Five Financial Concepts Everyone Should Understand
For anyone who’s missed our social media posts this month, April is financial literacy month. Of course, that’s an exciting month for us here at Generation Capital Management. That’s because woven into the very fabric of our company is a deep desire to make available educational resources for anyone who wants to improve their financial situation.
The problem with that, though, is that the universe of personal finance is expansive. It includes things as simple as understanding fixed monthly expenses to complex issues like estate planning and asset allocation.
That’s why I decided I’d put together a little blog post this month that would help to narrow that universe down to five key topics. But as I sat down to write this blog, I realized that I’ve written several blogs and made tons of videos on these topics already.
Instead of repeating myself, I decided to give you an introductory blurb for each area and then direct you to other content that we’ve already created to deepen your understanding.
And, as always, I would encourage you to reach out to me directly if you’d rather I tell you all about this stuff face-to-face or if you need help understanding anything. My email address is jhowe@gencapmgmt.com.
With that out of the way, let’s dive in!
Spending
I intentionally did not call this budgeting because it’s more important to know what you spent over the past year than it is to have some hypothetical pie-in-the-sky plan about how you’re going to spend your money.
I’ve probably said it a billion times now, but the best way to look at your spending is to review all your expenses over the past year through a spreadsheet export of every transaction, go line-by-line to remove the true one-time expenses, and then tally up the remaining expenses. Once you have the total, compare that to your net income (the money that landed in your bank account).
Did you spend more than came into your bank account? Now it’s time to put together a budget and figure out exactly where you overspent.
Did you have more come in than you spent? It’s time to think about the most optimal way to save (and, of course, find more ways to cut back if that’s what you’d like to do).
Emergency Fund
Video
The most important savings account that you should think about isn’t your retirement account, it’s your emergency fund. An emergency fund is a lump of money that isn’t invested and usually totals anywhere from three to twelve months’ worth of expenses for the household. This money should be easily accessible but remain untouched unless there is some kind of out-of-plan spending emergency. Some examples may include someone in the household losing their job, an unexpected medical expense, or a large car or home repair.
In our savings hierarchy here at GCM, we place this target as step one along with maximizing any employer match into our employer-sponsored retirement account.
The Importance of Saving Efficiently for Retirement
Blog Post
Most of us will reach a point in our lives where we no longer want to work, and all of us will reach a point where we are no longer physically able to work. Right now, the government provides some assistance to retirees through Social Security benefits, but this income typically cannot sustain a comfortable living without supplement from savings/pension, and it is in such fiscal peril that it may not exist for those of us who have 20+ years until retirement.
Therefore, it’s up to all of us to be stewards of our own financial futures. The tough part is that almost none of us learned how to financially survive during our formal education. And time is one of the most important factors of which we need to take advantage when it comes to saving for retirement.
The best time to start saving for retirement was when you received your first paycheck. The second-best time is right now if you haven’t yet. There are some key methods to optimize saving for retirement too (check out the resources below for that).
Just keep in mind that saving and investing are not the same thing.
This may seem like a strange clarification to make, but it’s important. Let’s take an employer-sponsored retirement plan (401(k), 403(b), 457, etc.) for example. If I tell my employer to take money from my paycheck and put it into my retirement account, it only gets invested if we choose an investment for it or if the plan has a default investment selection. And while the risks of being invested can be scary, it’s hard to achieve your long-term goals without the potential increased value that investments can provide over time.
Risk
There are two primary ways that I categorize risk: investment risk and non-investment risk.
Investment risk is the risk that we face from having our money invested in an investment vehicle other than cash. There are several other technical types of risk associated with that.
Non-investment risk is a catchall but applies to areas that some of us don’t think about. Not having enough insurance is a risk (life, liability, property, health, etc.). Having assets without a Last Will and Testament poses a risk that your assets won’t go where you would like if you pass away. Choosing to take a distribution from a retirement account poses a tax risk.
The primary problem with risks is that we may not realize they exist until we’re already facing the consequences.
Utilizing Debt as a Tool
Blog Post
It’s important to understand how low-interest debt can be used as a tool. Generally speaking, we may have an interest rate on debt that is lower than the rate of return that we could reasonably expect to earn on our investments. Continuing to carry that debt instead of paying it off may allow us to invest for our long-term goals and earn positive returns that exceed the “cost” of carrying that debt.
This one is a bit complicated, but I outline it with examples in my linked blog post.
Bonus Concept: Money Scripts and Your Relationship with Money
Blog Post
I wrote an entire blog post about this topic, but money scripts are the attitudes you hold about money which then influence the choices that you make surrounding money. It’s important to understand your relationship with money because emotions are the primary factor that cause us to make sub-optimal choices with our money.
As I mentioned above, feel free to reach out to me with any questions you might have or if you’d like to discuss any of this in person. You can reach me at jhowe@gencapmgmt.com.
