Whether you aspire to be rich or just want to stop living paycheck to paycheck, you need to understand basic money concepts. Unfortunately, essential financial terms and concepts often aren’t taught in school. So it’s up to you to learn them on your own.
To help, here are 15 money concepts you should know. Understanding these basics can help you avoid costly money mistakes and start getting ahead financially.
Know How Much You Make and Spend Each Month
Knowing how much money you have coming in and going out each month is the foundation to managing your money well.
“If you don’t know this by heart, then virtually every decision you make about your finances will be pretty much a guess,” said Charles Scott, president of Pelleton Capital Management, a wealth management firm in Scottsdale, Ariz.
Figuring out how much you make is straightforward: Check your pay stub or bank account to see how much is being deposited directly. To figure out where your money is going, you’ll need to review your bank and credit card statements. Scott recommended identifying these three categories of spending — fixed expenses such as rent, mortgages or car loans; variable expenses such as credit card payments and discretionary expenses such as entertainment, vacations and restaurant meals.
“Take the time to look back at what you’re currently spending, write it down, create at least the three main categories listed above and add it up,” he said. Then you’ll know whether you have more going out than coming in and what changes you need to make to your spending.
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Create a Spending Plan
You’ve likely been told time and again that you need a budget. But budgets often don’t work because the focus is on cutting out things. A more constructive approach is to create a spending plan to plot where you want your money to go each month, Scott said.
You have to go through the exercise of tracking your spending. But the goal isn’t to pinpoint which expenses to eliminate. Instead, you should figure out what’s most important to you — saving for a vacation, early retirement, paying for your kids’ college — and then align your spending with what you value rather than blowing your money on things that don’t matter.
“As you do this, over time you will begin to see where funds are actually going and be much more capable of aiming those funds where you want them to go,” Scott said.
Don’t Charge More Than You Can Pay Off Monthly
If you charge more on your credit card than you can pay off each month, you’re not alone. Nearly 40 percent of Americans have credit card debt and possess a median balance of $2,000, a GOBankingRates survey found.
“While it’s fairly common for people to have credit card debt and lots of it, common sense dictates that you should only charge what you can afford to repay,” said Holly Johnson, author of “Zero Down Your Debt.”
If you carry a balance, you’ll end up paying more than the amount you originally charged to your card because you accrue interest on your balance. For example, if you have a $2,000 balance on a credit card with a 15 percent interest rate and pay just $50 per month, you’ll spend $790 in interest over the four and a half years it will take you to pay if off.
“Charge only what you can afford to repay if you choose to use credit,” Johnson said. “That way, you won’t wake up one day with a growing credit card bill you cannot tame.”
Know Why Your Credit Score Matters
Nearly 60 percent of Americans don’t know their credit scores, according to a survey by LendingTree. However, this three-digit number plays a big role in your financial life.
Your credit score matters because lenders use it when deciding whether to give you credit and the terms of that credit, such as the interest rate. A good credit score can help you get a better interest rate — which means you’ll pay less to borrow money. Insurers, utility companies, cellphone companies and landlords also look at your credit score to determine whether you’re a credit risk.
You can get your credit score for a fee from myFICO or from the three credit bureaus — Equifax, Experian and TransUnion. Or you can get a version of your score for free from a site such as Go Free Credit.
Understand Your Credit Score
If you want to improve your credit score, you need to know what factors impact it. However, a survey by GOBankingRates found that 40 percent of respondents might not know all the factors that can affect their scores.
The commonly used FICO credit score ranges from 300 to 850. It’s calculated from five factors on your credit report: your payment history, the amounts you owe, how long you’ve been using credit, the types of credit you have and whether you’ve opened new credit accounts recently. You can see where you stand in each of these categories by getting a free copy of your credit report from AnnualCreditReport.com.
Negotiate Your Pay
A basic concept you should grasp early on is that if you want to earn more money, you need to be willing to ask for more. However, most people don’t do this. PayScale’s Salary Survey found that 57 percent of workers have never negotiated for a higher salary. However, the majority of people who do negotiate their salaries get pay increases.
Sites such as PayScale, Salary.com or Glassdoor can help you find the average pay for your position. You can use that information, as well as what you bring to the job, to negotiate a better salary if you’re not being paid what you’re worth.
Have Six Months’ Worth of Expenses in an Emergency Fund
“One common sense money concept that I give often, but many people do not follow, is to have an emergency fund equal to six to nine months’ worth of living expenses,” said Jamie Pomeroy, Minnesota financial advisor and creator of personal finance blog Financial Gusto. Having that much money set aside will help you get through a job loss or other financial emergency. The key is to have the money in a separate account.
“I often hear, ‘My Roth IRA is my emergency fund,’ or, ‘I have cash in my brokerage investing account,’” Pomeroy said. However, cashing out investments or a retirement account can trigger a tax bill — which means you’ll need more money to pay taxes in addition to the amount you need to cover an emergency.
Instead, you should open an interest-bearing savings account and set up automatic transfers from your checking account each month to build your fund. Then the money can be easily accessed when an emergency arises.
Save 15 Percent of Your Income for Retirement
You know you need to save for retirement, but you might wonder how much to put aside. Financial experts typically recommend setting aside 15 percent of your income annually.
“If you start crunching the numbers and factor in modest returns and employer contributions on 401ks and similar employer-sponsored retirement plans, that usually seems to be enough for people to save long term and be comfortable,” said Josh Brein, a Washington-based financial advisor and founder of financial planning blog The Art of a Plan.
If you’re saving anything for retirement, you’re ahead of many people. GOBankingRates’ 2017 Retirement Savings survey found that a third of Americans have $0 saved for retirement. However, you should aim to save 15 percent annually — even if that means starting small and increasing the amount you set aside each year.
It’s Easier to Reach Savings Goals When You Start Early
Time is on your side when it comes to saving money for retirement or any long-term goal. That’s because even small monthly contributions to a retirement account can grow to large amounts over time, thanks to the power of compound interest.
For example, you could have $1 million by age 65 if you started investing $158 per month at age 25 and earned 10 percent annually. If you waited until age 35 to start saving, you’d have to invest $442 per month with a 10 percent annual return to have $1 million by age 65.
Give Your Savings a Raise if You Get a Raise
If you get a raise, it’s easy to increase your lifestyle to match your higher income level. But you’d be better off financially if you increased your savings with every raise, Brein said.
“If you get a 5 percent raise in pay, you should save 5 percent more in your savings or retirement to match that raise,” he said. So if you’re saving $100 a week, you would boost that amount to $105 if you got a 5 percent raise. This way, you’ll have a higher likelihood of being able to live the lifestyle you want when you retire,” he said.
Learn the Basics of Investing
As entrepreneur and best-selling author Tony Robbins has said, investing can put you on the path to wealth. Even if you don’t earn a lot, investing your money can help you become rich. That’s why it’s important to understand the basics of investing.
One of the key concepts you should understand is the importance of diversification — investing your money in a variety of assets.
“Having your assets in more places than less offers a degree of protection from taking big bets on a limited number of selected investments,” said Michael Kay, president of Financial Life Focus, a financial planning firm in Livingston, N.J. In other words, if you invest all of your money in the stock of one company, and the company goes bankrupt, you’ll lose all of your money.
Life Insurance Is Crucial
People often don’t understand the reasons they might need life insurance, said Chris Huntley, president of Huntley Wealth & Insurance Services. “If you’re not sure, don’t be embarrassed,” he said. “It’s amazing how many people get this wrong.”
To find out if you need life insurance, ask yourself how the people who depend on you financially would get by if you died.
“If the answer is that they’d have to move, take a second job or ask the extended family for help, you’re probably a candidate for life insurance,” Huntley said. “Life insurance fills in the financial gap left by a loss of life. If you’re not there, life insurance steps in to help pay the bills, the mortgage or rent or to help pay off debt.”
Know How Much Life Insurance You Need
It’s one thing to understand that you need life insurance. It’s another to know how much you need because, if you’re not sure, you could be talked into buying an expensive policy that’s not right for you.
“Knowing this, you won’t be fooled into buying life insurance that will cover you when you’re 80 or 90, when you probably will no longer need coverage,” Huntley said. “And you can say, ‘No, thank you,’ to the agent who pitches you a life insurance policy that ‘grows in cash value’ or that you can ‘borrow from’ or ‘supplement your retirement with.’”
For most people, a 20- or 30-year term life insurance policy is ideal, Huntley said. That means the policy will pay a benefit if you die within 20 or 30 years of signing up for coverage. A term-life policy costs less than a whole-life policy that provides coverage for your entire life.
You Need an Estate Plan Even if You’re Not Rich
Estate planning isn’t just for the old, rich or famous. All adults need the proper documents to prepare for the unexpected and make things easier for the people they leave behind when they die.
For example, if you don’t have a will, the state — through the court system — will decide who gets your assets and who will raise your children. You should also designate a medical and financial power of attorney and have a living will. These documents allow you to name someone who will make healthcare and financial decisions for you if you are unable to do so yourself. If you have a serious injury, go into a coma, suffer from dementia or other such event, it will allow you to specify the treatment you would or wouldn’t want to keep you alive.
Building a solid estate plan allows you to spell out your wishes for both life and death. Ideally, it will help head off disputes over your care if you can’t make decisions on your own, and ensure your assets go to the people you care about after you die.
How to Choose a Financial Advisor
Even if you understand basic money concepts, it can be hard to create a financial plan on your own. However, the concept of paying someone to help manage your money might seem foreign to you. Even more confusing can be finding the right person for the job. That’s because even the term “financial advisor” causes confusion, Kay said.
“The title can mean anything and should largely be ignored until consumers can determine if the person wearing the title is a stock broker, insurance agent, bank employee selling annuities or a financial planner who charges a fee for advice,” he said. The key is to find a financial advisor who acts in your best interest rather than someone who just wants to sell you products to generate a commission.
You can find fee-only planners through the National Association of Personal Financial Advisors.
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About the Author
Cameron Huddleston is an award-winning journalist with more than 18 years of experience writing about personal finance. Her work has appeared in Kiplinger’s Personal Finance, Business Insider, Chicago Tribune, Fortune, MSN, USA Today and many more print and online publications. She also is the author of Mom and Dad, We Need to Talk: How to Have Essential Conversations With Your Parents About Their Finances.
U.S. News & World Report named her one of the top personal finance experts to follow on Twitter, and AOL Daily Finance named her one of the top 20 personal finance influencers to follow on Twitter. She has appeared on CNBC, CNN, MSNBC and “Fox & Friends” and has been a guest on ABC News Radio, Wall Street Journal Radio, NPR, WTOP in Washington, D.C., KGO in San Francisco and other personal finance radio shows nationwide. She also has been interviewed and quoted as an expert in The New York Times, Chicago Tribune, Forbes, MarketWatch and more.
She has an MA in economic journalism from American University and BA in journalism and Russian studies from Washington & Lee University.