Published November 1, 2016|7 min read
We can all admit to making a few obvious financial blunders at some point or another that we should have known better about.I can think of those times I let myself go overdraft on my checking, wondering why I didn’t pay more attention to how much money I had remaining in my account. There was that period when I had no clue that a late payment on a loan -- even when it was in full -- meant getting hit with a penalty fee.
Looking back, those facepalm-worthy moments taught me some valuable lessons about managing money better, avoiding the same mistakes, and becoming more financially responsible. But that’s not always the case for many people.More than two-thirds of American men and women are considered financially illiterate, lacking the most basic, rudimentary knowledge of simple financial concepts like savings, budgeting, credit or debt. And the worst part isn’t that a poor understanding of money can keep one stuck in a cycle of bad money habits -- it’s that the financially illiterate person isn’t even aware of their behavior and the net effect it can pose to their financial profile.Let’s be honest with ourselves and think about how many times we’ve made the following mistakes that could hurt our financial goals:
Your credit score is not just some randomly assigned number. A truly financially literate person will know that it’s a 3-digit representation of their creditworthiness, the first figure that a creditor or lender will look at to decide if you’re worth lending money to.FICO scores range on a scale of 300 to 850 (from poor to excellent), and they’re calculated according to what’s listed in your credit report -- a complete history of your credit activity. When you apply for a line of credit or loan, a score of 350 will get you rejected; a score of 750 will likely get you approved with an attractive interest rate. Anyone looking to gain some more money smarts will get a copy of their credit report and frequently monitor their credit score. It’s a number that you’re in control of changing based on the amount of credit you use, but more important, if you pay your credit cards and loans on time.
Understanding how interest compounds and accrues on a loan or credit card is one of the most important pieces of financial smarts anyone can have, since it can prevent you from paying more than you originally borrowed.One of the big misconceptions is not understanding how interest affects various types of credit accounts. Your credit card might carry a huge 24% penalty APR, but it doesn’t affect your balance if you pay it in full by the due date. On a student loan, though, interest is always building and capitalizing every day, even when you’re still in school.A financially literate person will get to know each of their loans (from student loans to auto loans and mortgages), calculate their interest rates, and take the steps to prevent them from taking hold of their finances, like paying off your interest first. For credit cards, the solution is simple: pay off your balance and the interest can’t touch you. It can save hundreds, if not thousands, of dollars in the long run.
More than one-third of the average household income is paid for taxes each year, yet it’s still so easy to be a novice about taxes, since many are deducted automatically from your paycheck. But when it comes tax filing season, the more you know the ins and outs of your income taxes, the better.Whether you choose to file your taxes yourself or hire a professional to do the heavy lifting for you, a big chunk of financial literacy comes from knowing where your taxes are going, the types of forms you need to file, and most important, if you can take any deductions to save money at the end of the year.You don’t need to learn taxes like a second language, become an amateur CPA, or know the exact differences between a W-2, a W-9 and a 1040. But keeping track of your financial activity throughout the year, saving your receipts, and maintaining records of everything you’ve spent and borrowed makes tax time a whole lot simpler. If you go the DIY route, investing in tax software like TurboTax can greatly simplify the process -- plus it can make all the difference between being financially smart and in trouble with the IRS.
Technically, there is no such thing as "good" debt, since interest rates (see above) will inflate the amount of money that you originally borrowed. A Financial Literacy 101 lesson will summarize it as this: Good debt is money borrowed to purchase assets that increase in value, while bad debt is money borrowed towards items that decrease in value. An example of good debt is a mortgage loan, since a home is an asset that appreciates in value over time. Borrowing money to purchase a rental property is also a type of good debt advocated by the likes of financial expert Robert Kiyosaki, since your tenant’s rent can help pay off the loan. Student loans may also be considered good debt because it’s hoped that your future salary post graduation can help pay off the money you borrowed to attend school.Bad debt, on the other hand, is reserved for the likes of high-interest auto loans, since cars begin to depreciate the moment you’ve driven off the dealer lot. In this case, your ongoing loan payments reflect the original value of the car, not the value of the vehicle as it decreases in value. Knowing the details of good versus bad debt may be the mark of a financially literate, versus illiterate, person.
There’s a reason why banks keep details of their fees and surcharges opaque, hidden behind a cloud of smoke, mirrors and fine print -- presumably, they don’t want customers comparing costs and prices and choosing to bank somewhere cheaper. In essence, they want you to remain less financially literate and pay unnecessary expenses against your knowledge.It’s not just overdraft charges you need to be vigilant towards. A host of other banking fees exist, but remaining oblivious to them goes against the point of smart banking. Many banks charge monthly maintenance or account fees, especially if your checking balance falls below a certain amount. Even a simple $8 maintenance charge amounts to $72 a year.Then there are account closure fees, lost credit/debit card fees, and even foreign transaction fees for traveling abroad, each of which can average $20 to $30. Stay financially intelligent, look up your bank’s fees, and seek out accounts with low to zero fees that won’t penalize you for going about your business.
HMO or PPO? Term or whole policy? Personal liability, or the other guy’s fault? Do I insure my new car, or just go without, and cross my fingers that I don’t get into an accident? Insurance is a topic so complex that it’s not even a matter of financial literacy or illiteracy if you’re in the dark about it.Your safest bet? Ensure that you insure yourself with even the most basic coverage you can while you research your options. Opt for a simple healthcare or auto insurance plan to keep you covered in the event of an emergency; even those with minimal coverage will minimize your out-of-pocket costs.Stay financially aware and assess your needs for additional insurance coverage; for instance, a single person with no dependents may not need a large life insurance policy, if any at all. An apartment dweller may consider renters insurance, while property owners are required to pay homeowners insurance. (And the financially intelligent person will know how it’s incorporated into your monthly mortgage payment.)If you read this article and found that you’ve made all of these mistakes, don’t despair. There’s no time like the present to start adopting better financial habits and save money. Some tips:
Start by building a household budget, mapping out a spending plan, and sticking to it
Pay off your credit cards and bills on time each month, and review your credit report at least once a year
Avoid putting all purchases on your credit card, but don’t avoid credit altogether
Investigate if your local bank, credit union, or community college holds a financial literacy course
Consult with certified professionals, like financial planners, brokers and agents when opening new accounts or shopping for insurance
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