April is Financial Literacy Month, and echoing my blog on Retirement Planning Week, all of these dedicated days, weeks, and months get tiresome. But when it comes to financial literacy, I believe the focus is critical. What concerns me is that many people outside the world of financial planning seem to view understanding basic finance as a luxury. For many, it has become acceptable to be financially illiterate. Sadly, this is especially true for women; I’ve observed far too many otherwise smart women laugh off their lack of financial knowledge, and it sets off all my inner alarm bells. (At the risk of being curt, I will say that ignorance is never cute or endearing. Can you imagine someone—anyone—joking about being illiterate in any other context?) Male or female, each of us is responsible for our financial future, and being numerate and understanding basic financial concepts is vital to be sure you’re making smart choices along the way.
If my concern has you wondering about your own financial literacy, now is a great time to review the basics. Let’s start with three of the biggies: debt, compounding, and the value of a fiduciary:
How is good debt different from bad debt? Debt is a huge problem in the US. In 2015, the average US household held “bad debt” of more than $15,700 in credit card debt and $27,000 in auto loans, and “good debt” that included about $48,000 in student loans and $169,000 in home loans. When used wisely, “good debt” such as a home mortgage, student loans, and business loans has the potential to generate benefits over time (though the decision to assume any debt deserves careful consideration). In contrast, “bad debt” like auto loans and credit card debt (which is also a loan) reduces your income and adds no value to your wealth. Every month that you don’t pay off your credit account in full, you are charged interest, so you’re paying more (and more!) for an item that is losing value.
What is compounding and how does it affect my retirement savings? The advice to “save early and often” is based on the idea of compounding. Simply put, compounding is the ability of an asset to grow exponentially—to generate earnings, which are then reinvested to generate more earnings. To illustrate: if you invest $1,200 annually beginning at age 25 and that money earns 11% annually (based on the historical long-term average of the S&P 500), in 10 years your savings will reach $22,000. With compounding, in 20 years you’ll have saved not just double the amount, but $85,000. In 30 years, that number jumps to $265,000, and in 40 years you’ll have socked away $775,000 to help fund your pending retirement. Time is the Archimedes’ Lever of investing. The earlier you start saving, the more you can leverage the power of compounding, and the easier it is to meet your goals.
What is a fiduciary? The recent DOL fiduciary rule has been making headlines lately, which has put a spotlight on fiduciaries. If the term is new to you, a fiduciary is required to always actin the best interest of the client. This is in contrast to non-fiduciary “advisors” who may receive a commission for products they recommend, adding their wallet to the list of priorities. Working with a fee-only advisor who is a fiduciary is a necessary part of financial planning. At the same time, it’s important to be your own fiduciary. I was recently working with a client whose husband died suddenly at just 52 years old. When I asked about his earnings and their joint assets, she had no clue. “When you reviewed your tax return last year, what were the numbers?” I asked. She had no idea. Every year she simply signed her name. By paying attention to your taxes, attending meetings with your advisor, and participating in the estate planning process, you can gain financial literacy and actively serve in your best interest.
Of course, financial literacy isn’t just about understanding the terms. It’s also about learning how money works in the real world, how to budget and invest, and how to make informed and effective financial decisions to ensure you have the resources you need to support yourself in the future. Start with these three concepts to be sure you’re on the right path:
Set a realistic spending plan that includes emergency and retirement savings. A study by the Federal Reserve Board recently reported the shocking statistic that 47% of respondents said they would have to rely on credit cards or selling belongings to come up with cash for a $400 emergency. To avoid the same fate (or change it if you’re already there), review your income and expenses, set a realistic budget, and include building an emergency fund (much more than $400 please!) and “saving early and often” for retirement as part of your plan.
Be sure you know the truth about your financial situation: MaryAnn and her husband had been living high on the hog for years. Their extravagant lifestyle included houses, cars, boats, horses, and world travel. Both she and her husband had sizable incomes, and MaryAnn assumed their finances were in great shape. When her husband lost his job, she quickly learned that their lifestyle was a house of cards built on debt. When she and her husband divorced after a 30-year marriage, her choice to remain in the dark about their joint finances had a tremendous impact on her life. No matter how much you trust your partner to take charge of the finances, be sure you know the facts and that you’re acting as a fiduciary to you and your family.
Work with an advisor you trust: Unveiling your finances—especially any financial missteps—requires a huge amount of trust in any situation. If you were raised to believe that finances should remain a secret, it’s time to become a family rebel. Be sure you know the basics, and then put your trust in an advisor who is truly acting in your best interest and can help you get on track financially as quickly as possible.