Understanding how to manage your financial resources is an essential life skill that is more important in today’s economy than ever before. The abundance of choices and the extension of credit have made your financial decisions much more complex than past generations have had to face. It’s easier to accumulate debt, and many people must deal with the impact of poor financial choices for many years to come. Today’s economic environment requires consumers to be far more financially literate to ensure they can make the right financial choices to create a secure future. Unfortunately, most Americans lack the financial savvy they need to make educated decisions in this complex consumer economy.
What is financial literacy?
Financial literacy is the ability to understand financial, credit and debt management concepts to effectively manage your financial resources for the long term and ensure that you make financially responsible decisions within your daily life. It helps you build your financial roadmap for making decisions aligned with your goals.
Becoming financially literate begins with learning a few key principles that provide a strong foundation for building a financially stable future for you and your family. Here are the essentials to get you started:
- Save now to make an impact on your future: A fundamental concept for saving money is realizing the importance of the time value of money. Your money today with its potential earning capacity is worth more than the same amount in the future. Since inflation steadily erodes the purchasing power of your money, your dollar becomes less valuable and buys fewer goods and services in the future. Also, you can take the money you have on hand today and get a return (interest, dividends or capital gains) by investing it. While the rate of return will vary over time, in the long run your money should grow. Plus, as you save, you reap the benefit of compounding, as we explain next.
- Put the power of compounding to work: Compound interest is interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan. Compound interest, or interest on interest, helps you grow your dollars at a faster rate than simple interest calculated only on the principal amount. The rate at which compound interest accrues depends on the frequency of compounding. The higher the number of compounding periods, the greater the compound interest.
- Develop a financial plan as a blueprint for making decisions: A financial plan is a comprehensive evaluation of an individual’s current and future financial state by using currently known variables to predict future cash flows, asset values and withdrawal plans. Most individuals work with a financial planner and use current net worth, tax liabilities, asset allocation, and future retirement and estate plans in developing financial plans. These metrics are used along with estimates of asset growth to determine if a person’s financial goals can be met in the future, or what steps need to be taken to ensure that they are.
- Use credit wisely and manage your debt: While credit is a powerful financial tool, if it’s used without careful consideration, it can quickly bring heavy debt, which often can be challenging to reverse. To use credit to your advantage, take care when selecting your credit cards, matching features with your financial lifestyle to gain added benefits. Also, consider your credit utilization, or how much credit you are using by dividing your total balances by your total credit limits. Try to keep your utilization under 30 percent. Also, don’t forget to annually review your credit score contained in a credit report to ensure its accuracy, and you can do it for free through the three major bureaus: Equifax, Experian and Trans Union.
- Maintain your financial health by budgeting: Just like a physical helps you assess the state of your health by identifying potential risks, measuring your progress and pinpointing next steps, budgeting can offer the same insight into your financial health. Without a budget, it can be difficult to hold yourself accountable for how you spend your money. By reviewing your budget over a period of time, you gain insight that enables you to make informed decisions aligned with your long-term goals. Budgeting is an essential part of any smart financial plan. It puts you in control of your financial life by uncovering spending and earning patterns.
With a new economic reality, understanding how to make sound financial decisions is a critical skill. As we live longer, have more financial options and try to manage in an increasingly complex world, you must become informed about your finances, develop good financial habits and understand where you are heading to ensure you stay on the path toward achieving your short and long term goals.
The information herein has been obtained from sources believed to be reliable, but Wealth Dimensions Group, Ltd. (“WDG”) does not warrant its completeness or accuracy. Prices, opinions and estimates reflect WDG ‘s judgment on the date hereof and are subject to change at any time without notice. Any statements nonfactual in nature constitute current opinions, which are subject to change. Projections are not guaranteed and may vary significantly. Past performance is not indicative of future results.