Two commonly used personal budgeting methods are the 50/20/30 and 70/20/10 rules, and their simplicity is what makes them popular. The former entails dividing your after-tax, take-home income pay into three areas—needs (50%), savings (20%), and wants (30%). The 70/20/10 rule also follows a similar blueprint, recommending that your after-tax, take-home income be divided into segments that cater to expenses (70%), savings or reducing debt (20%), and investments and charitable donations (10%).
Becoming financially literate involves learning and practicing a variety of skills related to budgeting, managing and paying off debts, and understanding credit and investment products. Basic steps to improve your personal finances include creating a budget, keeping track of expenses, being diligent about timely payments, being prudent about saving money, periodically checking your credit report, and investing for your future.
The lack of financial literacy can lead to a number of pitfalls, such as accumulating unsustainable debt burdens, either through poor spending decisions or a lack of long-term preparation. This in turn can lead to poor credit, bankruptcy, housing foreclosure, or other negative consequences.
Emma is a high school teacher who tries to inform her students about financial literacy through her curriculum. She educates them on the basics of a variety of financial topics, such as personal budgeting, debt management, education and retirement saving, insurance, investing, and even tax planning. Emma reasons that although these subjects may not be especially relevant to her students during their high school years, they will nonetheless prove valuable throughout the rest of their lives.
Understanding concepts such as interest rates, opportunity costs, debt management, compound interest, and budgeting, for example, could help her students manage the student loans that they might rely on to fund their college education and keep them from amassing dangerous levels of debt and endangering their credit scores. Similarly, she expects that certain topics, such as income taxes and retirement planning, will eventually prove useful to all students, no matter what they end up doing after high school.
Developing financial literacy to improve your personal finances involves learning and practicing a variety of skills related to budgeting, managing and paying off debts, and understanding credit and investment products. Here are several practical strategies to consider.
Create a Budget—Track how much money you receive each month against how much you spend in an Excel sheet, on paper, or with a budgeting app. Your budget should include income (paychecks, investments, alimony), fixed expenses (rent/mortgage payments, utilities, loan payments), discretionary spending (nonessentials such as eating out, shopping, and travel), and savings.
Pay Yourself First—To build savings, this reverse budgeting strategy involves choosing a savings goal (say, a down payment for a home), deciding how much you want to contribute toward it each month, and setting that amount aside before you divvy up the rest of your expenses.
Pay Bills Promptly—Stay on top of monthly bills, making sure that payments consistently arrive on time. Consider taking advantage of automatic debits from a checking account or bill-pay apps and sign up for payment reminders (by email, phone, or text).
Get Your Credit Report—Once a year, consumers can request a free credit report from the three major credit bureaus—Experian, Equifax, and TransUnion—through the federally created website AnnualCreditReport.com.5 Review these reports and dispute any errors by informing the credit bureau of inaccuracies. Because you can get three of them, consider spacing out your requests throughout the year to monitor yourself regularly.
Check Your Credit Score—Having a good credit score helps you obtain the best interest rates on loans and credit cards, among other benefits. Monitor your score via a free credit monitoring service (or, if you can afford to and want to add an extra layer of protection for your information, use one of the best credit monitoring services). In addition, be aware of the financial decisions that can raise or lower your score, such as credit inquiries and credit utilization ratios.
Manage Debt—Use your budget to stay on top of debt by reducing spending and increasing repayment. Develop a debt-reduction plan, such as paying down the loan with the highest interest rate first. If your debt is excessive, contact lenders to renegotiate repayment, consolidate loans, or find a debt-counseling program.
Invest in Your Future—If your employer offers a 401(k) retirement savings account, be sure to sign up and contribute the maximum to receive the employer match. Consider opening an individual retirement account (IRA) and creating a diversified investment portfolio of stocks, fixed income, and commodities. If necessary, seek financial advice from professional advisors to help you determine how much money you will need to retire comfortably and to develop strategies to reach your goal.
In recent decades financial products and services have become increasingly widespread throughout society. Whereas earlier generations of Americans may have purchased goods primarily in cash, today various credit products are popular, such as credit and debit cards and electronic transfers. Indeed, a 2019 survey from the Federal Reserve Bank of San Francisco showed that consumers preferred cash payments in only 22% of transactions, favoring debit cards for 42% and credit cards for 29%.
Other products, such as mortgages, student loans, health insurance, and self-directed investment accounts, have also grown in importance. This has made it even more imperative for individuals to understand how to use them responsibly.
Although there are many skills that might fall under the umbrella of financial literacy, popular examples include household budgeting, learning how to manage and pay off debts, and evaluating the tradeoffs between different credit and investment products. These skills often require at least a working knowledge of key financial concepts, such as compound interest and the time value of money.
Given the importance of finance in modern society, lacking financial literacy can be very damaging to an individual’s long-term financial success. Unfortunately, research has shown that financial illiteracy is very common, with the Financial Industry Regulatory Authority (FINRA) attributing it to 66% of Americans.
Being financially illiterate can lead to a number of pitfalls, such as being more likely to accumulate unsustainable debt burdens, either through poor spending decisions or a lack of long-term preparation. This in turn can lead to poor credit, bankruptcy, housing foreclosure, and other negative consequences.
Thankfully, there are now more resources than ever for those wishing to educate themselves about the world of finance. One such example is the government-sponsored Financial Literacy and Education Commission, which offers a range of free learning resources.
Personal finance is where financial literacy translates into individual financial decision-making. How do you manage your money? Which savings and investment vehicles are you using? Personal finance is about making and meeting your financial goals—whether that’s owning a home, helping other members of your family, saving for your children’s college education, supporting causes you care about, planning for retirement, and much more. Among other topics, it encompasses banking, budgeting, handling debt and credit, and investing. Let’s take a look at these basics to get you started.
Trends in the United States indicate that Americans’ financial literacy is declining. In its National Financial Capability Study, conducted every few years, the finance and bank regulator FINRA poses a five-question test that measures consumers’ knowledge about interest, compounding, inflation, diversification, and bond prices. In the latest study, only 34% of those who took the test answered four out of five questions correctly.1
Yet making informed financial decisions is more important than ever. Take retirement planning: Workers once relied on pension plans to fund their retirement lives, with the financial burden and decision-making for pension funds borne by the companies or governments that sponsored them. Today, few workers get pensions; some are instead offered the option of participating in a 401(k) plan, which involves decisions about contribution levels and investment choices. Those without employer options need to actively seek out and open IRAs and other tax-advantaged savings accounts.
Add to this people’s increasing lifespans (leading to longer retirements), Social Security benefits that barely provide enough for basic survival, complicated health and other insurance options, more complex savings and investment instruments to select from among—and a plethora of choices from banks, credit unions, brokerage firms, credit card companies, and more. It’s clear that financial literacy is a must for making thoughtful and informed decisions, avoiding unnecessary levels of debt, helping family members through these complex decisions, and having adequate income in retirement.
Financial literacy is the ability to understand and make use of a variety of financial skills, including personal financial management, budgeting, and investing. It also means comprehending certain financial principles and concepts, such as the time value of money, compound interest, managing debt, and financial planning.
Achieving financial literacy can help individuals avoid making poor financial decisions to help them become self-sufficient and achieve financial stability. Key steps to attaining financial literacy include learning how to create a budget, track spending, pay off debt, and plan for retirement. Educating yourself on these topics also involves learning how money works, setting and achieving financial goals, becoming aware of unethical/discriminatory financial practices, and managing financial challenges that life throws your way.