Five Must-Know Personal Finance Basics

You probably have distinct memories of learning to drive a car. Maybe you learned from your parents or an older sibling. Or maybe you took a driver’s ed class at your high school or community center. However you learned, chances are pretty good that someone showed you the ropes and made you practice – a lot – before handing you the keys to the family automobile.

This isn’t limited to driving, of course: Think about most of the things you do on a day-to-day basis – from cooking and using the washing machine to changing a tire or mowing the lawn. Before you started doing those things, someone made sure you knew how.

But what about personal finance? Do you remember who taught you about the pitfalls of high-interest credit card debt? Did you learn about the importance of saving for retirement in high school or college? Did a parent or relative ever sit you down and explain the basics of creating a budget you can live with?

If you’re like most people, your early financial education was pretty limited. If you were (very) lucky, maybe you did learn a bit about budgeting before you left the nest. But the sad reality is that most of us enter the adult world without a solid financial education – we have to learn as we go, and we end up paying the price.

In other words: When it comes to personal finance, most of us could probably use a refresher course. That’s why I put together this list of five things that every adult should know about money.

1. How to create – and stick to – a budget. This is such an important skill, and it never ceases to amaze me how many people simply don’t know how to create a basic budget.

 
There are dozens of different budgets out there, from simple, “big-picture” budgets to the free-flowing “waterfall method” to more structured plans like the 50/30/20 budget.

The type of budget doesn’t matter. What matters is that your budget ensures that you spend less than you earn and includes categories for savings and an emergency fund.

It’s also important to remember budgeting is supposed to be flexible. Let’s say you try a budget for a month and find yourself constantly short on funds for, say, groceries or gasoline. Instead of writing off the budget as a failure, try shifting some categories around. Allocate less for some other category, like entertainment. Or, try another type of budget altogether. But don’t give up. Budgeting takes practice, and it’s rare to create a perfect budget on the first try.

2. How to use credit cards . . . responsibly. I’m not opposed to credit cards. In fact, I feel that, when used responsibly, credit cards can be useful tools that help you build your credit score, which in turn can make it easier to do things like buy a home or apply for a bank loan.

But too many people treat credit cards as an additional source of income: They use their credit cards to cover gaps in their budgets, or to fund unnecessary purchases that they can’t otherwise afford. What’s more, many irresponsible credit card users only pay the minimum monthly payments. The result? They never really put a dent in their outstanding balances, and credit card debt quickly becomes overwhelming.

Responsible credit card use comes down to two main things: Only using your credit card for purchases you can afford, and paying your balance in full every month. End of story.

But since many of us learn about credit cards the hard way (meaning, “by racking up high-interest debt before we know any better”), another important thing to know is . . .

3. How to pay down debt. It’s very likely that you got your first credit card right after you graduated college or started your first “real” job. You were young and inexperienced, and you proceeded to do exactly the opposite of responsible credit card use. You’ve still got the debt to show for it.

The good news is that there are ways to pay down high-interest credit card debt. The bad news is that, you may not be familiar with any of those strategies. The real key to debt repayment is to stop using your cards and pay as much as you can afford to pay over the minimum payment (but no more than you can actually afford!). There are lots of good debt-repayment strategies out there. One of my favorite strategies is the snowball method. Other strategies – such as balance transfers or simply delaying all non-essential spending can also be helpful.

4. How to save money. I know. This sounds ridiculous. But while most of us understand that we should save money, we don’t really understand how to save money.

First of all, you should start saving as soon as you can – even if you can only save a few dollars out of every paycheck. I think that one of the best ways to save is to set up an automatic bank transfer. Pick an amount you can live with, and set up a weekly or bi-weekly transfer. The money will move directly to your savings account, and there’s no way that you can forget or decide to use the funds for something else.

What should you save for? Well, to start, I suggest that you save up at least two or three months of living expenses. The goal is to have enough money to live on if you lost your job or were unable to work for a month or so. Once you’ve got an emergency fund, you should start saving for retirement – it’s never too early!

5. How – and why – to monitor your credit report. Do you know what’s on your credit report? Your credit report – which contains information from the three major credit reporting bureaus – is used to determine things like the kind of interest rate you get on credit cards or a mortgage. Your credit report may also affect your ability to rent an apartment or get a job. By reviewing your credit report on a regular basis, you can make sure that your credit history is free of errors and/or fraudulent activity. Not sure where to start? You can get one free credit report a year from www.annualcreditreport.com. Check it out – and if you see any suspicious items on your report, contact your credit card company right away.

Sure, it would be nice if we all had some sort of basic financial education before we went out and started earning money and applying for credit cards. But even if you’ve had problems with saving, budgeting or responsible credit card use, it’s not too late: By learning the basics of personal finance, it’s possible to change your relationship with money.