Working with a trusted financial professional is important when it comes to strategizing and preparing to meet your financial goals. However, as most of us handle money daily, it’s important to have an in-depth understanding of the fundamentals of financial literacy. Below we’ve identified five financial basics everyone should know. Understanding these important concepts can serve as a basis for your financial standings.
Basics #1: Debt & Credit Scores
Understanding the ways in which credit or debt can work with or against you should serve as the foundation of your financial knowledge. First and foremost, it’s not wise to avoid credit or debt altogether out of fear or intimidation. Instead, it’s important to have a firm grasp on your financial standings and a plan for tackling debt responsibly.
Debt
When used correctly, debt can be useful. When misused, it can spiral out of control fast. Missed payments can accrue interest or penalties and may impact your credit score in a negative way. Debt that is managed responsibly can help you reach important goals like buying a car, purchasing a home, going to college, starting a business and more.
Credit Score
Your credit score is one of the factors lenders use to judge your trustworthiness and qualification for mortgages, auto loans and other lending opportunities. Landlords and employers may also check your credit before renting to you or offering you a job. Your credit score is dependent on a few factors including previous credit history, current debts, history of payments and more.
Basics #2: Interest
There are two sides to interest that can make it a tricky concept to grasp – interest accrued on debt and interest accrued on savings.
When you take on debt (like credit card debt, an auto loan or mortgage), you’ll be responsible for paying back both the principal amount and the interest accrued on the loan. The interest is how a lender makes money on the loan and provides the borrower with an incentive to pay the loan back in full and on time.
When you have a savings account that accrues interest, the interest earned gets added to the principal. Then, interest is earned on the new, larger principal, and the cycle repeats. This is called compounding interest, and it can be an integral part in growing your retirement savings – the longer the interest has to compound, the greater the savings will grow.
Basics #3: The Value of Time
As a rule of thumb, it’s never too early to start saving – for retirement, homebuying, a child’s education or whatever could be coming down the line. The earlier you start saving, the more you’ll be able to tuck away over time – especially with the power of compounding interest. This leverages the value of time to your advantage.
Basics #4: Inflation
Inflation has the potential to eat away the purchasing power of your money. That means, with inflation, the dollar you earn today may not be worth a dollar in the future. Below are two important concepts to remember regarding inflation.
Cash in a Mattress
Keeping all your cash under a mattress is not only unsafe, but it also literally costs you money. Assuming the annual rate of inflation is a hypothetical 3%, every dollar you keep under your mattress and not earning interest would shrink in value to $.97 next year.
Rate of Return
Because inflation erodes the purchasing power of your money, any returns you earn on your accounts may not be the “real” rate of return. If your account earned a hypothetical 6% rate of return over the last year, but inflation was 1.5%, your real rate of return was 4.5%.
Basics #5: Identity Theft & Safety
Especially as the world shifts to doing everything virtually, identity theft remains one of the biggest threats to financial and personal security. A cracked password or misplaced Social Security number can have big consequences on your current and future finances.
The common wisdom is to use a unique password for each site or service you use. A password manager can make this easier by generating and storing strong passwords automatically.
In addition to using strong, unique passwords, it’s also important to enable two-factor authentication (2FA) wherever it’s available. 2FA adds an extra layer of protection by requiring a second form of verification—such as a temporary code sent to your phone or generated by an authentication app—before granting access to your account. Even if a password is compromised, 2FA can significantly reduce the risk of unauthorized access and help safeguard your financial and personal information.
Understanding the fundamentals of financial literacy—from managing debt and protecting your credit score to harnessing the power of compound interest, accounting for inflation, and safeguarding your personal information—can provide a strong foundation for long-term financial success. Each of these basics plays a critical role in helping you make informed decisions and move confidently toward your goals.
While building your knowledge is an important first step, putting these principles into action with a thoughtful strategy is just as essential. To learn how these financial basics apply to your unique situation, contact your Patriot advisor for personalized guidance and a plan designed to help you stay on track toward your goals.