How to Understand Finance: A Primer
Finance - the Other "F" Word
When it comes to personal finance, what do you know? Understanding finance is more than just being able to balance your checkbook and pay your bills on time. Finance encompasses the concepts of budgeting, saving money, purchasing insurance, investing, and securing credit and loans. Oh, and paying taxes too!
Once you know how to understand finance, you'll be in more control of your future. You could be eligible for more favorable interest rates on personal loans, credit cards and mortgages. You'll likely be more secure in the months and years ahead - able to weather the storms of unemployment, unexpected medical bills and other maladies that life may toss our way.
For me, I always considered finance to be the other "F" word. I knew that I needed to have a better understanding of finance, but was too anxious and intimidated. It took a personal income tax class in law school for me to finally get excited about finance and take control of where my money was going each month in a positive, empowered way.
The following hub is a summary of the key elements to understanding personal finance: spending, saving and investing. Think of it as a Finance 101 lesson. After you learn the basics, you'll then be able to start exploring specific programs to get you on the road to great financial health.
Understanding Finance: Spending
When most people think about finance, the first thing that comes to mind is saving money. Yes, that is part of it too, but personal finance includes judicious, smart spending as well.
Did you know that in order to build a good credit score, you need to actually apply for (get approved) and use a credit card?
Other than opening a bank account, this is one of the first steps that should be made by young adults entering the world of finance. Make several relatively small purchases and pay off the balance within 1-3 months. After a year or two of building good credit, you can then seek and obtain more favorable terms on an automobile loan or finance terms on a larger consumer purchase like a treadmill or computer. Just make sure to continue making at least the minimum payments on time and eventually you'll be ready to buy a house or take out a small business loan.
That's right - smart consumer spending is one of the keys to understanding finance. Spending, saving and investing all build on each other!
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Understanding Finance: Saving
Understanding finance also means you should learn about saving. The first step is to open a savings account. Banks will often waive fees associated with a simple savings account as long as you maintain a minimum balance and/or regularly transfer money from your checking account into savings on a set date each month. Savings accounts are usually "liquid," which means they can be accessed at any time in case of emergency. There is very little return on your money; the biggest benefit is learning discipline and working on sticking to a budget. Even if you are on a tight budget, you'll want to contribute something each month to a savings account. Deposit $10-20 a week (perhaps giving up your fancy coffee drinks) and in a few year's time, you'll have a sizable account.
Similar to simple savings accounts are certificates of deposit, or CDs, and money market accounts. They often require minimum deposits of at least $1000 and, depending on their length of time (ranging from 1 month to 5 years or more), offer slightly higher interest rates payable to you, the customer. The catch is that you have to leave the money in the bank for a set amount of time, or pay a penalty.
Once you have a secure job, many employers offer participation in 401(k) accounts to save for retirement in the U.S. These accounts are even less liquid than CDs or savings accounts. You will pay a hefty penalty and taxes if you withdraw before retirement age. If you are self-employed, you could go with one of several types of Individual Retirement Accounts, or IRAs, which are similar in some respects to a 401(k) as far as liquidity, but with significant differences.
If you have children, you will probably also want to consider saving for college with a 529 account, offered by individual states. But experts suggest you should save for your own retirement first and put college savings second.
Many people consult a financial advisor to help plan and set up 529 plans and 401(k) and IRA accounts. These are people that understand finance!
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Understanding Finance: Investing
Now that you have spending and saving down, you need to think about investing as the final piece of your finance primer. Now I know that putting money into a 401(K), IRA or 529 college savings plan is investing. So, let's include it in both categories because its also saving for a particular purpose. There is some risk associated with these type of accounts, but when you use dollar-cost-averaging (this is the most complex term I am going to use in this finance primer hub), you usually end up with a decent return on your investments over time.
Dollar cost averaging is a term that refers to spreading out risk over many months or years by consistently investing the same amount each month, which results in buying at both high and low points in the market.
Other avenues for investing generally include purchasing stocks and bonds directly (through a broker), obtaining a whole life insurance policy, engaging in Forex trading, or even purchasing real estate - though since the residential property market has taken such a beating recently, some are wary of that option!
Unlike retirement accounts and college savings plans, you can use your returns for whatever you wish, whenever you want.
Summary of This Understanding Finance Primer
There is so much to be said about personal finance, you cannot begin to cover all the topics in detail in a single hub. Hopefully this primer will help you learn how to understand finance so you can dig deeper on your own and decide the best uses to which your money should be put.
Helpful links are included below and, if you have questions or your own finance tips to share, I encourage you to use the comment section below.
Money may not grow on trees, but you can encourage some healthy growth of your own accounts with a good, basic understanding of finance.
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© 2011 Stephanie Hicks
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