Mastering the Basics: 5 Financial Essentials You Should Know (But Might Not) - Quicken Loans Zing Blog

It surprises me how little I learned in high school. Don’t get me wrong – they taught us algebra and biology, English and history, and I can still conjugate a single verb in Spanish (tengo, tienes, tiene, tenemos, tenéis, tienen). But my education left something to be desired when it came to real life skills, especially financial skills. I was never taught how to make a budget, debt (and how to get out of it), and I certainly knew nothing about my credit score. Not knowing this valuable information can be a serious stumbling block in life – not to mention a pain in the neck to figure out. So to pick up where my high school left off, let’s look at the financial basics that you should know (but might not).

Build the Budget

Of all the financial basics to master, knowing how to make and operate a budget is the most important. In its simplest form, a budget allows you to track the money that you’re making, spending and hopefully saving. It can also be a good way to track investments and set goals for yourself, such as building an emergency fund or saving up for a house. You can create a budget with a pen and paper, an Excel doc/Google Sheet or, my personal favorite, with a web-based personal finance service.

If you’re creating a budget manually, you should start with listing the amount you earn in a given month. Begin subtracting necessary expenses, such as rent/mortgage payment, car payment, insurance, utilities and food. You then will want to set aside certain monies to be saved during the month. From there, you will subtract less essential expenses – like fast food or going to the movies – until you’ve spent (and saved) all of your money for that month. Before the month ever begins, you should have an idea of where every dollar is going. In the words of financial guru Dave Ramsey, “If you don’t (budget), you lose the chance to make (your money) work for you in the areas of getting out of debt, saving for an emergency, investing, paying off the house, or growing wealth. Tell every dollar where to go.”

If you’re computer savvy, you may want to start a budget through a web-based personal finance service like Mint.com or PersonalCapital.com. These free services have simple platforms, meaning you won’t have to wade through Excel spreadsheets.

Savings Accounts and Where to Find Them

A savings account is a bank account that earns interest, which is money that the bank gives you for having an account. Unfortunately, the average savings account in America only has a .06% Annual Percentage Yield (APY, or interest rate). Let’s break that down – if you had $10,000 in your savings account for a year at .06%, you would earn a flimsy $6 in a year. That’s not much.

However, there are some banks that currently offer savings accounts with higher interest rates on their savings accounts. Both GE Capital Bank and Synchrony Bank currently have savings accounts with interest rates of 1.05%. With that interest rate, your $10,000 earns $105 in a year. If your money is going to sit in a bank, you might as well be making the most of the interest.

Savings accounts are a great way to build an emergency fund (which should consist of anywhere from two to six times your monthly income), but you probably shouldn’t think of them as tools for drastically gaining wealth. If you’re hoping to save that money for retirement or a big purchase (like a new home), you would be better off looking at investment opportunities (we’ll talk about this shortly).

Getting Out of Debt

Getting into debt is easy, but getting out of the red can be a serious challenge. Typically, I like to split debt into two categories: bad debt and good debt. Bad debt most often refers to credit cards – because they have higher interest rates – and car loans – because cars depreciate in value the second you drive off the lot. In an ideal world, you shouldn’t get into a situation where you’re paying interest on these types of loans. It’s better to pay off your credit cards every month and save up for a vehicle (you can use your new savings account!).

Good debt usually consists of student loans and mortgages. These are loans that are taken out for the purpose of furthering your future net income. Student loans, for instance, are used to earn a college degree, which will likely give you a higher paying job. A mortgage on a house, unlike an apartment, allows you to build equity in your property over time. Not only that, but both of these loans are low in interest.

In order to pay off your loans, it’s best that you tackle them one at a time. For example, let’s say you have three $1,000 loans. The first one has an interest rate of 3%, the second’s rate is 4% and the third one has an interest rate of 6%. You should start by tackling the debt with the largest interest rate. You will still need to pay the minimum payment on the other loans, but diligently try to pay down the highest interest debt first. This will save you money in the long run.

Unfortunately, there is no magic trick to making your debt go away, but in many situations, it makes smart financial sense to refinance your mortgage and student loans.

Give Yourself Some Credit

Whether you’re interested in buying a house or you want to go back to school, there’s a good chance that you’ll need to get a loan at some point in your life. But before a lender will provide you with the funds you need, they want to know that you’ll pay them back. In order to see if you’re a reliable customer, they look at your credit score.

A credit score (often called a FICO score) is depicted as a number between 300 and 850, with numbers closer to 300 considered low credit and numbers closer to 850 considered high credit. With a higher credit score, you are likely to get a lower interest rate on certain loans and qualify for better credit cards. With a lower credit score, you might receive a higher interest rate (or not be approved at all).

A credit score is judged by your past credit history. Unfortunately, this means that people who have never had a loan or credit card automatically have nonexistent credit. You can take steps today to get your credit off the ground.

The three credit bureaus – Equifax, Experian and TransUnion – update and store your credit history. They take the following into consideration when tallying your credit score: your payment history, the amount of money you currently owe, the length of time you’ve had credit, if you’ve recently sought new credit and the types of credit you’ve used. At the same time, if you’ve missed payments or gone into bankruptcy, your credit score will be seriously damaged. If you’d like to learn more, take a look at this handy Zing video about how to improve your credit score.

Investing

If you’re planning on retiring at some point, you should have a long-term plan for investing. Unfortunately, the day of the pension is about over, meaning the responsibility of retirement is going to be largely on your shoulders. The best way to do that is through investments. Investing simply means that you’re spending your own money in a certain business, property or commercial ventures with the intention of making more money. Traditionally, when people talk about investing, they’re referring to the stock market. When you buy a stock, you’re actually purchasing an ownership share in that company.

The interest you gain from your investments has the potential to be much greater than that of a savings account (typically 5 – 7% in the stock market), but it is not guaranteed. Unlike a savings account, it’s possible to lose some or all of your investments, depending on the performance of the market. That being said, the stock market has historically been a great way for gaining wealth.

The key to profitable investing is diversification. Instead of putting your money into real estate alone or just investing your money into oil companies, your portfolio should consist of a wide variety of investments. This way, if one of your investments fails, your other investments can help you tolerate those short-term fluctuations in the stock market. Many investment services such as Betterment ask you about your goals and risk tolerance, and they then use your answers to prompt investment solutions for your individual situation.

Before you take a swing at the stock market, take a look at the 401(k) options that most employers provide. A 401(k) is a retirement savings plan sponsored by an employer. It gives you the opportunity to set aside a piece of each paycheck and put it toward your retirement investments. Unlike regular stocks, taxes on a 401(k) aren’t paid until you withdraw the money from your account (this is a great perk).

In most situations, employers will also match the amount you put into your 401(K). This is essentially free, pre-tax money that you can put toward your retirement.

Whatever you do, don’t try to save for retirement with a savings account alone. Retirement can cost hundreds of thousands of dollars. You’re not going to get there with 1.5% in interest.

Starting with the Basics

As you begin to learn more about financial basics, you’ll soon see the many ways they impact your life. Whether you’re starting a budget, saving for a rainy day, getting free from debt or preparing for the future, use this information to get you where you need to be.

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