans, you will owe income tax on those amounts. And similar to the traditional IRA, will be taxed at your regular ordinary rate.

RMDs (the “ouch” factor!):

Required Minimum Distributions (RMD) is the minimum amount you must withdraw from your retirement accounts each year. Per the IRS, you must start taking these withdraws at the age of 72 (73 if you reach age 72 after Dec. 31, 2022). And this is not optional. Failure to comply and you will be assessed a 50% penalty on the amount not distributed or for any shortfalls. A big ouch! It is important to note that Roth IRAs are exempt from RMDs.

The above is just a high-level overview. If you need more of a breakdown as well as assistance on how to incorporate a tax-smart investing strategy into your tax planning, consult with a Financial Advisor regarding your investments.

In closing of these 7 components, if you need a way to jump start tracking your income and expenses, then click here to download the Budget Per Month or the Budget Per Paycheck tracking sheets.

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Disclaimer: For informational purposes only. Does not substitute for professional financial advice. Please consult with a professional financial advisor.