What should I be doing with my money? Tons of online resources try to help us answer this question, but many of us don’t find them helpful. Why?
Part of the problem is there are too many sites telling us to do different things, often leaving us more confused than when we first asked the question. With so many conflicting opinions (and lots of misinformation) out there, how do we decide what the right next step is for us?
The key is to equip ourselves with the knowledge and skills to evaluate our options, make decisions, and execute a plan tailored to our financial goals. In other words, the key is to become financially literate.
The journey to becoming financially literate can be daunting. We don’t know what we don’t know, so we may not even have a clear picture of what it is we’re trying to learn. In this post, I’ll share how I think about personal finance topics to help stage the learning process for those who are in the early stages of their financial literacy journey.
Becoming financially literate
Many of us will start the financial literacy journey and immediately feel lost because we don’t know where to begin. On top of that, we might feel ashamed because we think we should know more than we do. We might feel embarrassed because talking about how we manage money can be such a taboo topic. We might feel defeated because, even before looking at any numbers, we sense that our spending habits and debt situation have our backs against the wall.
We all experience some combination of these feelings when we start to get serious about financial literacy. The goal of this blog series is to help you overcome these feelings to ultimately give you a greater sense of agency in your life by breaking down what you need to know about managing personal finances.
This post is the first in the series where I introduce seven broad topics that I believe capture everything someone would possibly need to know about to make good financial decisions. In future posts, I’ll dive deeper into each of these seven topics with the intent of giving you enough information to confidently make decisions that help you attain your individual goals.
Before beginning, I want to make it clear that I am NOT a financial advisor. I have not taken any formal training nor earned any certificates that equip me to offer personalized financial recommendations.
What I can provide are reflections based on my own journey and learnings. These reflections are shared to equip you with the information you need to make the right decisions for yourself.
With that out of the way, let me tell you about my journey to financial literacy.
My financial literacy journey
Over the last six years, I’ve had to teach myself much of what I know about managing personal finances because I didn’t receive much of that education growing up.
At home, there was only so much I could learn about personal finances. My parents were limited in the knowledge they could pass down because immigrating to the US presented them with cultural and language barriers that made it difficult to access financial advice.1
School did little to help. Topics related to personal finance are simply not a part of the official curriculum, so teachers don’t cover them.
Having not learned much about finances before adulthood, I found myself overwhelmed when I started working full-time. My level of ignorance made me feel insecure while navigating employee benefits like retirement account options.
These early days at work made me painfully aware that life will push forward whether I’m ready or not, and the actions I take (or don’t take) will influence how my life turns out. With this in mind, I decided to take the initiative and seek out educational resources that would improve my level of financial literacy, or ability to understand and apply money ideas and skills.
While some of these resources came from work, the most helpful ones came from publicly available sources.
My job gave me access to formal educational resources specific to individual employee benefits, but no official resources put benefits into context by teaching about personal finance management as a whole. Work also offered access to informal financial mentors and professional financial advisors. Both can be great given the right circumstances. However, they can come with biases or their own self-interest in mind. After all, financial advisors are in the business of selling you financial products and services.
My financial literacy took off when I found books, podcasts, and YouTube videos offering a diverse set of perspectives across a wide range of personal finance topics. I felt I could trust what I was learning because the narrators and central characters in those media had verifiable repeated success over long periods of time.
Early in the learning process, I made one serious mistake: I signed up for a real estate investing course that offered no real value and cost me thousands of dollars. If I could go back, I’d restrict myself to only content by or about time-tested experts that I can find for free. The best foundational advice can all be found in libraries and on webpages that don’t have paywalls, so there’s no need to take a risk by buying expensive products and services early on. As an early scam victim, I’m now extremely cautious about paying for any personal finance products and services, especially those that sound too good to be true.
With that said, investing in my financial literacy was a great no-regret move early on. If I had to start over, I would again start by learning the basics from reputable and free sources before doing anything risky.
Staging the journey
The second thing I did was a mistake: I opened a brokerage account and started investing in the stock market.
While I’m glad that I started investing early, it would have been wiser to think carefully about the different aspects of my finances and make a plan before taking risks with my money.
The way I see it, there are seven overarching categories that cover all of the most important topics in personal finance, and it would have been best for me to learn the basics of each of these categories before making any moves involving risk.2 These seven categories are cash flow, insurance, savings, investments, credit, pitfalls, and taxes.
Cash Flow
Although many don’t use this terminology, most people are very family with cash flow. It describes income (cash coming in) and expenses (cash going out). The wages you earn from a job are examples of income and your bills are examples of expenses. Everyone needs cash flow to live (excluding those who are 100% self-sufficient). In simple terms, we get jobs to trade time for money, and we use money to pay for our lifestyles. Budgeting, or the planning and management of expenses, falls under this category.
Insurance
Most people are somewhat familiar with insurance as well, but many don’t think about how insurance fits into their overall financial health. Insurance products can protect you and your loved ones from financial disaster in the event of misfortune like damage (e.g., car insurance), injury (e.g., health or disability insurance), or death (e.g., life insurance). Because you need money to buy insurance, it makes sense to figure out your cash flow before figuring out insurance.
Savings
Savings are sums of money that are set aside for later payouts. The money generally comes from income that’s not used to pay for expenses, so it makes sense to figure out cash flow before savings. I think it also makes sense to figure out insurance before savings because misfortune can strike at any moment. Your savings may not always be large enough to cover the cost of the misfortune. But a good insurance policy will cover those costs and protect your savings from getting wiped out.
Most know what savings are, but don’t always use them well. Savings can be used for large purchases (e.g., a computer, a car, a house), emergencies (e.g., urgent medical care), or life changes (e.g., unemployment, moves, family planning). Savings without a clear purpose can be under- or over- funded, so it’s important to define savings targets.3
Investments
Investments are commitments of money (or other resources) for greater future reward. I think of investing as the conversion of time, risk, and cash on hand into a reasonable possibility of future reward. Investing generally involves taking on some risk of losing money, so it’s unwise to invest any money that you cannot afford to lose.
Nowadays, people commonly invest in bonds (loans to the government or companies), stocks (portions of businesses), real estate (including residential and commercial properties), precious goods (like gold, silver, and fine art), and cryptocurrencies (like bitcoin and ethereum). By their nature, some of these investment vehicles cannot always be quickly turned back into cash (it can take a long time to sell a property).
As with savings, money for investing comes from excess income, so it makes sense to figure out cash flow before investments. Because you cannot always get out what you put in when you need it, investments are not considered a stable form of protection against financial hardship. That’s why it’s still a good idea to protect yourself and loved ones by buying adequate insurance and building up an emergency savings fund before investing.
Credit
The credit category covers matters where trust is used to delay payment for a product or service. Credit, or debt, enables us to borrow from our future income to make purchases in the present. Someone who uses credit is a borrower and someone who extends credit is a lender. A credit score is a number that describes a borrower’s credit worthiness, or how much confidence a lender should have that a borrower will pay off their debt as agreed. This number can be very important because it is often used to qualify people for new lines of credit (including credit cards, car loans, and mortgages) and even rental housing applications.
I like to think of debt as an amplifier for good and for bad. On the good side, someone can use credit well to accelerate investments, effectively making their returns greater than they’d be if they’d only used cash on hand. One can also use debt to discount purchases (by using rewards like cash back) and make large purchases that deliver a lot of non-financial value much sooner than would otherwise be possible (like a home).
On the bad side, someone who’s not careful can use debt to spend more money than they can afford. This kind of debt can not only hurt one’s credit score, but also charge interest that makes each purchase more expensive. If left unchecked, unpaid debts can grow faster than they’re paid off and create a debt spiral, which can be a very serious problem. Because credit can be so dangerous, I think it’s especially wise for people to take whatever time is needed to understand it well before experimenting.
In general, debt cannot substitute for cash flow or investments in the long term. Given its role as an amplifier of the two, it makes sense to figure out credit after cash flow and investments.
Pitfalls
I consider pitfalls to be unreasonable financial mistakes that lead to meaningful losses. The pitfalls that concern me most are get-rich-quick schemes (especially pyramid schemes) and gambling.
Get-rich-quick schemes are a type of scams that promise fast returns using strategies that cannot reliably achieve those results.
Pyramid scheme and multi-level marketing are terms that describe companies whose employees make money at the expense of newly enlisted employees. These companies are a type of get-rich-quick scheme. They use predatory enlisting practices and unsustainable business models to make money for existing employees. Although they are officially illegal in the United States, several continue to operate following controversial court rulings. If you’re approached by one of these companies, it’d be wise to walk the other way.
Gambling is betting on very low probability or random events. While investing also involves placing bets, gambling is significantly more risky because little to no strategy can be applied to minimize risk and it’s designed to make loss exceedingly likely.
In my mind, speculation falls under the category of gambling. Speculation can describe the placing of short-term bets on traditional investment vehicles (like stocks). This carries greater risk than investing over long time horizons because this approach incurs repeated transaction costs, higher taxes, and risk associated with volatility, or short term changes in the prices.
Speculation can also describe misinformed investments including those based on inconsequential or unreliable information. This includes anything that doesn’t influence the return of an investment (e.g., the outside temperature does not influence the price of gold).
It’s important to recognize and avoid pitfalls, as a single one can undo any prior financial success and lead to financial ruin. Before spending money on any educational courses or investment ideas, it’s worthwhile to find out how to identify potential pitfalls.
Taxes
Taxes are mandatory payments to the government that fund public services. The government taxes people upon some sort of transaction such as a payment, a sale, or an exchange of ownership. Some types of taxes include income tax, sales tax, capital gains tax, and estate tax.
Two of the more controllable types of taxes for most people are income tax and capital gains tax. Income taxes are federal and state taxes taken from income. Capital gains taxes are federal taxes taken from returns on investments including bonds, stocks, real estate, precious goods, and cryptocurrencies.
Taxes can have a significant impact on how much of the money you and your investments earn you get to keep.
To lower your income tax obligation in a given year, you can take advantage of tax deductions, which lower how much of your income is considered taxable. Here are some examples of things that lower taxable income in a given year: tax-advantaged retirement accounts (like a traditional 401K), savings accounts for health expenses (like an HSA or FSA), 529 plan (tax-advantaged savings accounts for future education expenses), capital losses (money lost while investing), and charitable donations.
To lower your capital gains taxes, you can hold investments over longer time periods. In a given year, your capital gains tax obligation is calculated as a percentage of the increase in price of the investment. For example: if you buy a stock for $10 and sell it for $15, you will be taxed on the $5 ($15 – $10) price increase. By holding investments for at least a year before selling, you lower the taxes you pay on capital gains.
While I think taxes are an important consideration for investors, I consider taxes less important than actually investing. So I think it makes sense to figure taxes out after investments. Failing to understand credit and pitfalls can have a much greater impact on the overall financial health of beginners than can failing to understand taxes. People who make a lot of money or are mature in their investment strategies should worry about taxes more than the average person just starting the financial literacy journey. And at that point, you’d probably want a tax professional to help you handle these issues anyway. For all these reasons, I think most can afford to figure out taxes last.
Conclusion
While there’s much more that can be said about each of these personal finance topics, I hope this introduction helps demystify what financial literacy is all about. If you get a handle on these seven topics, you can consider yourself financially literate. Stay tuned for my next posts, where I’ll dive deeper into each of these topics.
This is the order in which I wish I learned about these topics. If I had, I believe things would have clicked for me much sooner than they did. That said, there is nothing wrong with learning about these topics in a different order. If your interests inspire you to take a different journey, you should feel empowered to sequence your learning accordingly. Different journeys will make sense for different people.
The thing about personal finance is that it truly is personal. Different people will have different values, have different goals, and be at different stages of their financial journey. Even the same person can have their values and goals change over time. That’s why someone else’s journey and next best step may not be the right next step for you. May your knowledge and skills equip you to make the right next step for you.
Footnotes
1 Despite having little help, my parents got me off to a good start. They navigated the US banking system, instilled in me the importance of saving, and funded my first savings account.
2 There’s no one definite right way to think about personal finance management. Different people will make sense of personal finance topics in different ways. That’s part of what makes it personal. As long as the way you think about it makes sense, helps you reach your goals, and leaves room for growth, there’s nothing wrong with it.
3 Bank accounts can be great tools to enable not only saving, but also investing and borrowing. Not having a bank account can be a significant barrier to opening and funding brokerage accounts, which are used to buy and sell investment vehicles like stocks. A bank account is also helpful to have when applying for certain financial products like credit cards and mortgages.