By Sabrina Loh
It goes without saying that money is one of the most important things in life.
Money pays for all the things that make life possible, such as a roof over your head, food on your table, a good education, and medical bills. It also buys security and safety for you and your loved ones.
Despite how important money is in our lives, the basics of finance aren’t usually taught to us in school or by our parents.
Unfortunately, a lack of financial literacy can lead to poor financial decisions that could cause serious long-term consequences. For instance, racking up bad credit card debt, excessive and frivolous spending, never-ending payments, and not saving for retirement.
A recent study by the Money and Mental Health Policy Institute has shown that money problems and mental health are intrinsically linked. Poor management of finances often leads to stress and anxiety that further impact finances in a never-ending toxic cycle.
Creating a financially secure life can feel like a daunting task that requires the skill of an expert. However, many money issues can be solved simply by going back to the basics of finance.
In fact, a 2019 survey revealed that 9 in 10 adults say that nothing makes them happier or more confident than when their finances are in order.
So take a deep breath and use this guide to lay a solid foundation for a healthy financial future.
“A financially literate person not only manages their money with more confidence but also knows to handle the inevitable ups and downs of their financial lives.”
1. Understanding your paycheck
1. Understanding your paycheck
The first place to start in the basics of finance is with your paycheck. It is after all, where most people receive their income, especially if you work for an employer.
Understanding the information on your paycheck may seem like a no-brainer, yet few people check it regularly.
Make sure you review if you’re receiving the correct amount you’re entitled to, paying the correct amount in taxes, as well as any other deductions that are being made, such as EPF and SOCSO in the case of locals residing in Malaysia.
If you notice any miscalculations with those figures, make sure you raise this issue immediately with your relevant Finance or HR team.
It’s money that you worked hard for, so it’s important to understand what goes where and why.
Now that you know how much is your net pay, the next financial concept to understand is the need for and the value of budgeting.
Many people often associate a budget with restrictions and hassle, or they think they do not earn enough money to warrant a budget. However, budgeting is crucial regardless of your income level.
When you create a budget, you have a clearer picture of how much you spend and how much surplus you have left, which you can use to put towards your savings, retirement, debt, or into an emergency fund.
It allows you to make smarter decisions with your money, such as eliminating overspending. When you’re faced with spending money on something, a budget forces you to stop and think about the purchase. You begin to understand that by spending money in one area, you’ll have to cut back in other areas or have less to save.
Budgeting can also be flexible because you get to decide how much you want to spend on each category, so you can always make room for more ‘fun’ stuff. The best part is you don’t have to feel guilty as long as you’re sticking to your budget.
It allows you to still have fun, save and pay for necessities without worrying about your financial safety. A great place to start is the 50/30/20 technique.
3. Building an emergency fund
If the pandemic has taught us anything, it’s that life is full of unexpected curveballs. You can’t predict when your car will break down, or when you’ll need to make an emergency visit to the doctor.
Emergencies like these can set you back hundreds, if not thousands of dollars. This is where an emergency fund helps you to weather through life’s unexpected events.
Start by tallying up your monthly living expenses — calculate how much money you spend on rent or your mortgage, bills, groceries, and transportation. Your emergency fund should have enough to cover your living expenses for at least three months, and more if possible.
It may be tempting to tap into your emergency fund for events such as a vacation, wedding, or buying a car, but practice discipline and resist the urge. The whole point of an emergency fund is to prevent you from going into more debt during times of crisis.
4. Get out of debt
Not all debt is bad.
Good debt has the potential to increase your net worth and future value, such as by investing in properties or furthering your education; while bad debt involves borrowing money to purchase rapidly deteriorating assets or is used for consumption, such as in buying a car or owing money on your credit card.
One of the critical basics of finance is to understand the big differences between the two and to learn about how interest rates work on your loans.
It may be tempting to charge more than you can afford on your credit card but high-interest rates carried over several months can make those purchases significantly more expensive than when they started.
Two popular methods for settling outstanding debt are the avalanche and snowball method.
The avalanche method involves making minimum payments on all your debt, then using any additional funds to pay off the debt with the highest interest rate.
The snowball method, on the other hand, involves making minimum payments on all your debt, then paying off the smallest debts first before tackling the bigger ones.
Never forget to read the fine print of any credit cards you sign up for and loans you borrow to get a clear understanding of what you’re getting into as well!
5. Save for retirement early
When you’re young, retirement can feel so far away that it seems like a distant dream. In fact, that’s one of the most common excuses that young people use to justify not saving for retirement.
Even if you’re not earning a lot at the beginning of your career, one thing that you have over richer, older people is time. The sooner you put away money for retirement, the more time you’ll have across your life to save instead of racing to catch up.
Combined with the power of compounded interest, you earn interest on your contributions as well as your accumulated interest. So even a small amount can make a huge difference in the future.
Using time to your advantage is a fundamental financial basic that you should learn to cover all your bases.
6. Getting insured
Now that you’ve set up a solid budget, put away money for an emergency fund, retirement, and work towards paying off your debt, the next step in the basics of finance is to get yourself insured.
You’ve worked hard to build solid financial health, and it needs to be protected because you never know what life throws at you.
It’s better to prepare for the worst by getting insurance so that you don’t end up in financial ruin in the event of a disaster.
There are many types of insurance, but these four top the charts in terms of importance — medical insurance, life insurance, critical illness insurance, and personal accident insurance.
In the case of those who own a house or car, home insurance and car insurance are crucial and in some cases, compulsory.
You can purchase insurance to protect yourself against almost anything you can think of! Even things such as online shopping scams, snatch thieves, and getting your sports equipment stolen.
3 Rules to live by:
Building strong financial health is an ongoing process. Once you’ve established a solid foundation of financial basics, keep these 3 rules in mind to help you make wiser money decisions.
1. Set long term financial goals
When you set clear goals, it motivates you to do the work, see your progress, and in turn build up your momentum.
Long-term financial goals typically take more than 10 years to accomplish and can refer to retiring early, buying a house, or creating multiple income streams.
2. Set short term goals
Similarly, short-term financial goals motivate you to reach your targets and enjoy what you sowed sooner. For example, saving for a wedding, renovating your kitchen, or going on a holiday.
Achieving your short-term financial goals also gives you a confidence boost and the foundational knowledge to achieve your larger goals that will take more time.
3. Distinguish between wants and needs
Wants are items and services that are nice to have but you could ultimately live without, such as the things you buy for leisure.
Needs are necessities that you require to live a healthy life, such as a roof over your head, food, water, and healthcare.
Mixing up these two concepts can wreak havoc on your finances, so make sure you don’t trade financial security in pursuit of your wants.
The bottom line
Having a solid understanding of finance is crucial because it equips us with the knowledge and skills we need to manage our finances effectively, such as debt repayment, budgeting, saving for retirement, and saving for a rainy day.
A financially literate person not only manages their money with more confidence but also knows to handle the inevitable ups and downs of their financial lives.
Unfortunately, it’s something that many of us weren’t taught in school.
But the good news is that these concepts are easy to understand over time when broken down into digestible pieces.
You don’t have to be a financial expert to be excited about your finances, but it’s also something that you should never ignore over your lifetime.
So use this guide to tackle these financial basics one step at a time, and you’ll master these skills in no time.
Trust us, your future self will thank you!
Want to learn more about financial basics? Tune into our BigPay blog every week to improve your financial literacy.