Financial Literacy Pillars Part 1

Editor's note: This article is public for paid and free subscribers.

I wanted to follow up with a bit more detailed information about financial literacy, specifically the areas along with some tips that I think relate to retirement planning, investing, and the FIRE Movement. I posted an article last week that highlighted Financial Literacy Month and briefly reviewed what I call the five pillars of financial literacy. You can read last week's article here.

Recall that Investopedia defines financial literacy as "the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing."

Financial Literacy's Five Pillars

Here are the five pillars (key areas) of financial literacy again:

• Earn money
• Spending
• Savings
• Borrowing
• Protecting

Earn Money

We all need to earn money. If you earn a lot, spend reasonably, and save/invest easily, then perhaps you're in a good place concerning your career. If you are young and just getting started in the workforce, you should always be looking ahead for how you will advance in your career path and earn more money.

Do you understand the difference between gross pay and net pay? Are you aware of all the various items that can and likely will be deducted from your pay. Here are many of the typical deductions:

• Federal income tax
• State income tax - Several states don't have a state income tax
• Municipality income tax - Yes, there are a even a few cities that have an income tax
• Social Security & Medicare
• Health, dental, & life insurance premiums
• Disability insurance premiums
• Retirement pension plan contributions
• 401k plan contributions

This list covers most payroll deductions you might see. Many young people starting their first jobs are shocked by how much can be deducted from their paychecks. Get used to it, but learn how all of these deductions work and how to limit any excess or unnecessary deductions.

It doesn't take long to see that your net pay is a lot less than your gross pay. So understand how your pay works. Then learn how to increase your pay through promotions, new jobs at another company, second jobs, or you can volunteer for and work overtime if available.

There are also virtually unlimited ways you can earn money through self-employment, whether full time or on the side. The term "side gig" has come along in the past decade or more and many people try some side gigs to make extra money.

Be careful with side gigs that require a large investment up front. Do your research!

Spending

I could talk for days about spending. I'll say right up front that you must learn the difference between needing and wanting.

I'll say right up front that you must learn the difference between needing and wanting.

Develop a budget. There is a school of thought that says you can't improve something if you can't measure it. That will be difficult if you don't know where your money goes. Track (measure) your spending for a month or two prior to finalizing your budget.

If you never had a budget and are experiencing difficulty with money, a good budget can help a lot!

If you're single and live alone, it's all on you. If you're married or otherwise serious with someone to the point of sharing income and/or expenses, you need to discuss money and spending. With most couples, there is a saver and there is a spender. There is no right or wrong on this! It's simply about how you compare to your significant other. You might be the spender in your current relationship and then you are the saver in your next relationship.

With most couples, there is a saver and there is a spender. There is no right or wrong on this. It's simply about how you compare to your significant other. You might be the spender in your current relationship and then you are the saver in your next relationship.

My message here is that you and your significant other need to be on the same page concerning spending. Easy to say, sometimes challenging! Have the money discussion!

I want to make one more point about spending and how you think about disposable income or available spending money. Basically, I am talking about extra money after all of your expenses.

Hypothetical scenario. You are early in your career; assume you make $2,500 monthly and net $2,100 after taxes, insurance, etc. are deducted from your paycheck. Your rent, utilities, buying groceries, car insurance, gasoline, etc. all add up to $1,800 monthly and you've been putting $200 a month into an emergency savings account. You plan to begin contributing $200 monthly to a Roth IRA after your emergency fund reaches three months salary.

So your total extra money to blow on anything is $100 a month. Your Apple smart phone is a bit older and Apple just released their latest model. You can get it through your cell phone service provider and they will finance it for $35 monthly over 30 months. You think to yourself, "I make $2,500 a month, so I can easily afford $35 monthly." MISTAKE! You should be aware of your cash flow at all times. I suggest you think more like this, "I currently have $100 extra a month; do I want to give up 35% of it?"

You think to yourself, "I make $2,500 a month, so I can easily afford $35 monthly." MISTAKE! You should be aware of your cash flow at all times. I suggest you think more like this, "I currently have $100 extra a month; do I want to give up 35% of it?"

Now you might decide to buy the phone anyway, but understand that you get to eat out or meet up with friends only 2-3 times a month instead of 3-5 times a month for the next 2 1/2 years until the new phone is paid off!

Always consider a new monthly bill as it relates to your leftover extra monthly funds after all expenses, not how it compares or sounds against your gross paycheck every month!

Recap

In this article, I briefly provided some more detail to consider when thinking about earning and spending, the first two pillars of financial literacy. In Part 2, I will explore the remaining financial pillars, which are save, borrow, and protect.

Thank you for reading!

Mike Bishop

Editor, The FIRE Letter

Disclaimer: All strategies including recommended trades published here are for educational and informational purposes only. They are not recommended for any specific individual, business, or other legal entity. I don’t know your age, income, personal or financial circumstances and cannot possibly suggest any financial or investing decisions for you. Seek advice from your accountant, financial advisor, and attorney before making any investing decisions. Always conduct your own due diligence before making any investing decisions. Seriously!