Financial Literacy Begins With A Simple Question

Financial literacy is very difficult to learn if you begin with the tools and methods. It is not a subject that readily lends itself to examining specifics and from that learning the general case. Part of the problem is that financial literacy is composed of many interacting parts. The parts have different priorities at different points in one’s life and they are not of the same relative importance for everyone.

Where to start

At the most general level we should start with a simple question about financail literacy. What’s it for?

If we think about that we discover it is to help us to understand financial things and from that to create organization and efficiency in our financial decisions. That leads to the idea of optimizing and timing and provides guidance to the risk and rewards of certain tools and techniques.

Financial literacy is about money. What it is, how you get it, what you do with it after you get it, and where it eventually ends up.

What is money and what’s it for?

Money is a way to facilitate barter. When you think about it barter never went away. We are no different from a person trading fish for meat 10,000 years ago. But we don’t have the inefficiency of finding someone with meat to trade and who wants fish in return. How many fish, what quality, and what kind all would influence the amount of meat traded. We have the blessing of having that summarized into prices.

Money lets us wait to trade. A dollar in my pocket can be there for quite a while if I don’t find what I want. A fish in my creel might last a day. It’s value drops every hour. Money stores value.

Understand the words. Buy is to trade money for something. Sell is to trade something for money.

How do we get money?

We trade for it. We barter our time, talent, experience, enthusiasm, and ability to work with teams for money. It could be some kind of contractual committment. Salary or wages. It could be by being self-employed and trading only when someone appears. People who have great skill, or scarce skills, or lots of time, or exceptional enthusiasm can trade for more money than someone who has less. People whose personal style and leadership characteristics make other people more effective can command more, too.

It is all about barter. In the beginning, if you want to have more money, you must have more to offer.

What do we do with money?

In the most general case, money moves into one of three realms.

  1. You spend it to live the way you want
  2. You lose it to taxes, bad choices, or carelessness.
  3. You give it or leave it to somene else.

There is no other general choice. The methods will vary, but only the three choices are available.

I think we can all agree losing is the least desirable choice.

Avoiding loss is difficult

Once you

For example a student loan is a way to transfer money from your future ot the present so you can buy an education. Education can enhance your value in the market place and we presume the extra money we can command is more than the cost to repay the loan. If the education does not add enough income to the future, some of the loan and its interest will be a loss. Be sure you know how your education adds value and how much.

Another common loss is income tax. This one is interesting because it leads to other ideas. The key one is how much should government cost? People will pay taxes, more or less readily if the value of government is clear. If government becomes too expensive for what is received then people will resent taxes. If you find taxes too high, you might consider how to change the government attitude to spending your money. That will take a long time to fix, so some people move to lower tax jurisdictions. One thing to not do is try to make your tax cost zero. You can do that but it costs in other ways. Your best move is to optimize what you have after taxes are paid.

Most methods use time and money together.

Suppose you have established your cost of living, (consumption) the spend to live part of distributing your money, and have some left over. Ideally you create the leftover part first. You decide to transfer that money in time.

You can move it forward to spend another day, possibly in retirement. We call that saving. The saving amount should relate to how and when we want to spend the money in the future.

Alternatively we can send it backward in time to pay for spending we did in the past. That’s what borrowing does. Spend today, earn or get the money to pay for that in future. We should be cautious about creationg debt because we may find these required payments minimize or harm our abilioty to live the way want today and have enough to live the way we want tomorrow.

Understand both saving and debt in terms of the time when the money appears for purpose of spending.

The tools

Most people use tools to implement their financial choices. There are an immense numbe rof them. Lets see the obvious ones first:

A loan of some kind or other. Could be a student loan, a mortgage, a car loan, or a credit card. All of them create the spend now, acquire the money later situation. The differences usually realte to the duration you must pay and the security you must give for the loan. At their fundamental, they are all the same but their characteristics differ superficially.

The security given affects the interest rate you must pay. Interest is the price you pay to use someone else’s money.  Loans with no security cost more becasue the lender does not expect to be able to collecta ll the money. Credit cards cost extra becasue of the transaction costs. A mortgage is simpler to administer and so can cost less. Soem debt will have interest that is tax deductible. Try to have more of that and less non-deductible interest if you must have debt at all.

Organize your credit, getting money before you earn it, so the interest you pay is optimized. Pay off debt in the shortest time possible subject to cash flow limits.

Saving and moving money to the future. Again their are many tools for this. The differences will involve many things and most investment products vary because of the factors they use.

For example a bank saving account pays little or no interest. That’s becasue there are costs to the bank to operate the account, and you might take it away tomorrow so they can’t invest it anywhere easily. Plus, they are very nearly certain to give you back the money you invested. Investments that are liquid, you can take them back whenever you want, safe, banks are good for the money, and easy to access tend to pay very low yields. Investments that are risky, committed for a period of time, and difficult to manage always offer more. A landlord of a 3-plex should make more than a person putting money in a savings account because they must input more than merely money. Risk, management, hard to get money back, costs to get it back, and legal factors like rent control and tenant rights.

When you invest, know what you can add to the investment other than money. Know what you get back and when. If you don’t need the money for 40 years, you should invest it in ways that match that. You should not give up yield for liquidity.

You will decide who should manage the money while it is moveing to the future. Could be you if you are willing to invest the time and skill to do so, or it could be a manager who does it for you. You must decide what you are willing to contribute in addition to money to get the higher yield. Nothing is free. If you get mor eit is becasue you contributed more.

Which leads to the idea of wealth.

You will recall money is a store of value. If someone has more of it, it is becasue they contributed more to others and have not yet spent it to live. Altenratively, someone else gave it to them. If we view wealth as the accumulation of what we have contributed to the world minus what we spent to live the way we wanted, you will see welath differently than if you just see a number with a dollar sign in front. People who have a lot of money contributed more or no one would have given them the money in the firts place.

The tradeoff

If you want to live well, have enough wealth to live well after retirment, and have money to give away or leave to others, you will need to balance four things:

  1. How much will you be able to contribute to society? Trade your time and expertise for money.
  2. How much will you consume to live as you wish?
  3. How much will you give away or plan to leave to others when you don’t need the money any more
  4. How much and when will your losses impact.

The easiest to control is cost of living. Be sure you do not outspend your ability to earn. That requires discipline and understand of the balance involved. Little things matter. There is no magic. What you spend or lose, you cannot have for the future.

A risk people often forget about.

For everyone, the ability to earn income is their most valuable asset. The question relating to that and other similar things is what if? What if I don’t live long enough to maximize my eanrings. What if I have made committments based on being able to earn. Debts, spouse, children. It is a responsbile nove to insure anything you have that has significant value. If yur career will earn the same as an investment of $2.5 million, why do you insure it for $300,000? Some one will need the money.  Be sure you seek advice for the amount you need and only then assess the best format of policy for you in particualr and as things lie now. Everything changes over time.

The same analysis goes for loss of income becasue of disability.

Tools exist to address the question.

The takeaway.

It is about balancing how you earn money and spend money over time. There are many tools that allow you to move the money around in time. All of the tools are powered by compound yield afte taxes.

If you understand that you get more if you give more and all financail products address moving money in time or absolving you of risks you don’t choose to keep, it will be easier.

From then on it is just arithmetic to decide the mix. Complicated arithmetic sometimes but hey, “It’s not music theory.”

I help people understand and manage risk and other financial issues. To help them achieve and exceed their goals, I use tax efficiencies and design advantages. The result: more security, more efficient income, larger and more liquid estates. Please be in touch if I can help you. 705-927-4770

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