According to the National Financial Educators Council, a lack of financial literacy costs the average American over $1,200 each year! One of the main reasons people continue wasting money, instead of getting ahead, is that they’re unaware of some key financial concepts.
In one way or another, most people want to be more successful with money. They might dream of investing in alternative assets, achieving a certain net worth, or building independent wealth. But, all too often it takes decades for these things to happen if they ever do at all because they were never taught the financial concepts that make them all possible!
If you dream of a wealthier future, there are 8 important financial concepts that you must understand. After putting them into practice, you’re all but guaranteed to have greater success with money!
Unfortunately, many people struggle to make ends meet. Without a spending plan, they’ll buy until their heart’s content which typically leaves their bank accounts empty, if not worse!
Many people don’t save money and believe that they will once they start earning more. However, as their incomes rise, they tend to have greater lifestyle creep because they haven’t built the financial discipline that’s required to save!
Consider Mike Tyson. He made an estimated $430 million throughout his career, yet still had to file for bankruptcy. No amount of money would have prevented this from happening either, since you can’t earn your way out of poor spending habits and bad money management skills!
When it comes to budgeting, the most important financial concepts to grasp are living below your means and saving. Doing them ensures that you’ll have money left over at the end of the month. On top of that, savings is the catalyst that allows you to start an emergency fund, pay down debt, and begin working towards your dreams!
Many times, people’s thoughts about money also control their actions. They may use phrases like, I can’t afford it or I’ll never have the money to do that which gets ingrained into their subconscious mind. Little do they realize, these restrictive thoughts are part of the reason why their dreams are likely to never come true!
Your money mindset has a strong influence on the way you manage your finances. For example, if you view money as evil or bad, then you’ll do your best to get rid of it as quickly as possible!
However, seeing money as a tool that can improve your family’s finances and quality of life will likely be a source of motivation. Instead of squandering it, you’ll concentrate on building wealth for the difference it can make not only in your life but the lives of others as well!
It’s important to realize that past money mistakes can affect your mindset, too. You may feel guilt or shame for being wrong or having a lapse in judgment. But by forgiving yourself and understanding that everyone makes mistakes, you’ll feel at ease and be better prepared for everything that’s still to come!
As we discussed in the first financial concept, keeping your burn rate low allows you to save money. Then as your savings build, you’re able to build a strong financial foundation. However, there does come a point when saving money alone is no longer beneficial. In fact, inflation makes it detrimental to your long term success!
Inflation measures how fast the prices of material goods and services are changing. The higher it is, the faster your money is losing value and the fewer goods it will buy. Over time, inflation causes the money that you have sitting in checking and savings accounts to become worthless!
Still, you need to budget, so that you can save. But, there’s a limit to the amount you should have sitting idle in the bank. As a rule of thumb, keep it to roughly 3 to 6 months of your spending. Once you have this money set aside in a rainy day savings account or emergency fund, the remaining balance will need to be put to work.
Beating inflation requires that you earn a real rate of return. To do that, you’ll need to determine the best use of your money. For many people, this means paying down high-interest rate debt. Once your extra money is working and outpacing inflation, you’ll start building real wealth!
Whether you realize it or not, inflation also takes a toll on your income. If your earnings don’t keep up with it, then you’re getting a pay cut in real terms!
According to Yahoo!, over half of Americans have credit card debt. While the amount varies, they’re all subjecting themselves to the detrimental side of compounding interest!
Every month that you carry a credit card balance, you’ll owe interest. In some cases, even if you make the payments on time, the amount you owe can still grow larger. Because of this, you’re not only stuck in debt longer, you’re also forced to shell out more for interest!
For many people, this cycle can last for years, if not decades. They choose to live beyond their means and rack up debt, only to realize later that they’re handcuffed to a job for years to come!
Unfortunately, too many people are using the financial concept of compounding incorrectly. They pay interest, instead of earning it and building their fortunes!
To use the power of compounding to your advantage, you must invest. Doing so, allows your investment capital to grow and be reinvested for further growth. As your gains start earning gains, your wealth begins to grow exponentially!
Most decisions, financial related or not, have trade-offs. By making one decision, you’re likely giving up another option altogether. For example, if you choose a late night out with friends, you’re forgoing one of rest and recuperation.
Opportunity costs are the potential losses you would experience from choosing one option over another. This is an important financial concept because every dollar you receive has an opportunity cost associated with it.
For instance, every time you spend money there’s an opportunity cost, especially when it’s on things you don’t enjoy. Each dollar that’s spent on something less than ideal is one less that you have to spend on something that’s meaningful or makes you happy!
For example, imagine you’re at a dealership and are about to emotionally spend on a car that’s $200 over budget. If you buy, you’re choosing to spend $200 extra on transportation each month. But, by forgoing the purchase and staying on budget, you’ll have money to allocate to something that’s potentially more important. Not only that, but you may have to reduce spending in another budget category to make it all work!
When it comes to spending money, there’s no right or wrong answer. It’s just important to understand that there’s an opportunity cost associated with it and overdoing it will be at the expense of your goals!
How comfortable are you with your job security? Paying for an emergency? Fluctuations in financial markets?
These questions, among others, help to determine your risk tolerance. Once answered, they provide insights into your money personality and potential actions you should take to be comfortable during a financial crisis. For instance, imagine you’re worried about losing your job. Worrying and stressing about a job loss won’t improve your situation. But, updating your resume, job hunting, and building a cash runway are all actions that can!
Commonly, risk tolerance is a financial concept that’s associated with investing. The greater your risk tolerance, the easier it is for you to stomach large swings in the market. While this is part of it, risk tolerance also applies to other areas of personal finance, like determining what’s adequate insurance or the amount of cash you have in reserve.
When it comes to net worth, most people think of it in terms of dollars and what they can buy. After all, the greater it is, the more you have to spend!
In reality, your net worth is a good indication of your financial wellbeing. The higher it is, the easier you can handle emergencies and the less likely you are to be financially insecure. While that’s helpful to a degree, the real magic happens when you track your net worth over time!
Calculating your net worth every month or two shows whether your day-to-day habits are adding to your bottom line or making you broke. When your net worth is trending up, your financial health is improving. Whereas a falling net worth indicates your financial health is in decline.
Tracking your net worth doesn’t just show how much money you’ve amassed, either. It also indicates the amount of time freedom you have as well!
For example, imagine your net worth is $100k and you have $10k in monthly expenses. At this spending level, you’d have 10 months to spend however you wanted before you’d have to start earning money again. However, if you were able to be more frugal with money and spend $5k per month, then you’d have 25 months of freedom and a 150% increase in free time!
One common money myth that holds people back from living out their dreams is that retirement happens at a certain age, like 62. Despite working for 40 years, some people won’t have saved enough money to quit work and support themselves during the decumulation phase.
Rather than age, your understanding and execution of all the previous financial concepts determine the date you can retire!
For instance, if you want to be working well into your 60s, then there’s not much incentive to pay attention to any of the financial concepts listed above. However, if you want the freedom to chase your dreams, you’re going to have to save aggressively and implement every one of these concepts without delay!
Understanding these financial concepts gives you the knowledge to make better decisions with your money. But, your situation won’t improve until you continually put them into practice!
Are there any financial concepts you would add? Comment below.
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