7 Reasons Why Financial Literacy Should Be Learned at a Young Age
Learning how to manage your money for a lifetime of financial well-being does not have to be overwhelming. As former President Bill Clinton stated, financial literacy is simply “a very fancy term for saying spend it smart, don't blow it, save what you can and know how the economy works.” Read on to learn seven reasons why now is the time for you to start honing your financial literacy savvy.
1. Knowing How to Use a Budget is the Foundation for a Lifetime of Good Financial Habits
The word “budget” doesn’t sound like fun, but it simply means creating a plan for how to spend money (which does sound like fun). Knowing how much you earn, how much you spend and how much you save is the most basic way to help you avoid mistakes that will set you on a bad financial path. Experts recommend a 50/30/20 budget: spend 50% of your after-tax dollars on necessities like rent, electricity, gas and food; 30% on wants, like miscellany and entertainment; and 20% on savings and debt repayment.
2. Understanding Interest Can Help You Use It To Your Advantage
Interest is a fee paid for the use of another party’s money. Sometimes you gain interest and sometimes you pay interest. An example of gaining interest is when a bank pays you interest on the money in your savings account. The bank will pay you a percentage, usually .01% - 0.6% annually. So if you have $200 in the bank and it pays you 0.5% interest, you gain $1.00 for the year.
You pay interest when you borrow money from a lender. For example, when you use a credit card, you are borrowing that money and the credit card company charges you interest. An average credit card interest rate is 17%. A $100 purchase will actually cost $117 after one year, so it would be smart to take $100 from that savings account and pay off the credit card, because otherwise you are paying more interest ($17) than you are gaining ($1). Paying attention to your interest rates and what you are gaining vs. losing will help you make wise short-term and long-term financial decisions.
3. How You Save Your Money Makes a Big Difference in Your Return on Investment
There are several ways you can save your money. You can use a piggy bank; a savings account; a certificate of deposit (CD); a money market account; United States Treasury bills or notes, among other things. Each of these has a different return on investment (ROI), which is how much you gain or lose on the money you deposited. A piggy bank yields no ROI, so it probably isn’t your best bet except for the purpose of keeping some cash handy. There are pros and cons to each method of savings. For example, some accounts give a greater ROI, but penalize you if you don't keep a minimum balance. Some have a waiting period before you can take the money out, which is inconvenient if you need funds in a hurry. Knowing what savings options fit your needs can make your money work for you.
4. Balancing Your Checkbook (Yes, They Still Exist!) and Debit Account Helps You Avoid Unnecessary Fees
People do still use checks, so knowing how to balance a seemingly archaic checkbook is important. Unlike debit card transactions that post within hours if not seconds, it can take days, weeks or months for a check to get cashed. Watch your bank account regularly to see when funds for those checks have been withdrawn and how much money you have in the bank. If you do not have enough money in your account and someone tries to cash a check you've written, it “bounces” because of non-sufficient funds (NSF). That means the person cannot receive the money you committed to paying them with your check. Not only will your bank charge you a fee for a bounced check, but the person or company to whom you’ve written the check may charge you as well.
Keeping track of withdrawals and deposits is just as important with your debit card. If you make a debit card purchase and do not have enough money in your account, many banks will allow the transaction—which sounds pretty nice of them until you get hit with overdraft fees. Overdraft fees range from $10 to a whopping $40. That could make your $5 grilled cheese a $45 grilled cheese. Some banks even continue to charge $5 to $10 a day until there are funds in your account. If you don’t get a paycheck for another week, that $45 grilled cheese could now cost you another $70. If you have a bank that simply declines the transaction, you are spared the overdraft fees, but are in the publicly embarrassing situation of being unable to pay for your lunch.
5. Your Credit Rating and Credit History Have a Huge Impact on Your Life
No doubt you have often heard the terms “good credit" and “bad credit”—what exactly do they mean? A credit rating is a score that estimates how safe it is to lend a person money, based upon previous dealings. The term “previous dealings” is important, because lenders judge if they should lend you money based on whether you have borrowed money in the past and are paying it/have paid it back. This is called your “credit history.” Having a good credit history is incredibly important for your life: it impacts applying for a credit card, purchasing a home or car, renting an apartment, buying insurance, signing up for certain utilities, and even getting a new job.
6. There Is Such a Thing as Good Debt and It Will Help Build Your Credit Rating
While it seems counterintuitive, having debt actually gives you a better credit rating, provided that you fulfill your payment obligations in a timely manner. Lenders want to see that you have a credit history, which you cannot have if you’ve never had debt. 18-year-olds can start establishing a credit history by becoming an authorized user on their parents’ credit card and/or opening a secure credit card.
Often “debt” is considered a bad word, but not all debt is bad. Good debt is an investment that will increase in value over time and/or generate income. A home mortgage is an example of good debt, because a home usually increases in value. Still, it is important not to have too much debt. Financial experts recommend that no more than 15 to 20 percent of your income goes toward paying consumer debt. This does not include a mortgage, but does include credit card debt, student loans, car loans, and other types of loans. If you’re paying too great of a percentage of your income on debt, you are in the Debt Danger Zone. Mastering that 50/30/20 budget discussed, above, will help you keep a healthy amount of debt as you get older.
7. Student Loans Are One of the Best Types of Debt to Have
Finally, we’ve gotten to the financial topic that probably worries you the most: student loans. The bad news is that tuition costs are incredibly high. The good news is that student loans are one of the best types of debt you can have. First, federal student loans have low interest rates that will not change over time. Second, as long as you make your minimum payments, student loan debt will improve your credit rating. Third, having a college education increases your lifetime earning potential. So while having to pay off student loans is stressful, it is a positive investment in yourself that will increase in value.
Individuals with higher levels of financial literacy are more likely to have rainy-day funds, retirement plans, minimal credit card debt, low-cost mortgages, and a healthy attitude toward money. Learning the basics of financial literacy at a young age gives you skills that will help you make smart money choices throughout your life.