How to Become Financially Literate

From: “The Financial Physician: How to Cure Your Money Problems and Boost Your Financial Health”

book 1

FINANCIAL ILLITERACY

THE AILMENT 

Would you sit down at a high-stakes poker table in Las Vegas if you didn’t know how the game was played? Of course not! If you did, you would be throwing your money away. In the beginning, you might be lucky and win a few hands, but in no time flat, your ignorance will catch up with you and you would lose your shirt. 

Well, everyday, millions of people do something just as inconceivable. They go through life without understanding money and finances. They try to make ends meet, pay their bills, fill their families’ needs, buy homes and cars, save and invest even though they have little or no knowledge about what they’re doing. So many of them fail … unnecessarily.

Most of us have never been taught how to manage our personal finances so most of us are financially illiterate. 

DIAGNOSIS 

At school, they teach us about all sorts of subjects, many of which we may never use. We learn about ancient civilizations and mythology, but not about the basics of managing our money. Although managing our money is an essential skill that we constantly must use, it’s not a part of most school curriculums. So when it comes to money, most of us don’t know what to do.

To complicate matters, the subject of money and finance is made to seem complex, confusing and beyond our grasp. When we first learn about it, most of us find it intimidating so we’re not drawn to it. Many of us hope that others will manage money for us or think that we can always learn about it at a later time, but few ever do.

Lack of financial literacy is the reason why most people don’t accumulate wealth. It’s also why they make financial mistakes, fall in debt, can’t provide for their loved ones and jeopardize their futures. Getting into financial trouble is easy; people have lost all their money because they made just one financial blunder. The most common mistakes include speculating, putting too much money into one asset class, overpaying, spending frivolously and taking bad advice.

The National Foundation of Credit Counseling is the nations largest and longest serving national nonprofit credit counseling network. Each year, it counsels more than ¾ of a million people about bankruptcy. It estimates that 25% of those it counseled attributed their financial problems to the fact that they didn’t know how to manage their money.

VITAL SIGNS 

The most prominent symptom of financial illiteracy is buying what you can’t afford. People routinely purchase items that are more than they need and cost more than they can afford. To do so, most take on debt. In many cases, they don’t understand debt and how it can quickly spiral. Before long, the amounts they owe mount and exceed what they can afford to repay. 

When it comes to their finances, most folks don’t know what they’re doing, they don’t know how to figure out what they can afford, the best ways to buy, save and invest. Much of the present financial crisis occurred because people took out mortgages that they didn’t understand and subsequently couldn’t repay. When it came to mortgages, they were illiterate and didn’t know what they were getting into. They couldn’t tell when they were being “sold,” being put into no-win situations or given poor advice. 

Nearly half of all Americans live from paycheck to paycheck because they don’t understand how to manage their personal finances. They are only one or two paychecks away from being broke. They have no wiggle room for the emergencies and unexpected expenses that always pop up. 

KEEPING UP WITH THE JONSES

Lots of people get into financial trouble because they try to keep up with their friends and neighbors. They see them living extravagant, luxurious lives and want to follow suit. However, it’s hard to tell what lies beneath those lavish facades. The people who seem to have so much may earn more than we do or be subsidized by their wealthy families. They may be putting on a grand front when everything inside is falling apart and be deeply in debt. 

Live within your means. Don’t be envious or tempted by the opulent lives of others. Putting on a big show may be all they have. Realign your priorities from today to tomorrow and build your net worth and your future.

TREATMENT    

Get more education. Learn about basic economics. If you asked ten people what the GDP (gross national product) is, only one or two would know. Learn about the items below, which I’ll discuss in detail in the chapters that follow. They are: 

Investing: I regularly see people who have hundreds of thousands of dollars at risk and do not understand where that money is and how that investment works. So my first job is to educate them and encourage them to learn on their own. Learn the basics. If you don’t, you can’t take an active role in managing your own investments. You can’t help make decisions on how to invest your own money and will be forced to rely on others. 

At the least, every investor should know the basics about stocks, bonds, mutual funds and annuities. Specifically, they must understand the advantages, disadvantages and costs involved for each such as commissions, penalties and surrender fees. Finally, they must know how to measure the risks involved. 

Credit and debt: When used properly, credit is great because other people’s money can help you get rich. An example of good credit is low-interest, fixed-rate mortgages that are used to acquire property that increase in value. For example, if you can put down 20%, borrow 80%, and the value of the property increases, that is an excellent use of credit. Unfortunately, as the value of their properties has gone up, too many people have refinanced them and used the equity to fund consumer purchases.

The best example of bad debt is credit cards. Credit card debt is cancer to the financial body. Most credit cards charge high rates of interest, but despite that fact, many people use them to support themselves or buy items that they cannot afford, really do not need and should not buy.

Insurance: Although insurance accounts for 10% to 15% of most people’s expenses, most know little or nothing about it. You don’t have to become an expert, but learn the basics about insurance. Most people I see have either too much or too little insurance, they don’t understand it and how it should be used. Few shop around to find the best values. As a result, they have too much, too little or the wrong type of insurance. They also tend to have the wrong deductibles and pay the wrong premiums for the wrong types of life insurance. 

Taxes: Most people are so fearful of the IRS and so ignorant about taxes that they pay others to do work that they easily could do themselves. Many could have prepared their own tax filings while others might have noticed costly mistakes that their tax preparers made. Since taxes take a portion of our wealth, we should all manage our money in the most tax-efficient way. To do so, we must understand deductions, tax-free investments, tax-deferred investments and other strategies that enable us to keep more of our money. The more money we can keep, the more we can invest for our futures.

Estate planning: Many people die without a will or having done any estate planning. They have made no provisions or left no instructions on what should be done when they die. Estate planning can insure that your money will go where you wish and it can decrease taxes and red tape for  your survivors. Most people are not prepared to die and leave their families with time-consuming and costly messes that easily could have been avoided.

Goal setting: Few people have a plan. They live their lives on the fly. If they can save some money, they do — but usually, they can’t and they don’t. You can’t succeed if you don’t know where you want to go. Determine how much money you want for the future. It could be money for the down payment on a home, for you kids’ education, for investments, an emergency fund, for your lifestyle or your retirement nest eggs. 

  • Set specific financial goals
  • Write your goals down
  • Live with discipline to achieve your goals. 

Goal setting helps us lead more financially disciplined lives. When we know that we have firm objectives, we will be more inclined to work to achieve them. Realistically, most goals won’t be fully achieved, but if you achieve some of them, or better yet, most of them, you will be well ahead of the game. You will be saving or investing some, rather than saving or investing nothing and then trying to scramble when it may be harder or too late.

Most people don’t say, “I’ll save $300 every month and put it into a mutual fund portfolio that will pay for my retirement.” Nor do they set aside specific sums for each of their children so that they will have the money they need to pay for their college educations when they need it. They don’t put money aside to pay for vacations. Instead, they charge them on high-interest credit cards.

Keep current: Stay up to date of finances and the economy. Pay attention to the economic developments that are reported in the media. News and information affects your investments and impacts your financial planning. Follow the news about subjects such as finance legislation, unemployment, inflation, and housing starts.

Things change. And when they change, they can provide money-making opportunities for those who see them coming and are prepared to act. Follow the news and developments about subjects such as finance, tax legislation, unemployment, inflation, housing starts, politics and market performance. Learn what’s going on in your locale and in your areas of interest. Form alliances with people who can be your investment partners.

Become more disciplined: Don’t spend money unless you have it. It’s old advice that is seldom followed. People keep spending when they can’t afford to. Since most don’t plan for the future, they just live for today. Unfortunately, the future comes very quickly and catches them off guard. When it does, they may be well past their peak earning years and may be unable to acquire what they need. Starting early in life really helps. 

If you don’t start planning for your child’s college education until he or she is 14, it may be too late. And, if you can pull it off, it will take a major effort that may leave you with little money for anything else. However, if you start when your child is one, you can put in less, let it build and compound.

Build net worth by:

  • Preparing for the future instead of just living for today
  • Buying what you need, not what you want
  • Educating yourself about finances
  • Being as frugal and disciplined as you can.

Becoming financially literate isn’t hard, but people don’t take the trouble to increase their knowledge. Many are afraid that they won’t be able to understand what they have to do or think that they lack the discipline to live a more financially healthy life. Become financially literate by:

  • Reading books and publications on finances. Many excellent books can teach you basic personal financial management. 

MY RX

For most people, the financial crisis has been a wake up call. It has forced them to begin learning more about and paying attention to their financial situations and their futures. In the new financial landscape, people will become more frugal, more goal conscious and hopefully more financially literate so they can achieve their goals.

Financial literacy is an ongoing process. Once you start and gain some knowledge, you’ll want to keep up. It will become an interest, a fascination, that you enjoy and incorporate as a regular part of your life. Plus, it will help you increase the quality of your life.

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