The MHP Guide to Financial Literacy
An unfortunate reality in the United States is that although we are home to some of the most prestigious schools and universities on the planet, we are failing our students in the one type of education that could be most impactful. Unless someone is actively studying finance, accounting or economics, the students of our country are often graduating with little to no sense of financial literacy. It’s no wonder then that we have such a large wealth gap in this country that’s only getting worse. Folks may have heard of stocks, bonds, and assets as concepts but don’t know how to effectively grow their wealth because they simply lack the knowledge - which is evidenced by the top 1 percent owning an ever-growing 44 percent of financial assets. Wow.
At My Home Pathway, we believe that everyone deserves to have the knowledge they need to take control of their financial future and that’s why we’ve come up with this guide. In this guide we’ll touch on concepts and topics that can help establish a solid foundation upon which you can start building your own wealth. Let’s get into it.
First things first, let’s talk about budgeting. At the most basic level there is no way you can build wealth if you’re spending more money than you’re bringing in. This is where a budget is critical. By properly planning and examining your spending habits, you should be able to get a place where you’re ultimately able to have a little extra money left over every month that you can either save or invest as you see fit. If you’re struggling to create a good budget on your own, there are lots of free tools online that you can use to make your life easier.
So now that you’ve gotten yourself to a point where you have some excess money to work with, you’re on the right path. Now we need to get you someplace where you can store that money which is where bank accounts are helpful. Bank accounts are safer than keeping your money as cash on hand because the money you store with banks will be FDIC insured meaning it’s much harder to steal and will also open up options for you that let you take advantage of the single most impactful way to grow wealth which is compound interest. Who you choose to bank with is up to you, but be sure to consider your options carefully. Credit Unions for example can offer lower fees and better interest rates on savings accounts and loans but may have fewer branches and ATMs. Retail Banks on the flip side may offer more convenience but at the cost of better rates. There are now even fully online banks or others that are a hybrid mix of online and brick and mortar branch locations like First Republic Bank.
Now once you’ve settled on an institution to bank which, the next decision you’ll want to make is what type of account to open. Checking accounts are the most liquid, meaning you can most easily move money in and out, which makes them ideal for day to day financial needs such as paying bills and making several deposits or withdrawals in a single month. Some checking accounts may even offer interest on your account balance but they won’t be nearly as high as what you’d get with a savings account. Savings accounts will offer slightly higher interest rates at the expense of some flexibility. They’re flexible enough where you can still use the funds for major life events such as buying a car, emergency funds or even vacations. You can even consider high-yield savings accounts which can offer rates as high as 20 to 25 times the national average but will also require much larger initial deposits, higher minimum balances and higher fees. Depending how much money you have saved up you can even consider a mix of all three, where you keep enough money in your checking to manage routine expenses while the remainder of your money is kept in a savings or high-yield savings account.
Great, so now you’re at a point where you’ve got some extra money to work with and you’ve got yourself maybe even a few bank accounts to store that money. That means it’s time to start looking at ways you can get your money to work for you, and that’s by looking at investing options that will provide higher returns that you’d ever be able to get from checking and savings accounts alone. Here are some options you can take a look at.
1. A CD or Certificate of Deposit is one such option. This is a product offered by banks and credit unions that offer premium interest rates in exchange for the customer agreeing to keep the money in the bank for an extended period of time. This is one of the least riskiest options of enjoying higher returns on your investment than many of the other options we’ll discuss next but it’s also the most limiting as your money is quite literally locked away for whatever time period you’ve agreed upon with your institution. There may be certain situations where you can withdraw your funds early but not without some sort of penalty. This is something you’ll want to look into carefully and understand completely before locking away your funds in a product like this.
2. Another option you can look at for higher returns are bonds. Bonds typically don’t offer as high of an upside as you might get with stocks which we’ll touch on in just a minute but they also carry less risk. Bonds are simply loans made out to people that need money, which can often times even be a government entity that is agreed to be paid back at a certain date with a certain interest rate applied. Interest rates can impact your return from bonds and so you’ll want to keep a close eye on what the interest rate environment looks like. For a more in depth understanding of the relationship between bonds and interest rates here’s a fairly quick Khan Academy video on this exact topic. Another risk is that the borrower may not be able to make payments when they are due and default on the loan. Bonds come in different ratings ranging from AAA to D and which type you go with will depend on your risk tolerance but even with the highest rated AAA there is no guarantee that this risk is not there, as we saw with the 2008 financial crisis.
3. Stocks can be yet another investing option you can look at. Unlike CDs and bonds you are not lending out money for a period of buying but rather paying to own a piece of a company. As a partial owner you’ll be able to benefit from that company’s performance. The risk here lies in having to pick the right companies because not all businesses are guaranteed to succeed. You’ll want to research companies and their future plans carefully when deciding on individual stocks to invest in as a poor stock choice can just as easily go down as it can go up. However there are many investing strategies you can take when working with stocks. Rather than picking individual companies you can also bet on select cohorts or industries through ETFs (Exchange Traded Funds) of Index Funds which allow you to invest in a mix of companies altogether thereby inherently diversifying your portfolio. As a general rule of thumb, when it comes to investing it’s highly advised that you diversify meaning you don’t put all your eggs in one basket. If you have $5,000 to invest and you put it all in one company and that company does poorly, you can very easily lose over $1,000. However if that same $5,000 was spread across multiple companies the impact one single company’s negative performance will have on bringing down your portfolio will be much smaller. Now of course the same is true on the flip side where a single company’s positive impact will also not be as large but this is where you’ll want to decide what level of risk-tolerance is acceptable for you.
4. A newly emerging asset class that can also be viewed as an investing option could be cryptocurrencies. Some of the larger cryptocurrencies like Bitcoin and Ethereum seem to have gotten to a point of mainstream appeal where even companies like Tesla, Paypal and Microsoft have bought in, but the space itself is still highly speculative and should be entered very cautiously. Even the more established coins like the ones mentioned above have much more volatile prices than stocks. The most volatile of the bunch are what are called altcoins or alternative crypto-currencies. These are newer cryptocurrencies coming into the market with much less proven track records but promises of new capabilities that have the potential promise of exponential returns. This however is again very speculative and should be taken with extreme caution as there is also the possibility to massive losses that equals the possibility for massive gains.
5. Another great way to build wealth is to buy a home. Building equity can be the single most effective way for someone to build their net worth. In fact on average homeowners tend to have a net worth that is 41 times greater than that of their renting counterparts. There may ultimately be many factors that will help you decide whether buying or renting a home is better for you and if you want to read more about this topic you can do so here with our blog post on this here. In summary though one of the greatest benefits of homeownership is that your mortgage payments will go towards building equity whereas renting is simply a perpetual expense. If you ultimately do decide though that buying a home may be the right option for you it’s very likely you’re going to need a loan as the majority of folks will not have the money set aside to buy a home outright and for large purchases like these you’ll want to have good credit.
When it comes to credit scores, it really comes down to the fact that lending institutions need to believe that you are creditworthy for them to want to loan you money. The more creditworthy you are, the more they’ll be willing to loan you and the best way to build that creditworthiness is to have used your credit responsibly in the past which is captured by your FICO score. We break down FICO and APR here, and you can read more below.
What is a FICO score? A FICO score is a three digit number that can range from 300 to 850 and helps lenders make better decisions on whether or not to provide a loan. You can essentially think of it as your financial report card. Just like in school, there are several factors that contribute to your overall grade. For FICO scores those factors are:
Payment History (35%)
Amounts Owed (30%)
Length of Credit History (15%)
New Credit (10%)
Credit Mix (10%)
Because these scores are used by institutions to make decisions on loans, it’s very important for you as a consumer to be focused on your FICO score and ensuring you’re doing all that you can to keep it high or to improve it if it is not in one of the better categories. As mentioned earlier, without a high FICO score it may be challenging to find access to capital when you need it.
The world of finance is vast and large and so to wrap your head around it in its entirety with a single blog post or even in the course of a few hours may not be a realistic goal, but hopefully this guide gave you a nice jumpstart to your educational journey. If you want to be better about your finances, improve your credit score and/or ultimately want to buy a home we’d highly recommend that you download and check out the My Home Pathway app, available now on both iOS and Android, for personalized guidance.
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