Financial literacy is the most important concept to study when learning about money. During our younger years in school, we learn very little about the real world, especially about income.
Most of us learn to take our hard-earned, hourly income, and use it for paying expenses. This could not be further from the reality of what people do with their income.
For instance, your income should not be used to cover only expenses, rather it should be used to purchase assets. Purchasing assets that generate money is key, especially passively.
The ultimate goal is for your assets to cover your expenses even when your income slows or stops completely. Many people hear the term ‘asset’ and get overwhelmed. An asset is quite valuable because it is expected to provide future benefits for a business or individual.
A great example of an asset that generates passive income is a duplex. Imagine buying a duplex, living in one half, while renting out the other half. By renting out the other half, you can make the rent high enough to cover your mortgage, too.
Now imagine owning multiple duplexes that generate enough money to cover the mortgage plus a little extra in your pocket. This is the idea of having a passive income. This passive income comes monthly from renters needing a place to live.
You could benefit from this because they are essentially paying for you to live rent-free. Ultimately, you will profit by purchasing more property, increasing your overall portfolio.
Aside from having a passive income, limit yourself to unnecessary expenses and save as much money as possible. Building up a savings account is more important than you realize and will benefit you in the future.
Let us now dive deeper into the concept of financial literacy.
Budgeting Basics
To further understand the importance of financial literacy, one must first establish a basic budgeting plan. A budgeting plan will allow you to see exactly how much money is coming in and where it is going.
Too many people rely on their brains when tracking income and expenses. You need to see a proper budgeting plan on paper or using an app to assist. This is where your financial plan becomes truly detailed, allowing you to pinpoint exactly how your funds are allocated.
Building a personalized financial roadmap is the cornerstone of proper money management. By following these essential steps, you will achieve the structure needed to make informed financial decisions and realize your objectives.
Here is what to consider when developing a personalized financial roadmap:
- Gather Essential Data. Begin by compiling your financial records, pay statements, bills, and receipts from recent months. This provides a comprehensive overview of your earnings and spending habits.
- Calculate Total Earnings. Determine your overall monthly income, including your salary, any supplemental income, or other revenue streams.
- List Consistent Obligations. Identify your recurring, necessary expenditures like rent/mortgage, utilities, loan repayments, and insurance premiums. These are the fixed costs that form the bedrock of your financial plan.
- Establish Savings Targets. Decide how much you intend to save each month, whether for an emergency reserve, retirement, a home down payment, or another financial objective. Prioritize your savings by automating transfers to a separate account.
The idea here is to get your brain thinking differently to be more in tune with your finances. Once you have a basic blueprint of your income and expenses, you can start managing finances more efficiently.
Related Article: “Nip it in the Budget: How to Resist Spending“
Monitoring Your Expenditures
The initial step in addressing these hidden financial drains is to identify them. This is where expense monitoring becomes crucial. Tracking your spending will allow you to see precisely where your funds are going, revealing those subtle yet significant expenditures.
Monitoring your expenditures is part of financial literacy, which can be extremely difficult and overwhelming in the beginning. However, once you have all the necessary information, it will be easy to see how much you are making versus spending.
You would be surprised how fast a coffee a day can add up, especially if you are trying to lower your expenses. Lowering expenses takes time and patience because it changes how you view money.
Becoming a savings-obsessed person and watching where your money goes will empower you to control your finances better. These are a few methods for monitoring your expenditures:
- Budgeting Applications. Numerous user-friendly budgeting applications can automatically categorize your spending and generate reports, facilitating the identification of areas for improvement.
- Spreadsheets. For those who favor a more hands-on approach, creating a simple spreadsheet can track your earnings and expenditures.
- Traditional Methods. Pen and paper can also be effective – simply record all your purchases for a while to gain insights into your spending patterns.
Start tracking your hard-earned money coming in and watch how quickly it leaves. Ask yourself if it is worth it to spend money on certain, unnecessary items. Think of ways to save that money and learn to substitute certain things.
For example, consider making your coffee at home instead of spending a premium price at a shop. Learn to bring your own lunch to work instead of ordering out. Most of the time, extra expenditures come at the cost of convenience.
50/30/20 Rule
Arguably, it is the most popular method people use and will undoubtedly help you, too. The 50/30/20 rule provides a simple framework for prioritizing your spending and ensuring you allocate enough towards savings.
Using this rule will change how you think about money and where it is spent. You will become obsessed with how your money is used and not just spent without thinking. Avoid spending money on frivolous items just because you can.
Instead, be mature and responsible about saving for your future. Plan on saving as much as you can for the next decade or so and then reassess your situation. Seeing your savings add up over time will help to maintain direction for a secure financial future and demonstrate your understanding of financial literacy.
This concept divides your income into three categories:
- 50% Needs. Used for essential expenses such as housing, utilities, groceries, transportation, healthcare, and minimum debt payments. These are the costs you must have to cover to maintain your lifestyle
- 30% Wants. Discretionary spending on things you enjoy but do not necessarily need, such as dining out, entertainment, hobbies, travel, and personal care. These are the extras that add enjoyment to your life
- 20% Savings. Dedicated to your financial future, including contributions to retirement accounts, emergency funds, debt repayment beyond the minimum, and savings for specific goals like a down payment on a house
Use the 50/30/20 rule to build a strong financial plan that supports how you live today and protects your future. This system helps you make informed choices with your money
This rule should be applied in every circumstance of making money and should be considered a foundation rather than a suggestion. If our public school system taught us this early in life, we could all live paycheck to paycheck, but have plenty of savings to feel secure about.
Saving Money
Saving money is more important than making it because it demonstrates financial maturity. When most people get paid, they immediately blow it on things they do not need or to impress their friends.
You could have a high income, but if you are spending it all every single week and have nothing of value to show for, it shows you do not understand the importance of saving. As a friendly reminder, living the high life will come to a grinding halt once you lose your job.
This is why saving money is more important than you realize. With the 50/30/20 rule in mind, you could change your spending habits and learn to buy items without financing them. Imagine saving for a few years and buying a car, with cash, without having a monthly payment to deal with.
This idea alone should empower you to make smarter financial choices. It seems ignorant to expect you will work for the same company your whole life. Companies fold every day and if you rely on them to finance your life, think again.
Focus on setting up a proper savings early in life and decide what you want to do with it. These ideas could be starting your own business or investing into something that makes you a consistent income.
Savings money is about creating a foundation of financial security that allows you to pursue opportunities and weather unexpected storms without constant stress. Think of it as buying yourself time and freedom.
The ability to choose how you spend your days, rather than being dictated by immediate financial needs, is a powerful reward for disciplined saving. This idea of financial literacy is a goal we should strive to achieve.
Remember, it is not how much you make but how much you save!
Focus on Assets
Categorized as tangible (real estate, cash) or intangible (stocks, patents), assets are resources you own that generate value.
To build wealth, focus on acquiring appreciated assets like real estate and stocks or income-generating assets such as dividend stocks, bonds, and rental properties.
Aim to build a portfolio that generates enough passive income to cover your expenses, especially during periods of income loss.
Passive income is essentially money you earn with minimal ongoing effort. It is about creating income streams that continue to generate revenue even when you are not actively working.
Many passive income streams require significant upfront effort, like building a website, writing a book, or purchasing rental property.
While some passive income streams may require initial setup or occasional maintenance, they do not demand constant, active work like a traditional job. Income like this aims to create financial freedom by allowing you to earn money without constantly trading your time for it.
Another goal to achieve when investing into assets is diversification.
Diversification involves spreading your investments across a variety of assets. This helps to reduce the impact of any single investment performing poorly.
Essentially, this means not putting all of your eggs in one basket.
Be sure to maintain liquid assets, which can be quickly and easily converted into cash without a significant loss in value. These are perfect for emergencies and will help set you up for retirement through dedicated accounts.
This is not a short-term strategy, but a long-term commitment to building a solid financial foundation. Consistent, disciplined investment in these types of assets will create a portfolio that can weather market fluctuations and provide financial security over decades.
If you are unsure where to begin, talk to a friend who does investments or seek a professional to establish goals in your financial literacy quest.
Paying Yourself First
The “pay yourself first” philosophy is a cornerstone of personal finance. This emphasizes that you should prioritize your own financial well-being before allocating funds to other expenses.
Utilize your income strategically by budgeting and paying yourself first through consistent investing or reinvesting returns.
It is not about being selfish, it is about building a solid foundation for your future. Learn to put yourself first here because it is your future you need to plan for.
Some examples for paying yourself first include:
- Prioritize Savings and Investments. Instead of waiting to see what is left after paying bills, immediately set aside a predetermined portion of your income for savings and investments.
- Automation is Key. The most effective way to implement this is through automation. Set up automatic transfers from your checking account to your savings, investment, or retirement accounts on payday. This removes the temptation to spend the money.
- Consistency Over Amount. Even small, consistent contributions are more powerful than occasional large sums. The power of compounding works best over time, so starting early and being consistent is crucial.
- Treat Savings as a Non-Negotiable Expense. View your savings and investment contributions as essential bills, like rent or utilities. This mindset shift helps you prioritize your financial future.
The idea is to create a safety net for unexpected expenses and help achieve long-term financial goals. Knowing you are consistently saving and investing provides peace of mind.
Focus on developing financial discipline because it will benefit you throughout your life. By consistently investing, you can build a large enough portfolio so that you are not dependent on a job.
By consistently “paying yourself first,” you are making the wise decision to prioritize your financial future and build a foundation for long-term wealth.
Remember, once you know enough about financial literacy, share the knowledge!
References:
- Segal, T. (2023, July 1). What is diversification? Definition as Investing Strategy. Investopedia.
- Featured Image courtesy of Vecteezy