Checking credit reports and understanding the terms of a loan are important tools for protecting yourself financially. Credit: First Republic Bank

Becoming financially literate empowers you to feel secure in handling your finances while working toward financial goals. There are five key components of financial literacy: earning, spending, saving and investing, borrowing and protecting money. 

1. Earning money

If you are earning money, you should have a place to store it. The main options are two types of bank accounts: savings accounts and checking accounts.  Checking accounts are meant for frequent transactions, such as direct deposit of paychecks, paying bills and more. Savings accounts are meant for storing and growing money that you don’t need to touch frequently. 

To make sure you’re saving regularly, set up automatic recurring transfers into a savings account. You can also set up multiple savings accounts earmarked for specific purposes, such as vacation expenses, upgrading to a new apartment, purchasing a home and/or vehicle, or even for birthday and holiday celebrations. By setting up the automatic transfers, you “force” yourself to put money aside and will be less likely to stray from your budget. 

2. Spending money

Allocating money toward bills and other monthly expenses is part of effective financial planning. Your individual bill total may vary, but commonly held wisdom suggests that about half your take-home pay should go toward necessities. This may include rent or mortgage payments, a mobile phone plan and groceries, to name a few things.  

A budget helps you address where money is being spent monthly. Budgets also help you determine how much you can save every month and where you can cut back on unnecessary expenses. Saving money can help you build an emergency fund for unexpected expenses or help you afford long-term goals. 

3. Saving and investing money

Your budget will help you determine how much you can save and invest. If you pay yourself first — allocating money to savings and investments before any other expenses — you can continuously build savings and budget accordingly. 

Saving and investing are critical for building long-term financial security. This might mean saving for retirement or to pay for college. You can choose to save money in a savings account or, alternatively, invest your money in stocks, mutual funds and bonds. If you want to get started with investing, you can speak to a financial professional for tailored guidance. 

For savings outside of a standard bank account, ask your employer about the benefits of maximizing your 401(k) contribution, if they offer that, while taking advantage of the employer match, if applicable. Also, consider yearly contributions to an IRA as a supplemental nest egg for retirement or a savings vehicle for a first-time home purchase. 

4. Borrowing money: Loans and other debts

At some point or another, most people borrow money, which must be repaid. Common examples include credit cards, auto loans, student loans and mortgages. 

Regardless of how you choose to borrow, it’s crucial to understand the terms of the debt you’re taking on, including details like interest rate (be it simple or compound interest), grace periods, how to pay and when payments are due. Misunderstanding terms and managing debt poorly can be expensive and may damage your credit for years to come.  

To that end, keep on top of your credit history and score by using credit monitoring tools. Your credit score will be a major determining factor in the interest rates and fees you’ll be offered when borrowing money. 

5. Protecting money

Another element of financial literacy is knowing how to protect your money to reduce the risk of identity theft or fund depletion. 

Having an overall idea of the components that affect your credit score is key to maintaining good credit and protecting your money. Your credit utilization ratio, or the ratio of revolving credit balances to available credit, significantly affects your credit score. Keeping a low ratio is a good way to not only improve your credit score but also ensure you have credit available when you need it. 

You’ll also want to regularly check your credit report to spot any outstanding payments or discrepancies. Beyond getting a sense of your financial situation, spotting errors can help improve your credit, since inaccurate information can negatively affect your credit score

Another way to protect yourself from adverse financial situations is to create and then add to emergency funds and nest eggs, from which you can access money in case of an emergency. This practice can help you avoid going into debt or needing to borrow money for unexpected expenses. Savings accounts are a good place to establish and maintain these funds. 

If you’re investing for a long-term goal, it’s important to have the right asset allocation. This means having the right blend of investments that can help position you for growth while including more conservative investments designed to lessen risk. 

How to improve your financial literacy

Depending on your financial background and current finances, acquiring and acting on financial knowledge can take time. Financial literacy is an ever-evolving process, and a variety of financial resources are available to help you continue to learn.  However, just being cognizant of financial literacy, on the whole, is an excellent first step.  And understanding financial literacy topics can often influence loved ones and friends to learn more about their own personal finance management.  

To help on your journey, you can embrace some of these ways to learn more about specific financial products and literacy topics, such as: 

  • Employer resources: Your employer may offer financial services and education to help you become more financially literate, such as financial counseling, tools and trackers or retirement planning.  
  • Online resources: Many online resources host valuable information for increasing your financial literacy. Many of them are free and easy to access. 
  • Financial advisors: Seeking help from a financial advisor with experience in financial planning can help you become more financially literate, as they are a source for expert knowledge and can speak to your individual questions and needs.  

This article originally appeared on the First Republic Bank website.

© 1997 – 2021 First Republic Bank.
Banking products and services are offered by First Republic Bank, Member FDIC and Equal Housing Lender 

The strategies mentioned in this article may have tax and legal consequences;  consult attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this article. 

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