Most of us were never explicitly taught how to handle money. While financial education courses are included in secondary school curricula in England, these mandates only apply to locally governed schools, of which only make up about 60% of England’s schooling system.
Further, the majority of theses courses present financial literacy through arithmetic and don’t focus explicitly on financial concepts. If you are lucky, you may have learned how to manage money from your parents but many people, young and old, have to learn on their own through trial and error.
We believe that everyone should have a basic financial education so that they learn how to responsibly manage money. That is why were are here to offer a quick guide on basic concepts everyone should know about personal finance.
Things like credit, budgeting, interest, and saving are important concepts everyone needs to have a firm grasp on to navigate today’s economy. Without any further ado, let’s get to it.
Budgeting is a simple concept that everyone has heard of but most people never learn how to do it effectively. Budgeting is more than just keeping track of how much money you spend; it’s about creating a plan that helps you manage expenses and get ahead. Here are the basic steps to making an effective budget.
1. Calculate Expenses
The first thing you need to do is calculate your total expenses. You can do this by consulting your bank statements, receipts, and other financial records.
Since some expenses are intermittent, the best way to get an accurate picture of your expenses is to calculate an average for a 6-12 month period. Total expenses can vary significantly depending on where you live. Living in London will accrue more expenses than living in Manchester, for example.
2. Determine Income
Next, figure out what your total income needs to be to cover your expenses from month to month. Make sure you include any extra sources of revenue, such as cash gifts, personal sales, and (if applicable) interest and stock dividends.
3. Allocate Income for Expense
At the very least, your income should cover your basic expenses. Most financial experts recommend spending 30% of your income on housing, 20% to savings, and the rest for other expenses.
4. Determine Savings and Payoff Goals
If you are going to save and manage any debt effectively your income has to cover your basic expenses with room to spare. If you are making more than you are spending, then good job! You can save the extra amount.
If you make less than you are spending, you will need to cut spending. The best way to do this is to track individual expenses and cut out any non-necessities. Try to cut spending so you can save at least 20% of your income every month.
5. Be Realistic
You should try to stick to your budget as much as possible as that will help you achieve your goals quicker. It is ok to deviate from your budget sometimes, but make sure you get back on track as soon as possible.
Let’s talk about interest, another concept many have heard of but may not know much about. There are 2 major kinds of interest: simple interest and compound interest. Simple interest is relatively straightforward: An initial amount of money (called the principal) gains value in proportion to a fixed percentage of that initial value over a period of time. So if you invest £10,000 with an interest rate of 3.875% over 5 years, you would have a total of £11,937.50.
Most kinds of interest in the modern economy are compound interest.
Compound interest is sometimes called “interest on interest” consists of a principal amount increasing by a fixed rate than increasing the principal amount by that amount for the next interest period.
In other words, compound interest is “reinvested interest.” There is even a simple maths formula for calculating compound interest:
Where P is the principal amount, r is the interest rate, t is the time period, and n is the number of times interest is compounded per unit (t). Here is a simple example: Take the £10,000 from the previous example.
If compound interest is gained at a rate of 3.875% every month for 5 years.
This is more than what would have happened with simple interest. It may not seem like much initially, but over a long enough period of time compound interest can really add up. Whereas simple interest grows linearly, compound interest grows exponentially.
Compound interest can work for or against your favour. Most credit cards charge compound interest on remaining balances, which means that every month interest charges will increase exponentially. Over the long run, even a small purchase can turn into a huge debt. That is why it is so important to keep credit card balances paid off.
On the flip side, compound interest from investments can net you a lot of money. Some of the richest people in the world made much of their fortunes through compound interest on investments. Even a relatively modest principal investment can see great returns over a long enough period of time.
Many people are wary of credit as the thought of spending money you don’t currently have can be anxiety-inducing. However, properly using and managing credit is necessary for financial health. Your credit is basically a measure of how “financial trustworthy” you are and determines whether you are eligible for loans, bank accounts, and more. When you take on debt and manage that debt in a timely fashion, your credit score will increase.
Credit is a double-edged sword, as managing credit is good for finances, but having credit can tempt you to spend more.
The best way to responsibly manage credit is to make sure you make all your payments on time.
Ideally, you should be able to pay off your credit card balance in full by each pay period. Charges that rollover to a new pay period will collect interest and interest rates for credit cards can be as high as 17.56%.
If you can manage, a smart way to build credit is to use a credit card for monthly expenses like utilities and then immediately pay off that balance in full.
If you are having trouble managing credit debt, there are a few methods. The avalanche method involves paying off the minimum for all cards and putting extra funds towards the highest interest account.
Even though it might make sense to pay off the largest amount first, the avalanche method takes advantage of human psychology to incentivize good payment habits.
The satisfaction of paying the highest interest debt keeps you motivated to keep making payments. Psychology is cool (use it to your advantage!).
You could also opt for a balance transfer option.
Balance transfer option transfers your remaining balances to a new account with 0% interest for a time.
If you make the payments on time, you shouldn’t see any interest charges. The total payment period will be longer, but your debt won’t increase from interest charges.
Speaking of investing, what is it? In a nutshell, people invest in companies by buying shares. That money helps the company grow, which in turn increases the value of those individual shares. IN other words, investing helps companies grow and investors see a return on that growth proportional to the amount of their investments.
Most securities investments like stocks, bonds, and mutual funds gain compound interest which is why investing is a great strategy for financial health. Investing in stable growing companies provides a continual stream of revenue that you can sit on and watch increase with interest. Many people save for retirement by investing saved funds and with the right investments and a bit of luck, it is entirely possible to live solely on income from investments.
A good way to get your feet wet investing is to take a small amount of your savings each month and try investing it into stocks. Even it’s only £10 a week, that comes out to nearly £500 a year. As you get more comfortable with investing you can slowly add more money every month.
So there you have it, personal financial basics that everyone should have a solid grasp on. Understanding these fundamental lessons are necessary for navigating today’s economy. We understand that financial health is more than just knowing financial basics and in today’s economy, even the thriftiest spender can still have trouble. But the fact of the matter is that no matter the economic circumstances, knowing how to navigate these basic concepts can only help you.
With that in mind, it always helps to educate yourself about finances. There are several free online courses on topics in finance you can peruse at your own leisure. Even just a few minutes a day learning about these topics can help you in the long run.
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