Financial Literacy
Part 1: What is Financial Literacy?

“Someone’s sitting in the shade today because someone planted a tree a long time ago.”

— Warren Buffett

Summary

• Knowledge is the foundation of financial literacy, but action is what realizes its benefits.

• The value of a financial plan, one that accounts for and adapts to your needs, is limitless.

• Setting goals is only as valuable as the decisions you make to reach them.

• Proper budgeting can help you maximize the value of each and every dollar.

• Debt isn’t something to be afraid of; it’s something to account for.

• Investing, by definition, creates future value by deferring immediate gratification.

Introduction

In simple terms, financial literacy entails understanding concepts related to money, transactions, budgeting, investing, debt, and the like. Like all forms of literacy, however, capability does not translate to action—just because someone is literate doesn’t mean they’re avid readers.

The most successful financial “literates” are those who receive, understand, and evaluate information in their day-to-day lives in order to make informed decisions and recognize the likely outcomes. Similarly, those who are well-versed in finance often don’t exercise their knowledge, leading to avoidable pitfalls. Susan Schulze, once an advisor and now the Vice President of Practice Management, asserts that “economic stability goes both ways,” suggesting that “difficult job markets and rising costs are external pressures, but proper financial literacy is an internal, self-determined form of rebalancing affordability by taking action.”

In essence, grasping these concepts is just the first step; the more important one is applying them. Today, we’ll be quickly reviewing the basics, but as the series progresses, we’ll drill deeper and introduce more advanced aspects in an accessible, easy-to-understand way.

Financial Planning: Setting up for success

People understandably get excited when planning vacations, but not so much when it comes to financial planning. The lack of enthusiasm makes sense at first glance—the former involves flights and experiences; the latter uses spreadsheets and dull numbers.

But let’s unpack that idea for a second. When researching your trip, did you budget for flights? Pack your bags efficiently to optimize baggage fees? Exchange currencies to make purchases? Book time off work? Purchase travel insurance? Invest in some outfits or accessories? Congratulations! If you did any of the above, you practiced aspects of financial planning.

Further to the point, if travel is something you value, a detailed financial plan can help you afford to do more of it in the future.

Figure 1 2021 Schwab Modern Wealth Survey.

Once you realize that financial planning is a tool to put what does excite you within reach, it becomes a more enjoyable exercise. At its core, it’s a document that outlines your current financial situation, short- and long-term goals, and strategies to help you achieve what matters to you.

Let’s break down some of the components of a financial plan, which ironically relate back to financial literacy.

Setting goals: What matters most

A good financial plan starts by acknowledging your goals, but a great one is based on the motivations behind them.

Goals are important for virtually all facets of life, and it’s no different for your personal finances. They serve as a destination and influence the decisions you make to get there. That said, if you don’t have a clear route, you may take a wrong turn somewhere.

SMART goals help address this issue by setting your target and working backwards to figure out how you’ll make it happen:

• Specific: The more specific the goal, the more likely it is to be accomplished.

• Measurable: Quantifying what you consider success can help track progress.

• Achievable: Unrealistic can quickly turn into unachievable, leading to disappointment.

• Relevant: Ask yourself why this matters and how it contributes to your overall happiness.

• Time-bound: Talking about doing something is the greatest way to avoid doing it at all; establish a timeline.

Although today’s topic covers financial literacy, savings goals aren’t the only kind of way you can enrich yourself. Life is meant to be lived, and wealth is really just a way to take the opportunities to do what brings you joy—something our free goal-setting worksheet can help you with.

Budgeting: Balancing needs & wants

Budgeting is a fundamental aspect of money management and involves drafting a plan that encourages healthier financial habits. It accounts for your income streams, living expenses, debt management, and helps strike a balance between spending and saving. To compile a budget, you’ll need:

• Income: Tally your total income and where each is coming from.

• Needs: Consolidate your non-discretionary expenses, such as rent, food, and so on.

• Wants: Calculate your discretionary expenses, such as eating out, trips, etc.

• Savings: Assess your saving habits, whether through a registered account or portfolio.

• Debts: Measure your debt obligations.

• Goals: Set a target and adjust the above costs to reach your goal.

Once you've established a budget, stick to it as best you can, track your progress, and reassess on a monthly basis if your circumstances change significantly. Your budget should be a flexible framework to maximize every dollar, not a rigid set of rules. This is where many go wrong. There’s no way to know when an unexpected expense will pop up, such as vehicle repairs or a medical emergency, or when you’ll receive a promotion or sudden influx of money. As such, budgets must be malleable.

Debt: Borrowing and building credit

Indebtedness isn’t exactly a terrible thing, it’s simply another tool. When used responsibly, it can help you get ahead. When abused, it can drag you down further than you’d expect.

Few things in life are free, and borrowed money is no exception. The direct cost of loans are the interest rates that come along with them, ranging from 0% to 400% in extreme cases. The indirect cost can actually be much worse in the long-term. If you’re late on payments, continuously run a high balance, or are outright delinquent, your credit rating can suffer.

A bad credit rating can impact your eligibility for more important loans, such as a mortgage or a car loan. A credit card is convenient, yes, but not as much as being able to own a house.

We’ve written an extensive blog on managing debt previously, but for today’s discussion, it’s important to recognize the difference between good and bad debt.

• Good debt: is typically used to purchase items that will increase in value or generate long-term income, such as student loans for university or trade school, or mortgages for the purchase of your first property. These purchases typically have lower interest rates, as banks are aware that both can enrich you and, in turn, themselves.

• Bad debt: is used to purchase items that will depreciate over time or fail to generate long-term value. This category often includes credit cards and cash advances, which typically carry higher interest rates due to their lack of value creation.

Investing: Crafting a Brighter Future

Cash is considered liquid capital, meaning you can easily exchange it for goods or services. Securities (stocks, bonds, ETFs, etc.) would be considered less liquid—you could sell them if the need arises, but if it's urgent, you might have to sell at a loss.

So, why risk it? If you’ve budgeted correctly and can take care of your immediate needs and store up a rainy-day fund, you may have some surplus cash. With proper portfolio management, your investments can appreciate in value. It’s a trade-off between having money today or deferring, letting your wealth grow, and accessing a much larger amount in the future if everything works out.

As always, there are risks involved, and your investments could experience significant losses if managed poorly. The saying “don’t put in more than you’re willing to lose” is valid, but historically, all primary asset classes have risen over time.

Setting an investment plan, similar to a financial one, is vital. Take an inventory of your risk tolerance (how much you can lose), your risk appetite (how much you’re willing to lose before worrying), and your time horizon. From there, you can work with a professional to find a proper investment strategy that fits your needs.

Craig Ellis, Vice President of Portfolio Management, shares that "investing is ultimately a negotiation between risk and return" and that "what many don't realize is that avoiding one risk often exposes you to another."

For example, some might fear missing out on the latest top performers, and to avoid the risk of lost perceived opportunities, they may rotate into the latest trend and disturb the long-term stability of their portfolio. Along a similar vein, if a hyper-conservative investor were completely opposed to the risk and volatility associated with equities piling their wealth into government bonds, they’d likely be disappointed with how the traditionally “safe” asset class has performed in recent years.

Diversification, a topic for another day, can be an investor’s greatest ally. While professional portfolio managers can handpick securities to create a balanced portfolio capable of weathering different market conditions and properly managing risk, it may be harder to do so for young investors. Thankfully, exchange-traded funds (ETFs) contain a basket of various products all in one convenient package, allowing virtually anyone to diversify their holdings with ease.

There’s Always More to Learn

This article was a brief introduction to some of the more common concepts related to financial literacy. Future entries will explore the finer details of what we've discussed today (and more) as part of a larger series, so you can navigate your finances with confidence.

But remember—knowledge without action isn’t a recipe for success. Financial literacy is about being able to process information and act accordingly in your day-to-day life.