Increasing your financial literacy is important, especially if you’re just beginning your journey in finance. Whether you’re opening your first bank account or just trying to make sure you’re well equipped with knowledge, there are certain concepts that all beginners should learn.
Without understanding how to use money, you can’t successfully navigate life in our society. While there are ever-escalating levels of financial literacy, there are certain basic concepts that beginners must master before moving up the ladder of monetary knowledge. Here are a dozen crucial terms that you need to comprehend on your journey to financial fluency.
- Financial literacy is something that every person needs in our society. Understanding concepts like checking and savings accounts, credit scores, and taxes will help you succeed in managing your own money.
- Checking and savings accounts are good places to keep your money available to you.
- Maintaining good credit is an important part of financial success.
- Taxes are mandatory, and penalties for not paying them can be punishing.
Strategies to Improve Your Financial Literacy Skills
You have to keep your money somewhere, and generally, the safest place is in a savings bank or credit union, as they are insured by the Federal Deposit Insurance Corp. (FDIC) against losses. These financial institutions offer a variety of accounts, and a checking account is one of them. A checking account is designed to provide quick access to your funds for daily transactional needs, such as paying bills or buying products.
You should keep only the amount of money that you need for expenses in your checking account, though that should be at least enough to meet the bank’s minimum balance requirement, which allows you to avoid paying a monthly fee to keep your account open. You can tap your cash by writing a paper check to any person to whom or entity to which you owe money, but be careful—do not overdraw your account by asking for more than is in it. If you do, you could wind up with bounced checks and overdraft fees.
You can also access the cash in your checking account by using a debit card, which in this digital age is a more popular and convenient vehicle than a paper check. Debit cards allow you to avoid carrying cash. Most stores accept them, and all you have to do is swipe your card through a machine and enter in your personal identification number (PIN) to transfer the cash from your account to the vendor.
You can also use your card at an automated teller machine (ATM) to get cash. Of course, you cannot access more money than is in your account, and some banks will charge you a fee to use the card.
Debit cards have largely replaced paper checks due to their ease of use.
A savings account is where you keep the money that you are, well, saving. Funds are held for future use rather than the cash you need to pay for regular expenses. Depending on how much you hold in it, you may have to pay a monthly fee to keep the account open. There may also be a minimum balance requirement and a limit on how much money you can withdraw in a given time frame.
As the bank has use of the money while it sits in your account (it can lend it to other customers), it compensates you by paying monthly interest, increasing your hard-earned savings. Most savings accounts are also insured against losses by the FDIC.
Interest is, quite simply, the price that a person or entity pays for borrowing money. Interest is determined as a percentage of the amount borrowed over a period of time.
There are two kinds of interest: simple and compound. The first is paid only on the actual amount borrowed, called the principal. The second is paid on both the principal and the interest already paid. As a result, compound interest earns more money for a lender than simple interest.
A loan is an agreement between two people or entities where one party temporarily gives a sum of money to the other. The party getting the money pays interest for the privilege. Loans can be used for such purposes as buying big-ticket items such as a car, a house, or an education.
The loan terms will include the length of time before the money has to be paid back (known as the date of maturity) and the percentage amount and kind of interest to be paid and when. There may also be collateral involved, which is something a borrower offers as a guarantee that they will pay the money back. If the borrower can’t pay it back when required, an event known as a default, then the lender takes possession of the collateral instead of getting their money returned.
A credit card is a kind of loan that is available to consumers whose finances are in good enough shape to qualify for it. A financial institution issues a plastic card with an account number and the cardholder’s name on it. The card can be used to purchase goods in stores and online up to a certain amount of money, known as the credit limit. It can also be used to take a cash advance if the cardholder needs money.
The cardholder must pay back the amount of money used, either all at once every month or in minimum monthly installments. If they keep a balance on the card, monthly interest is charged and added to it. This is known as revolving credit. Credit card interest rates tend to be high, and as interest not paid is added to the principal every month, they can quickly balloon to an amount that the cardholder may be unable to pay back, which is why it is always wiser to pay your balance in full every month. Credit card debt is a significant problem for many people in the United States.
Accumulating credit card debt that you cannot pay off can happen easier than you might think, and should be guarded against.
Your credit score is one way for banks and credit card companies to tell if you can qualify for a loan. They look at your history with money in something called a credit report, of which you have more than one. The most trusted credit score is the FICO Score, compiled by FICO (formerly Fair Isaac Corp.). It is used by 90% of U.S lenders. The three major U.S. credit bureaus—Equifax, Experian, and TransUnion—developed VantageScore, which lenders will also consider, as an alternative to FICO.
Each credit score is generated through its own mathematical formula called a scoring model. The criteria looked at include:
- Your history of paying bills on time (or not)
- Any current debt
- How many and what kind of loans you may have
- How long you have had those loans
- The amount of your available credit you are currently using
- Any new applications for credit you have made
- Whether you have defaulted on any debt in the past
Scores generally range on a scale from 300 to 850. The higher the score, the better your chances of getting credit. Your credit score will ultimately determine the kind of interest rate and loan terms you are offered—if, of course, a loan is offered at all.
When you use money to acquire an asset that you hope will generate income or appreciate in value, that is an investment. There is no guarantee, however, that investments will always make you money—it is quite possible to lose money instead. Generally, the riskier the investment, the higher the profit if it does succeed. Even a savings account is an investment, although the low interest rate means that the money it generates won’t amount to very much. This is due primarily to its safety, being guaranteed against loss by the FDIC.
Possible investments of varying risk are all around you, from real estate to opening a business. A major form of investment is the stock market. Let’s get into two ways you can do that: stocks and bonds.
Successful investing is one way to grow your money supply, but it does come with risk.
A stock is a share of ownership in a company, which the company issues for purchase as a way of raising capital. They are acquired via the stock market in a practice known as trading. When the company does well, the price rises and your stock value increases. If it does poorly, the price drops and your investment loses money.
Stocks come with considerable risk, because they are tied to the success of the company. If the firm does badly or loses the confidence of its investors, the stock price can quickly fall. Indeed, it’s possible for an investor to lose all of their money when a stock tanks. Of course, this also means that they can generate higher profits if they succeed.
Bonds are issued by governments and corporations as a means of raising money. Unlike stocks, they do not provide ownership in the issuer. Instead, a bond purchaser makes a loan to the issuer that must be paid back at a predetermined time. The issuer pays periodic interest to the purchaser while it has use of their money, generally twice a year.
Bonds are safer investments than stocks and used by investors to generate a steady stream of income that can compensate for potential losses in stock investments. The U.S. government issues them in the form of Treasury bonds (T-bonds) that have a term of either 20 or 30 years and are considered virtually free of risk.
Bonds may provide a steady stream of income, but the amount is fixed. This means that their value can be reduced by inflation, which is an overall increase in the price of goods and services over time. If things cost more but your income doesn’t increase to match the rise in prices, then your money is worth less than it was before, because it can’t purchase as much as it used to be able to buy. To calculate the rate of inflation, the government looks at a consumer basket of commonly purchased items, known as the Consumer Price Index (CPI), tracking the cost of buying the items in the basket over time.
Economists theorize a variety of causes of inflation, including too much available money in an economy, expectations of rising prices becoming a self-fulfilling prophecy, and sudden shocks to an economic system. An example of the last would be the COVID-19 pandemic, which caused soaring worldwide inflation in 2021 and 2022.
It was Benjamin Franklin who wrote, “In this world, nothing is certain except death and taxes.” Governments, whether federal, state, or local, tax their citizens to raise revenues to fund their activities and services, such as building and maintaining infrastructure (e.g., roads, bridges, subway systems), running schools, fielding a military, and providing social programs like Medicare and Social Security. Taxes are mandatory, have been around for more than 5,000 years, and are how we pay for the collective good.
There are three basic types of taxes: income, property, and sales. They are levied as a percentage on what you earn, own, and buy. Federal, state, and local income taxes are withheld from the paychecks of salaried employees. For the self-employed, federal income taxes must be paid only in estimated quarterly installments. Federal income tax returns must be filed annually, usually no later than April 15, though the date can vary slightly depending on weekends and holidays. Most states also use April 15, though there are some exceptions.
Property taxes are collected at regular intervals, most often semiannually, and are paid in arrears (i.e., you pay your 2022 taxes in 2023). Sales taxes are paid when you make your purchase. If you don’t pay your taxes, the repercussions can be severe, so it’s very important to understand how they work.
Why is financial literacy important?
If you don’t understand the basic concepts of our financial system, then you won’t be able to accumulate the money necessary to live well in it.
Which is better: bonds or stocks?
It depends on your investing goals. Bonds are less risky than stocks and provide a steady stream of income. Still, their worth can be eroded by inflation. Stocks can be a gamble, but when they rise in price, they can provide much better returns than bonds.
Why do I have to pay my taxes?
The government levies taxes to provide for the common good. Without them, society wouldn’t be able to function. Paying taxes is a social responsibility and should be taken very seriously, as the consequences for not paying them can be harsh.
The Bottom Line
Money is the engine of our society, so knowing all about it and how to use it is crucial to success. Increasing your financial literacy can help you realize your potential when it comes to managing and investing money.
You need to know where to put, how to protect, and how to grow your hard-earned cash while understanding the economic forces that could damage it if you are not careful. Oh, and never forget to pay your taxes.