Financial Literacy: Skills to Manage Your Money

Introduction

Financial literacy—the knowledge to manage your money effectively—is one of the most important life skills. Unfortunately, we receive very little financial education in schools, if at all.

Under these circumstances, how can you grow, save, and spend your money to extract the maximum value of your assets?

What is Money Worth?

The biggest flaw in the education system is failing to teach people how to use their money. Instead of investing in assets, far too many people put them in a low-yield savings account, which usually just depreciates in value over time.

Recall the myth of Sisyphus, whose punishment was to push a heavy stone to the top of a hill. Each time he nears the summit, the boulder slips from his hands and rolls back down. Destined to fail his task, he must repeat the process for eternity.

This isn’t so different from what most people do with their money! Consider the absurdity that while depreciation continuously depletes their hard-earned savings, they compensate by working themselves even harder.

What we call ‘money’ only has value because the government gives its people confidence in its worth. But if you’re in the US, the same government has allowed an unprecedented rate of currency creation due to the COVID-19 pandemic.^[1]

Printing all that money doesn’t necessarily add value to the economy. Instead, it may devalue the dollar, thus putting your hard-earned work to waste.

How to Grow Your Money

Invest in Assets

Aside from immediate living expenses, the best thing you can do with your money is to earn interest from it. The sad reality is that most people are living paycheck-to-paycheck.^[2] Without setting aside some capital to invest, they end up working their entire lives.

Meanwhile, others are investing in stocks, bonds, real estate, and/or businesses so that when their investment returns outgrow their living expenses, they can reach financial independence and retire. At some point, they might earn enough for you to quit your job and retire early. Instead of working for money, your money could work for you.

Compound Your Money

Compounding is an extremely important investment concept, in which your returns on investment are reinvested to yield even greater returns the next year. With the average 10% return rate of the S&P500 (500 largest companies listed on the stock market^[3], here’s how much $1 would compound over time:

• $1.10 in 1 year (110%)
• $1.21 in 2 years (121%)
• $1.33 in 3 years (133%)
• $2.59 in 10 years (259%)
• $6.73 in 20 years (673%
• $17.45 in 30 years (1745%)
• $45.26 in 40 years (4526%)

As you can see, the returns begin to multiply rapidly, giving even the smallest investor an opportunity to become a millionaire with just $5 a day! Of course, it requires a lot of discipline to stay invested and weather market downturns, but it has generally proven to work over long periods of time.

Save For a Better or Earlier Retirement

While it may be tempting to just live in the moment, saving for retirement shouldn’t be overlooked. With an average lifespan of about 80 years and a retirement age of 65, you’re looking at 15 years of living expenses while retired.

Furthermore, those numbers are just based today’s statistics. Improvements in medicine and science may increase your lifespan, and therefore the number of years and funds you’ll need to live comfortably during retirement.

Unless you plan to work through your retirement years, investing in a retirement plan (401(k) or IRA) can go a long way. A Roth designation on your retirement plan also allows your funds to compound tax-free. The earlier you start, the more time compounding works in your favor!

Make sure you take advantage of your employer’s match on contributions to your 401(k). A 5% match on a 40-hour workweek is like getting an extra 100 hours of paid vacation hours per year!

How to Save More Money

Avoid Taxes

Taxes usually make up one of the largest expenses from your annual income, sometimes even exceeding 40% for some individuals. Although almost half of your take-home pay goes to taxes, there are legal tax-saving strategies to reduce it as much as possible.

Preserve Your Money’s Value; Beat Inflation

The last thing you want for your finances is for inflation to deplete the value of your hard-earned money. If you remember compounding, inflation is the exact same, but in reverse. With an average annual inflation rate sitting at around 3%, your money will lose half its value in 23 years. By the end of 45 years, it’ll be worth only 25% of what it’s worth today!

If you’re too afraid to invest, you can put your money in Treasury Inflation-Protected Securities (TIPS)^[4]. The value of these government-backed bonds increases at the same rate as inflation.

Investing in TIPS ensures that you won’t ever get paid less than the amount you put in (your principal).

Avoid Bad Debt

Not all debt is created equal, so a general rule of thumb to follow is to only use debt for emergencies or income-producing assets.

An example of good debt would be student loans for a high-paying degree, or a home mortgage for a property you intend to live in or rent out. The interest rates on these loans are usually in the single digit percentages.

Bad debt includes taking loans for non-essentials, including credit card debt. Credit card interest rates can go as high as the double digits. If you must use a credit card, be sure to pay off your bills fully each month, because interest begins to accrue on unpaid balances leftover at the end of each month. Be sure to learn about other hidden credit card costs as well!

How to Spend Less Money

Budget

If you’re struggling to build up your portfolio, or simply don’t know where your money is going, it’s time to start tracking purchases and budgeting. You can reward yourself with fun purchases from time to time, but most of the money should be spent on essentials.

You can also think of price tags in terms of work hours; a new $1000 phone purchase would require almost 60 hours of work if you earned $20 an hour and had paid 25% in taxes. Is it worth it to get one every two years when your current phone still works?

If you’re still not convinced, remember how compound interest works. Highly successful people know that every dollar they save today can compound to about 50 in a few decades. Start putting aside money to work for you, and your future self will thank you for it!

Avoid Expensive Trends

Corporations often find ways to compel you to replace your purchases sooner and more often, a tactic known as planned obsolescence. For example, the newest phone model might seem superior, but the difference is minimal at best. Or they might force updates that diminish your phone’s performance, forcing you to get a new one.

In these cases, it’s best to find a high-quality competitor with products built to last, so you can be happy with your purchase for a long time. Set some rules for yourself, such as only buying something new if the purchase significantly improves your quality of life, saves you time, or makes you more money. Otherwise, you’re probably better off investing your money elsewhere.

Reduce Non-essential Expenditures

According to one study, we spend about $18,000 a year on non-essential expenses.^[5] The top four of these items include drinking, eating out, ordering takeout, and ordering lunch.

These non-essential food expenses account for over half of our non-essential spending, clocking in at $9000 per year. According to the latest food cost report by the USDA, this is more than double your average food cost per year.^[6]

Additionally, prepared food often contains excess sugar, salt, and fat. Not only are we spending more to eat, but we’re paying for it with our health too. It’s simple to buy items and prepare meals in bulk, which is both healthier and helps with managing weight.

How To Protect Your Health and Financial Health

Health Savings Account

If you have a high-deductible health plan, consider looking into a Health Savings Account (HSA).^[7] This account functions almost like a Roth IRA, with a few caveats.

For starters, the HSA is exclusively for healthcare costs (at least until you turn 65). Furthermore, HSAs are fully tax-exempt. So if you contribute a tax-deductible $3000, you’ll get a tax-return check, AND you won’t pay taxes on any earnings!

While you could use the funds for medical expenses, save it! You already received a tax-deduction to contribute, so you can’t do it again! You might as well let it grow tax-free. Meanwhile, you might be able to deduct your medical expenses if you pay out of pocket.

After your turn 65, you can withdraw HSA funds penalty-free for non-medical purposes. You could effectively use it as a retirement account, allowing it to compound earnings year after year.

Work Less For Increased Productivity

There are plenty of people who will try to convince you to work 60 to 80 hour work weeks. After all, you’re “still young and healthy” right now, so you can handle it.

It may be tempting to trade your time for more money, but your body will definitely make you pay much more than you earn later. Stress is highly damaging to the body and burnout will eventually lower your productivity. Your body definitely doesn’t like running on 4 hours of sleep and 3 cups of coffee every day.

You’ll eventually get sick and have to take unpaid medical leave. With enough time, your bad habits will catch up to you and cost you a fortune in healthcare costs.

Nobody cares about your well-being more than you. Never allow anyone to persuade you how to abuse your body, especially if they’re not footing your medical bill.

Engage in Self-Care To Mitigate Healthcare Costs

Investing in yourself may have a higher return on investment than focusing solely on money. Self-care habits make you more productive and successful, which in turn can make you more wealthy. But failing taking care of yourself first comes with additional financial consequences.

When we fail to take care of ourselves due to lack of food, water, or sleep, our bodies release adrenaline and cortisol to keep us going. These hormones help us survive dangerous situations; their purpose isn’t to keep our bodies in overdrive for hours.

By letting these hormones go unchecked, they subject our bodies to undue stress and wreak havoc on our organ systems. Chronic stress may lead to disease and increased mortality.

Remember that the next time you neglect your needs, it will cost you dearly. Your body will pay back its dues many times over in the future. You may end up with a terminal illness or require medical care you could’ve prevented in the first place.

Do yourself a favor and prioritize your well-being, because nobody will care more than you do. In doing so, you’ll increase your lifespan and live a higher quality of life.

Summary

• Given enough time, compound interest multiplies your money in the magnitude of the hundreds.
• If your money works for you, you don’t have to work for your money.
• The sooner you save for retirement, the earlier you can retire.
• Learn how the tax laws can work in your favor.
• Inflation depreciates the value of your money, so don’t hold onto it in cash.
• Avoid ‘bad debt’ so you can take on ‘good debt’ that makes you more money.
• Your HSA is arguably the best retirement account you can have.
• Overworking can destroy your productivity and result in call-outs. Sometimes less is more.
• Take care of your body, or your body will pay you back tenfold in medical costs