Your financial well-being depends on having financial knowledge.
It’s crucial to improve your financial literacy, especially if you’re just starting out in the world of finance. There are several ideas that all novices should learn, regardless of whether you’re creating your first bank account or simply attempting to ensure that you’re well-versed in the subject.
You can’t function in current society successfully if you don’t know how to manage money. Although there are several levels of financial literacy, beginners must understand some fundamental ideas before climbing the knowledge ladder. On your path to financial fluency, you must understand the following 12 key terms.
You must deposit your money somewhere, and a savings bank or credit union is typically the safest option due to the Federal Deposit Insurance Corp.’s (FDIC) protection against losses. A checking account is one of the accounts that these financial organizations provide. A checking account is made to give you easy access to your money for everyday transactions like paying bills or making purchases.
The minimum balance requirement of the bank must be met in order to avoid paying a monthly fee to keep your account open, therefore you should only retain as much money in your checking account as you need for expenses. Write a paper check to any person or organization you owe money to in order to access your cash, but be careful not to overdraw your account by doing so. If you do, you can incur overdraft fees and bounced checks.
A debit card, which is more widely used and practical than a paper check in this digital age, can also be used to access the money in your checking account. You can avoid carrying cash when you use a debit card. The majority of retailers accept them, and all you need to do to transfer money from your account to the seller is swipe your card through a machine and enter your personal identification number (PIN).
In order to obtain cash, you can also use your card at an ATM. Naturally, you are only able to access the funds in your account, and some banks may charge you a fee for using the card.
Your savings are kept in a savings account, as the name implies. Instead of the cash you need to cover normal expenses, money is retained for future use. You might have to pay a monthly charge to keep the account open, depending on how much money you have in it. A minimum balance requirement and a cap on the amount of money you can withdraw in a given period of time might also be present.
The bank compensates you by paying interest each month, which boosts your hard-earned savings because the money has some utility while it is in your account (the bank can lend it to other customers). The FDIC also provides loss insurance for most savings accounts.
Simply put, interest is the cost that a person or other entity pays to borrow money. Interest is calculated as a portion of the total amount borrowed over time.
Interest comes in two flavors: simple and compound. The principle, or real borrowed amount, is the sole amount on which the first is paid. The second is added to the principal as well as any prior interest. Compound interest generates greater profits for a lender than simple interest as a result.
A loan is a contract between two persons or entities wherein one party temporarily lends the other party a certain amount of money. For the privilege of receiving the money, the recipient must pay interest. Loans can be used to pay for expensive purchases like a car, a house, or a college degree.
The length of time before the loan must be repaid (sometimes referred to as the date of maturity) and the kind, percentage, and timing of interest are all included in the loan terms. Collateral, which is anything a borrower supplies as a promise to repay the loan, may also be present. The lender seizes the collateral in the event that the borrower is unable to repay the loan when due, a situation known as a default, rather than receiving their money back.
Consumers with sufficient financial standing can apply for a credit card, which is a type of loan. A financial institution issues a plastic card bearing the cardholder’s name and an account number. Up to a predetermined sum of money known as the credit limit, the card can be used to make in-person and online purchases of goods. If the cardholder needs money, they can also use it to get a cash advance.
The cardholder is required to reimburse the whole amount spent, either in a single payment every month or in minimum monthly installments. Monthly interest is assessed and added to the balance if they keep a balance on the card. This type of credit is revolving. It is usually advisable to pay off your balance in full each month because credit card interest rates are frequently high and, since unpaid interest is added to the principal each month, they can quickly grow to an amount that the cardholder may not be able to repay. For a large number of Americans, credit card debt is a serious issue.
Banks and credit card businesses use your credit score as one indicator of your lending eligibility. You have more than one credit report, and they all contain information about your financial history. The FICO Score, created by FICO, is the most reliable credit score (formerly Fair Isaac Corp.). 90% of lenders in the United States use it.
VantageScore, which lenders will also take into consideration, was created by the three main U.S. credit bureaus—Equifax, Experian, and TransUnion—and is an alternative to FICO.
A scoring model, which is a unique mathematical formula, is used to create each credit score. The factors considered 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
Typically, scores fall between 300 to 850. Your prospects of obtaining credit are better the higher your score. If you are offered a loan at all, your credit score will ultimately determine the type of interest rate and loan terms you receive.
An investment is when you spend money to purchase an item that you anticipate will increase in value or produce income.
But, there is no assurance that investments will constantly increase your wealth; it is entirely conceivable to experience a loss of capital. In general, the larger the risk, the higher the potential payoff.
Even a savings account counts as an investment, even though the small amount of money it will ultimately produce due to the low interest rate. This is mostly because of its safety, which is supported by the FDIC’s loss guarantee.
A stock is an ownership interest in a corporation that is made available for purchase by the firm in order to raise money. Trading is the process of acquiring them on the stock market. Your stock value improves when the business does well, which raises the price. If it performs poorly, the price drops and you lose money on your investment.
Equities carry a high level of risk due to their connection to a company’s performance. The stock price may drop sharply if the company performs poorly or investors lose faith in it. In fact, if a stock declines, an investor could lose everything they have. Naturally, if they are successful, this also means that they can make more money.
Governments and businesses both issue bonds as a means of raising capital. They do not give ownership in the issuer, unlike stocks. Instead, a buyer of bonds provides the issuer with a loan that must be repaid over time. While using the purchaser’s funds, the issuer periodically pays interest to them, often twice a year.
Bonds are a safer investment than stocks and are utilized by investors to produce a consistent income stream that helps offset potential stock investment losses. They are distributed by the U.S. government in the form of Treasury bonds (T-bonds), which are thought to be almost risk-free and have terms of 20 or 30 years.
Bonds may offer a consistent income stream, but the sum is fixed. This indicates that inflation, which is a general increase in the price of goods and services over time, has the potential to lower their worth. Your money is worth less than it used to be if things cost more but your income doesn’t rise to keep up with the increase in costs since you can’t buy as much as you used to. The Consumer Price Index (CPI), which tracks the cost of purchasing the items in the consumer basket over time, is used by the government to determine the rate of inflation.
Inflation is thought to be caused by a number of factors, including excess money supply, self-fulfilling prophecies about rising prices, and abrupt shocks to an economy.
An illustration of the latter is the COVID-19 pandemic, which resulted in extremely high global inflation in 2021 and 2022.
In this world, only death and taxes are guaranteed, according to Benjamin Franklin.
Governments, whether at the federal, state, or local levels, levy taxes on their citizens to generate revenue to pay for their operations and services, such as the construction and upkeep of public utilities like roads, bridges, and subway systems, the operation of educational institutions, the fielding of a military, and the provision of social programs like Medicare and Social Security. Taxes are a necessary payment method for the common good that have been around for more than 5,000 years.
Income, property, and sales taxes are the three main categories of taxes. They are assessed as a percentage of your income, assets, and purchases.
Salary employees’ paychecks are withheld of federal, state, and local income taxes.
Just anticipated quarterly installments of federal income taxes are required from self-employed people.
Annually, federal income tax returns must be filed; the deadline is typically April 15; however, weekends and holidays may cause the date to change somewhat.
Notwithstanding few outliers, most states likewise utilize April 15th.
Property taxes are gathered on a regular basis, usually every half-year, and are paid in arrears (i.e., you pay your 2022 taxes in 2023).
You must pay sales taxes at the time of purchase.
It’s crucial to comprehend how taxes operate since the consequences of not paying them can be severe.
Why is financial literacy important?
You won’t be able to amass the wealth required to live comfortably in our financial system if you don’t comprehend its fundamental ideas.
Which is better: bonds or stocks?
Depending on your investing objectives. Bonds offer a reliable revenue source and are less risky than equities. Yet, inflation has the power to reduce their value. While stocks might be risky, they can offer substantially better returns than bonds when their prices climb.
Why do I have to pay my taxes?
Taxes are imposed by the government to fund public goods. They are necessary for society to function. Because the repercussions of not paying taxes can be severe, paying taxes is a civic obligation that should be taken extremely seriously.
The Bottom Line
Knowing everything there is to know about money, as well as how to use it, is essential for success in contemporary culture. You may be able to manage and invest money more effectively if you increase your financial literacy.
You need to grasp the economic factors that could harm your hard-earned money if you are not careful in order to know where to deposit, how to protect, and how to increase it. Oh, and make sure you pay your taxes on time.