Growing up in a household where money was tight, I was always aware of what I was buying and how expensive it was. I would insist on buying the savings brand whenever it was an option, and I would never buy something I couldn’t afford. It wasn’t until later that I understood all of the basics about spending and saving money.
What is money?
This sounds like an easy question, but it is actually pretty hard to conceptualize. Money is a commonly agreed upon form of value. Value is measured in currency, a specific form of money, such as the US dollar. Currency can be exchanged for goods and services of equivalent value.
Banks are a form of storage for cash. Banks make money by loaning out the money you store. There are two primary types of bank accounts: checking and savings. Checking accounts are designed for frequent purchases. Savings accounts tend to be limited in the number of withdrawals but also earn interest.
Debit cards allow for quick payments using checking accounts. Money is removed from the bank account when the charge is made. Debit cards are limited by the amount of money in the connected bank account.
Credit cards are different from debit cards because the funds are not immediately removed from a bank account. Rather, the funds are loaned from the card issuer, and must be paid back later. Credit cards have a cap called a credit line, which is determined by the issuer. Some credit cards have rewards (e.g. cash back) for purchases, but they also have fees and may incur interest. I have a more extensive post about credit cards here.
Loans are borrowed money that are paid back over time, often with interest. Student loans, car loans, and mortgages (house loans) are common types of loans.
Interest is additional money owed for using someone else’s money. An interest rate is a percentage of the money borrowed that will be added to the money owed, often annually (e.g. 5% every year). A compounding period is the interval at which interest will be added to the money owed. Compounding periods are important because interest can be accrued on other interest, so the more frequent the compounding period, the more money will be owed. An Annual Percentage Yield (APY) is an interest rate adjusted for the compounding period so that it shows the percent change from the original.
The word debt comes from a Latin word meaning “to owe” – debts are an umbrella term for owed money. There are two types of debts: secured and unsecured. Secured debts are less risky for lenders because an asset, or a physical item of value, can be collected if the borrower does not repay their debts. Common secured debts include those on houses and cars. Unsecured debts, however, are not backed by assets and are thus more risky for lenders and tend to have higher interest rates. Student loans and credit cards are common examples of unsecured debts.
Credit comes from a Latin word meaning “to believe or trust.” In terms of modern finance, credit is an assessment by lenders of how likely borrowers will pay back debts. A credit score is a numeric value used to represent one’s ability to pay back debts. In the US there are three major credit reporting agencies (Experian, TransUnion, and Equifax) that record what debts one may have and if they are repaying them. Then there are two primary algorithms (VantageScore 3.0 and FICO Score 8) that take the recorded information and create a score that ranges from 300 (poor) to 850 (excellent) using many key factors. Credit scores affect ability to be approved for credit cards and loans, as well as what interest rates may be charged for those products.
An investment is anything for which someone allocates money that may yield more money in the future. Investments come in the form of stocks, bonds, real estate, money put into a self-owned business, etc.
Stocks are partial ownership or shares of a company. As a company appreciates (increases) or depreciates (decreases) in value, so does the value of the stock. Some stocks pay dividends, or portions of the profits made in a certain quarter, to their shareholders.
Obviously there is a lot more to explore with these topics, but these are the basics needed for financial literacy.