There’s a direct connection between financial education and financial success. You don’t have to earn an MBA to stay above water, but without a basic understanding of personal finance, credit, banking, investing, saving, spending and budgeting, you’re much more likely to sink into debt and the paycheck-to-paycheck lifestyle.
Failing To Plan and Budget
Millions of Americans stumble through their financial lives rudderless, always just one forgotten bill or surprise expense away from disaster. No matter your age, income or experience, sound financial health starts with a budget — but if you’re financially illiterate, winging it might be all you know.
In its simplest form, budgets keep track of money coming in and money going out. You can do that with a basic spreadsheet or even a pencil and paper — but you don’t have to. Free apps like Mint do the hard work for you by organizing all your accounts under one roof, laying out your income and expenditures in easy-to-read graphs and charts, identifying trouble spots and helping you set and reach financial goals.
Not Managing Credit
With the exception of your household budget, your credit report is the most important part of your financial life. Your report — and your corresponding credit score — tells everyone from lenders and insurance carriers to potential employers whether or not you pay your bills on time, if you’re carrying more debt than you can handle and if you’ve ever declared bankruptcy or been sued for money owed.
The contents will determine whether you can borrow money to buy a car or a home, and what you’ll pay for those loans if you’re able to get them. If you’re not up to speed on this all-important subject, the three credit bureaus that compile your report — Experian, TransUnion and Equifax — offer helpful primers on how your score is tabulated and the importance of factors like your credit utilization ratio and payment history.
Free sites like Credit Karma make it easy to check and manage your credit after that.
Carrying a Credit Card Balance
The financially illiterate tend to look at credit cards as money on the side they can spend when they don’t have enough cash to pay for their purchases. The big mistake is to charge more on your card than you can cover in any given statement period and carry the balance over to the next month.
When you pay your statement balance in full each month, you incur no interest charges and borrow money from the bank for free — hopefully, while collecting points, cash back, miles or other rewards. Credit card companies use the interest payments they collect from those who carry a balance to reward responsible borrowers who do not.
Paying Only the Minimum Balance
Carrying a balance is bad enough, but sometimes it’s unavoidable. If there’s no other way one month here or there, don’t worry — just pay your balance in full two months in a row and the finance charges will stop once more. What you should never do, however, is pay only the minimum balance — the financially literate know better than to take the bait.
If the bank will let you slide with paying 2% of your balance, the unschooled might ask, why not just pay the minimum and keep the other 98% in your checking account for another month? The “why not” is an interest rate of 16%, 18%, 20% or more.
Making only minimum payments of 2%, a $5,000 balance with 18.9% interest would take more than 30 years to pay off and would cost you $19,564.30 in total.
Chasing Credit Card Bonuses
Credit card issuers lure customers with big introductory bonus offers, often in the form of tens of thousands of miles or hundreds of dollars in cold, hard cash. The catch is that you have to spend a minimum amount of money on the card in a specified period of time to cash in on the reward.
If you were going to spend the required minimum anyway, by all means — but the financially illiterate might be tempted to charge money they don’t have just to land the bonus. By spending beyond their means just to get the perks, they risk carrying a balance and incurring finance charges that quickly negate the introductory rewards.
Not Taking Advantage of Matching Employer Contributions
If you have a job that offers a 401(k) plan with a matching employer contribution, congratulations. You can save for retirement automatically just by showing up to work — and you can do it with someone else’s money. An employer match is when your company deposits the same amount of money into your 401(k) that you do up to a certain threshold.
It’s free money — and one of the greatest benefits that any business can give its employees.
Those with insufficient financial literacy, however, often pass on this golden opportunity to build a nest egg with their boss’s cash. That’s because pre-tax 401(k) contributions are pulled directly from your paycheck, and if you don’t know what you’re passing up, you might opt out just to keep as much of your check as possible.
Shying Away From Investing
When you buy stocks, you’re purchasing an equity ownership stake in a company. When you buy bonds, you’re loaning money to a government or business to be repaid with interest.
The financially illiterate are unlikely to know these facts or other basic information about investing, and study after study shows that those who don’t understand investing are so intimidated by it that they avoid putting their money to work for them.
If you’re ready to get educated, be aware that there’s a ton of misinformation out there. The SEC’s introduction to investing at Investor.gov is a good place to start learning, and once you master the basics, you’ll feel confident enough to start small with money you can afford to lose.
Paying Fees to Brokerages
In order to invest, you’ll need a brokerage account, and since the financially illiterate tend to be intimidated by investing, they’re the easiest people to convince that they need a professional to choose their investments for them. Historically, expensive full-service brokers were the only kind of brokers there were, but thanks to free, self-directed investing apps like M1 Finance, there’s no need to pay a dime to a brokerage in fees or commissions.
While it’s true that some investors can benefit from full-service brokers, novices who are just starting out would almost certainly be better served by opening a free account, buying a simple and inexpensive index fund ETF and contributing to it on a consistent basis.
Paying Fees to Banks
If you shouldn’t have to pay to invest, you certainly shouldn’t have to pay to do your banking — yet the banks bank on the financially illiterate doing exactly that. If you’re behind on your financial education, you’re much more likely to open a checking or savings account without understanding common fees like:
- Maintenance or service fees
- Out-of-network ATM fees
- Insufficient fund fees
- Excessive transaction fees
- Fees for dropping below the bank’s required minimum balance
You should never pay those fees or any others for a standard bank account. That includes overdraft charges, which until recently there was no getting around, even with “no-fee” banks. According to CNBC, more than a half-dozen banks — including Ally and Betterment — have dropped even their overdraft charges and are truly fee-free financial institutions.
Taking Out Toxic Loans
Credit cards charge high interest rates, but 20% is nothing compared to payday loans, which are dangerous, predatory lending traps that were designed with the financially illiterate in mind. These short-term loans come with supersized interest rates that can approach 400% — and they’re backed by your next paycheck.
Unlike personal loans, which can be paid back over years, payday loans give borrowers just a few days or weeks to repay. If they can’t, the loan rolls over into a new term with new fees tacked onto the principal. The end result is an endless cycle of poverty and debt as already desperate borrowers watch their paychecks shrink while their loan grows.
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