Financial Literacy – Lesson 1 – Where do I start?

Last week we described the mindset needed to understand the value of money. Although the concepts presented were very basic, its importance can not be overemphasized. When one begins to build resources and wealth one must also understand the field and space that one is operating in. Much like chess has rules and bounds on which to play, money has similar rules and bounds. There are limitations to the power and importance of each “piece” and strategy and tactics follows your knowledge of how to maneuver. To be frank, you can not play a competitive game of chess if you do not understand the value, power, and limitations of each piece.

So how do we get started?

With the basics.

The foundation of effectively managing your money comes from your knowledge of your money. It then stands to reason that we start with your current situation and knowledge and that is summed up in one word. BUDGET. Do you budget your money? If not, YOU MUST START HERE.

I know, I know. Very basic.

What you do, if you do not do this already, is to currently assess your financial situation. You must know how much money comes in every month and where that money goes out every month. Every single dollar needs to be accounted for and addressed. Likewise if you have debt, this needs to be addressed as well. Start by taking all of your current monthly bills and adding them up, we will refer to these as expenses. Next, take all of your monthly income and add this figure up. Subtract your monthly income from your monthly expenses. If this number is not a positive number, you’re in trouble. You are living beyond your means and you must either reduce your expenses or increase your income to make this number a positive one. This means that you are using up more value than you are providing and is not sustainable. I know it is appealing to live a life full of excess but what you are actually doing is giving up future opportunities for present ones and sooner or later this will catch up to you and you will have neither. I am going to continue and assume that you are not in this category, but if you are, take heed and change this situation as soon as you can.

With your monthly expenses summed up, divide this number by 4. We do this to come to a weekly average of your budget (4 weeks in a month typically). This smooths out your monthly expenses and sets your budget in a weekly figure, making you aware of the weekly cash flow you must set aside to pay your obligations. You should then use a credit card responsibly to pay these obligations as they come up, and then pay your credit card balance off IN FULL every month before the due date to avoid paying any interest. Why do I advise the use of a credit card? Because this process will help you 1) build good credit standing, 2) help you stick to your budget and plan, understanding where “your means” really are, and 3) to take advantage of credit card perks like cash back or flyer miles for paying expenses you would anyway. When used responsibly credit cards have the function of taking your monthly expenses and smoothing them out. You could very well find that a majority of your monthly expenses may fall on one week or day, like the first of the month. Using a credit card and avoiding excessive fees where possible makes it to where you can shift this amount and average it over the course of a month while also earning credit card perks and building good credit. If you are new to credit, or have a negative credit standing, you may have a low credit card limit. In this case, you’ll have to use your card to make smaller purchases, like gasoline or food, and pay the balance off IN FULL before the due date every month until your credit score becomes positive enough to cover your monthly expenses with its increased credit limits. Some may need to provide capital to get issued a credit card, this is called a secured card and is done because of your credit standing. You may need to save this amount first before you can implement this course of action.

Speaking of saving, lets get to that.

When you receive your income (paycheck) you MUST PAY YOURSELF FIRST. When you receive these funds, aim to take 10%, AS A START, and set them aside in a savings account. The higher you can get this percentage, the better obviously. This is done so you are not tempted to spend the money. Without thinking, take 10% (if possible) of your income and put it into a savings account. If you can only comfortably save 5%, adhere to that but aim to improve this number. Next take your weekly obligations and also set that aside, understanding this money is already accounted for and gone. What you are left with is income that you can spend and not hurt your financial situation. I encourage you to save a portion of this if possible, but this represents your “means”. You can not spend more than this amount of money or else you will be living in a state of unsustainable excess. At some point, you will become comfortable with living on this allowance. You will understand what limitations you have in financial matters and that is important.

The reason I stress this process is simple. Many people have a nasty habit of spending everything they have. They receive their income, spend spend spend, and then pay off obligations and MAYBE just MAYBE if there is something left over, they save. They work more and more hours, accumulating overtime, and still spend it. They get raises doing the work they do, but still mysteriously end up being just as bad financially than when they got paid less, or worked less hours. This is why some people can get paid $1000 or $2000 a week, and still end up living paycheck to paycheck. Don’t believe me?  $150k and still paycheck to paycheck. Here is another example. AND another. It is NOT as uncommon as you think.

The problem stems from having the habit of spending everything you make. No matter how much you make. The solution is to have a budget and understanding how to live off a certain amount. Many people will find that they can live comfortably on a set amount of income in this manner. If you get a raise, work more overtime, or come across unexpected income, set that aside the same way you did your monthly obligations. Any amount of money over the budget that you have grown accustomed to living on is money that is not necessary or vital to your well-being. You should save enough money to cover your monthly expenses for 3 to 6 months, in case of an emergency. If you lose your job or CHOOSE to change careers, if you have unexpected car repairs or other expenses, or just find yourself in a tough financial situation, you wont need to sell investments in order to bridge the financial gap you’ll be experiencing. Investments should be taken only with money you do not immediately need. “Immediately” means in 6 months time or less. Investments tend to trend higher OVER TIME, but frequently experience moments of volatility, moments where the value of an investment will go up or down for no real rhyme or reason. This is the most basic of situations to be in before seriously considering investments of any kind.

This is going to conclude this conversation on this lesson. I provide this conversation to prepare the reader in future topics and assume that this scenario has been reached. If anyone has any questions, please comment below or contact me and i will try to respond in a timely manner.

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