This article was recently published in CommunityAmerica's "Let's Talk Money" section of theKansas City Star.
There are three foundational concepts to know to help you build your financial expertise. These 3 concepts can help you build and achieve financial peace of mind.
1. Budgeting
This concept is often misunderstood as a way of keep you from spending money on what you want. But budgeting is actually quite the opposite! It’s all about financial awareness — of how your money is being spent so you can align your spending with your priorities and goals.There are several methods that can help you set up a budgetand track progress, including the 50/30/20 system, which has you allocate 50 percent of your income to needs, 30 percent to wants, and 20 percent to savings.
Another approach is the envelope system, where you put a set amount of cash for the month into one envelope for each designated spending category, such as groceries, gas, restaurants, medicine, hair care/makeup, and entertainment. When you eat out (or order delivery) and pay with the cash in your restaurant envelope, you’ll see once the envelope is empty that you’ve spent your monthly limit for that expense.
Regardless of the method you choose, you’re deciding how your money will be spent. What you see as your “wants” or “needs” may fall differently in someone else’s budget. For example, if lattes and yoga classes are considered “needs” in your book, then so be it.
Because just like a diet, the best budget is one you can stick to.
2. Credit Score
Credit scores are numerical representations of your “creditworthiness” – how likely you are to repay a loan based on your previous borrowing history, as well as your ongoing credit activity.
Credit scores are used to screen applicants for mortgages, car loans, credit cards and insurance, as well as apartment or other rental agreements, and can also determine the interest rates and credit limits you’ll be offered.
Everyone has more than one credit score, and actually more than the three you get from the credit reporting bureaus - TransUnion®, Experian® and Equifax. In fact, you could have many credit scores because every entity evaluating your credit uses a different model and will give you a different score.
If you only remember one thing about credit scores, it’s that paying your bills on time is one of the most important things you can do to maintain or improve your credit.
3. Interest vs. Compound Interest
Interest is expressed as a percentage, and in the case of a loan, interest is the “cost” or “fee” you pay to borrow money.
There is simple interest and compound interest. Simple interest – for loans – is calculated using only the principal amount of a loan, while compound interest is based on the principal amount and the interest that accumulates on it during a credit period.
Because compound interest builds or accrues at a higher rate, a credit card balance can add up fast — as interest is being added to the accumulated interest of previous periods. That’s why if you’re making only the minimum payment every month, you’re not actually reducing the amount you owe on the item you initially purchased. Instead, your money is only going to pay interest.
Conversely, when it comes to your savings or investing, compound interest has a positive effect — it allows your money to “earn” money. For example, if your compound interest rate is 10 percent on $1,000 savings, you first gain $10. As your balance increases and the interest “compounds,” you earn money on your original investment plus the interest that’s added each month.
Remember, when you're looking at putting your own money somewhere like a savings account or CD, to look for a higher rate, compounded more often. If you're borrowing money, like for a loan or on a credit card, find a low rate, compounded less often.
The Importance of Financial Literacy
Your finances aren’t just about your money. They affect so many aspects of your life — where you live, how you live, vacations, goals (such as retirement, starting a business, or how you give back to your community), and the well-being of your family.
Learning about financial terms and concepts is an important step to help guide you on your journey to financial well-being. If you have questions about setting a budget, improving your credit score, or want to learn more about using interest to your advantage, CommunityAmerica is here for you. Contact a certified Well-Being Coachtoday, or visit your nearest branch.
FAQs
3 Essential Financial Concepts You Should Understand
- Budgeting. This concept is often misunderstood as a way of keep you from spending money on what you want. ...
- Credit Score. ...
- Interest vs. ...
- The Importance of Financial Literacy.
When following the 10-10-80 rule, you take your income and divide it into three parts: 10% goes into your savings, and the other 10% is given away, either as charitable donations or to help others. The remaining 80% is yours to live on, and you can spend it on bills, groceries, Netflix subscriptions, etc.
What are the five financial concepts? ›
Financial literacy is about understanding concepts like budgeting, building and improving credit, saving, borrowing and repaying debt, and investing—and having the ability to apply them to real-life situations.
What is the hardest concept in finance? ›
Generally, our research shows that candidates' CFA Level 1 hardest topics are Financial Statement Analysis, Fixed Income, Quantitative Methods, Derivatives and Economics. Meanwhile, CFA Level 2 most difficult topics are typically Financial Statement Analysis, Portfolio Management, Ethics and Derivatives.
What are the three C's of finance? ›
Character, capital (or collateral), and capacity make up the three C's of credit. Credit history, sufficient finances for repayment, and collateral are all factors in establishing credit.
What is the basic concept of finance? ›
Essentially, finance represents money management and the process of acquiring needed funds. Finance also encompasses the oversight, creation, and study of money, banking, credit, investments, assets, and liabilities that make up financial systems.
What is the 50 30 20 rule? ›
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. The savings category also includes money you will need to realize your future goals.
What is the 70 20 10 rule? ›
The 70-20-10 budget formula divides your after-tax income into three buckets: 70% for living expenses, 20% for savings and debt, and 10% for additional savings and donations. By allocating your available income into these three distinct categories, you can better manage your money on a daily basis.
What is the 30 day rule? ›
The premise of the 30-day savings rule is straightforward: When faced with the temptation of an impulse purchase, wait 30 days before committing to the buy. During this time, take the opportunity to evaluate the necessity and impact of the purchase on your overall financial goals.
What are the 5 C's of finance? ›
The five C's, or characteristics, of credit — character, capacity, capital, conditions and collateral — are a framework used by many lenders to evaluate potential small-business borrowers.
There are six basic principles of finance: 1) the principle of risk and return ties higher risk to higher potential returns, 2) the time value of money principle recognizes money loses value over time, 3) the cash flow principle prefers earlier cash flows to later ones, 4) the profitability and liquidity principle ...
What are the 5 basics of personal finance? ›
Personal finance basics include budgeting, saving, investing, managing debt, and understanding credit. Budgeting involves tracking income and expenses, setting financial goals, and making informed spending decisions. Saving is important for emergencies, future goals, and retirement.
What is the hardest financial skill? ›
“The hardest financial skill is getting the goalpost to stop moving.” “Saving is a gap between your ego and your income.” “Money buys freedom, but freedom doesn't create money.”
Is finance harder or accounting? ›
Is finance harder than accounting? Accounting relies on precise arithmetic principles, making it more complex, whereas finance requires a grasp of economics and accounting without as much mathematical detail.
What is the most basic financial model? ›
Three-Statement Model
The three-statement model is the most basic setup for financial modeling.
What are the 3 major functions of finance? ›
The three basic functions of a finance manager are as follows:
- Investment decisions.
- Financial decisions.
- Dividend decisions.
Most financial management plans will break them down into four elements commonly recognised in financial management. These four elements are planning, controlling, organising & directing, and decision making. With a structure and plan that follows this, a business may find that it isn't as overwhelming as it seems.
What are the three main approaches of finance? ›
3 approaches to Financial Management
Action control, personnel control, and result control differ from each other but are usually combined. 1. Action control: This approach controls the actions of personnel by preventing certain actions or ensuring that they follow certain regulations or processes.
