Creating freedom with financial literacy

Beyond the basic notions of talking, listening, reading and writing, literacy extends into the capability to understand, participate in and subsequently make important decisions that affect everyday life.

This is even more significant when it comes to financial literacy, which I’m of the belief should form part of every school’s curriculum, in addition to being a core subject at TAFE, university and trade courses. Sadly however very little is taught at any institution and many never learn the basics until it is too late.

In understanding the importance of financial literacy from an early age, we consider the opportunity to have choice, and in turn financial freedom in years to come, something we all have the opportunity to achieve. Remembering it is not about how much money a person earns that determines an individual’s financial path but that it is what you do with your money that matters.

Given helping our clients achieve financial freedom is at the core of what we do, we are passionate about educating people around the importance of fiscal choices and what it means in the long run.

Let us now explore some of the key fundamentals.

 

Assets Vs Liabilities

Sadly a regular pattern we see with many people is that they start earning money and they have no roadmap of how they will progress through their financial life. When their income increases so do their monthly outgoings.

What gets modelled as a strong financial position for some people might not actually be as you see it.  Many people would perceive someone as doing well financially if they live in a nice house, drove two nice cars, have a jet ski and maybe a holiday apartment at the beach. Regularly this lifestyle is funded by debt and if that is the case, this family has very little financial security. If these are the only things the family own they in fact have little or no assets. If their income stops, essentially all they have will disappear.

Whilst our clients might acquire some of these things, what is important is recognising what is an Asset and what is a Liability. As Robert Kiyosaki from Rich Poor Dad fame outlines: an asset is anything that puts money in your pocket, and a liability is anything that takes money out. With that in mind reflecting on the list above, which one of those items puts money in your pocket?

 

Credit Cards

For many young adults heading out into the world on their own, it is very tempting to get a credit card to help out when times are a little tough or to purchase that little something special.

However credit cards remain one of the most profitable divisions for every bank in Australia. Simply put, they make money when you don’t pay the outstanding balance back on time, and you pay interest at around 20% per annum.

But you ask, what about the 55 days interest free I get. Yes you get that, but my point remains, most people don’t pay the balance by the due date and so the cycle of very costly debt starts and for many it never ends.

By way of example, a $2,000 credit card debt that is paid off over the allowed period of  25 years with a monthly payment of $33 may appear okay and manageable, however the total interest paid for this period of time is a whopping $8,000.

If in doubt, pay for the goods when you have the money in the bank and plan for a great future.

 

Personal Insurances

We all know about car and house insurance, but what is your greatest asset? Your car or your home?

Your greatest asset is in fact, your ability to earn income for the next 5, 10, 40 years. As a living, breathing human with personal and financial responsibilities, you are worth a lot – not just to yourself but to others. Personal Insurance is all about understanding and protecting the value of your most priceless asset – you, and ensuring you are better prepared for the future.

So what insurance does what?

  • Income protection, protects your income – 75% of your salary is paid. Number of days to wait to be paid could be 30, 60 or 90 depending on your unused sick, annual and long service leave and your personal debt position.  Most policies pay for two years or to age 65, a very big difference so take note.
  • Life Insurance – if you have family and debts, you probably should have life insurance. A common misconception is to only insure the ‘bread winner.’  If you have young children with a spouse at home, the replacement costs, not working, caring for children that have just lost a parent can be enormous. Consider your position.
  • TPD –TPD stands for Totally and Permanently Disabled and this insurance is for when you are still breathing but unable to do much else. As morbid as it sounds, it is actually much more expensive to be alive and in this state than if you sadly passed away.

So why have these insurances?

Firstly replacement of income. If you suffer a trauma event, it is likely that you will need some time off work; therefore  a lump sum payment can replace your income so you can concentrate on treatment, rehabilitation and spending time with family. Household bills and living expenses will continue so payment could assist with these.

Repayment of debt is also important. A trauma event could result in partial or total disability, with the likelihood of returning to work in the same capacity minimal, or you might not be able to work at all. This means it is unlikely you will be able to generate the same, if any, income as before. Consequently you will need to consider how you would repay your debts, including your mortgage.

 

Compound Interest and getting into the Millionaires Club

Compound Interest is your secret weapon. So what is compound interest? Put simply, it is the addition of interest to the principal sum of your deposit or loan In other words, interest on interest.

Let’s assume:

Interest rate = 7% per annum.

Investment amount = $10,000

Principal + prior period interest = $10,700

Interest is now calculated on $10,700 so, principal (compounded) * 0.10 = $749

New Principal invested is $11,449

This is also the principle the banks use against you.  Don’t pay back that Credit Card and the interest keeps compounding and it gets harder and harder to get ahead.

So what is possible???

Say you are 25 today, and you have $5,000 to invest and you can spare $1,000 per month.  If you can achieve a 6% return on your money per annum by age 55 you will have $1,000,000.

But wait until you are 35 to start this target and the goal posts change dramatically. If you start with $5,000 you now need to save approximately $3,333 per monthly to achieve the same result.

 

While all these points are just the tip of the iceberg in creating solid financial habits, hopefully it will give you an insight into how being financially literate can help anyone achieve great outcomes by making good decisions early in your life.