What Are Money Skills?
Money skills, simply put, are habits built up over time that help you find financial freedom. More specifically, they can be broken down into a few different categories.
Some money skills are geared towards helping you save more money. Other money skills focus on keeping you out of debt. Others still emphasize managing your money so that you can maintain that balance once you’ve found it.
Ultimately, all of these different classes of money skills are useful in their own ways, and it’s vital that you have a solid understanding of what they are and why they matter.
Why Money Skills Are So Important
If your car gets a flat tire, a bit of discipline and prior planning can be the difference between a day’s inconvenience and the start of a long downfall.
If you happen to have the savings ready to buy a new tire, you’ll be up and running again in a few days. A month from now, you’ll probably barely be able to recall that moment.
On the other hand, if you never developed your money skills and don’t have any cash or savings, you’ll probably have to use credit cards or payday loans to fix your car. Then, because you didn’t plan for this unexpected cost, you’ll have a higher credit card bill at the end of the month.
If you can’t quickly pay this off, the high interest rate on your credit card will soon make this debt snowball out of control. Or worse, you might not be able to repair your car or get to work.
A month from now, you could find yourself without a job or in fast-growing debt, cursing that one flat tire for being the thing that set you back years in your financial plans.
While that situation may seem extreme, it illustrates the point. Strong money skills give you the confidence to spend money when you want without worrying about crippling your financial future.
What Money Skills Do You Need To Have?
At its core, money skills are meant to help you have more money to enjoy life. Even though money can’t buy happiness, it’s still a useful tool.
But, learning everything you need to know about money can feel incredibly daunting. To simplify this process a bit, we’re going to break money skills into four categories—saving, investing, managing debt, and boosting your income.
Money Skill #1 – Making A Monthly Budget
First things first, you need to learn how to make a budget if you don’t already have one. This is so important because it lays the groundwork for everything else you’ll be doing later and makes it easier to save money.
Without a budget, you can’t keep track of how much money you’re earning or spending, where it’s going, or how much or little progress you’re making towards your goals.
It’d be like building a bed blindfolded. You have no clue what kind of mess you’re currently making, and you’ll eventually have to lie in it.
Pay Yourself First
While there are several different ways to make a budget, there’s a common theme that emerges across a lot of them. It’s called “pay yourself first.”
At the beginning of the month, you decide how much money you will set aside for savings and investments. When you get your paychecks, you’ll set aside the money and pay yourself first before spending the money on anything else.
If you need it, you can use the Earnin App to get your paycheck more quickly.
Now, you’ll spend whatever is leftover on whatever needs to be paid—rent, bills, food, movies, games, trips, etc.
It’s important to note that this won’t work for everyone, but it still provides a useful change in mindset. By setting aside money to save at the start of your budget, you make sure your long-term goals are met.
If your next long-term goal is to buy a house, the money that you set aside should go towards a down payment. That way, you can have a constant reminder of the reason why you’re budgeting and saving in the first place.
It may seem trivial, but a lot of the time, we need to trick our brains into thinking rationally. Paying yourself first is simply one of many tools to help do so.
Know Your Savings Rate
Your savings rate is the proportion of your after-tax income that you save or invest. But why should you care about it? How do you calculate it? And, what is a “good” savings rate?
First, your savings rate is important because it gives you a rough estimate of whether you’re saving enough to meet your financial goals.
If you find you have a savings rate of, say, 0%, it doesn’t matter how much money you’re bringing in. You’re not setting yourself up for financial success.
Most financially successful people save between 15% – 20% of their after-tax pay. For most people, this is a good range to aim for.
Now, how can you calculate your savings rate? You take the total amount you save or invest and divide it by your after-tax income.
For example, let’s assume you earn $2,000 in after-tax income, and you contribute $300 to a 401K, $200 to a Roth IRA, and $50 to your savings or emergency fund. That’s a total of $550 that you’re saving or investing!
The remaining $1,450 will pay your rent, buy your groceries, clothes, and cover your utilities and other everyday expenses. If we take the $550 and divide it by your post-tax income of $2,000 we get a monthly personal savings rate of $550 / $2,000 = 27.5%.
A savings rate of 27.5% is great if it’s sustainable. This leads us to the next part of our money skills, finding a healthy balance.
Finding A Healthy Balance
When a lot of people think of being frugal, they picture penny pinchers who haggle over even the smallest expense. This is not only an incorrect view of healthy budgeting, it’s downright unhealthy.
You work hard for your money. You shouldn’t have to hoard it all away. Trying to force yourself to live on only the bare necessities when you have enough money to spend a little more is probably not the best decision.
Taking such a rigid approach usually makes people miserable, and it also makes their budget short-lived. By instead searching to find a balance, you’re actually doing yourself a favor!
Now, let’s talk about the other extreme. Just like it’s possible to be unnecessarily cheap and make yourself miserable in the short term, it’s equally possible to spend like there’s no tomorrow.
This way of building a budget is just as bad because it leads to misery in the long-term. Most people don’t want to be in their mid-80s and still have to work a 9-5 job every day because their past self didn’t know how to manage money.
Many people spend their lives bouncing between these two extremes. They spend thoughtlessly, usually on things that don’t even make them that much happier.
Then, they think, “Oh crap, what have I done?” and over-correct. Some people get scared by a large credit card bill at the end of the month. Others feel guilty when they see a low balance in their savings account.
Whatever the reason may be, it causes a lot of people to subject themselves to an unrealistically strict lifestyle. And sooner or later, it becomes too much, and they break down to go back to their old ways.
Help your future self by finding a healthy middle ground and breaking this tiring cycle.
Money Skill #2 – Managing Your Debt
Notice that the title here says, “managing your debt,” not “eliminate your debt.” That’s because we’re going to talk about the difference between “good” debt and “bad” debt, and how you can use debt-managing money skills to your advantage.
Note: irresponsible debt is always bad debt. You should exercise strong caution when managing your debt, and this shouldn’t be used as a license to take on debt at-will.
Bad Vs. Good Debt
Excluding irresponsible debt, how can you tell the difference between good debt and bad debt? Well, the main distinction between the two comes from whether it adds or subtracts value.
Using Your Money Skills To Pay Off Bad Debt
Bad debt is a bit more straightforward than good, as many would argue all debt is bad debt. When it comes to your debt management money skills, we define bad debt as debt that has a high interest rate or loses value over time.
A fantastic example of high interest debt is credit card debt. This is one of the reasons it’s so important to know what credit cards are and how credit cards work. Most have very high interest rates (10+ percent per year), so any credit card debt you may have will grow incredibly fast.
An example of debt for things that lose value over time would be taking out a loan to buy a new car. New cars are infamous for rapidly depreciating in value. So when you borrow to buy one, as soon as you drive it off the lot, odds are you already owe more on your car loan than the actual car itself is worth.
If you’re allowing debt to grow faster rate than you can keep up, or you repeatedly take out loans to buy things that aren’t worth their value, you’re being less efficient than you could be.
If you instead paid off that credit card debt, you’d save yourself money in forgone debt payments. Likewise, avoiding a car loan for a new car will help you lose less money as a used car depreciates in value slower than a new one.
These principles basically boil down to this: don’t be wasteful with how and when you choose to take on debt.
Using Your Money Skills To Utilize Good Debt
On the flip side, good debt is debt that adds value. This would include loans for education or buying a home, as each is an investment in your future and has the potential to earn you money.
An education will often give you more marketable skills, and so taking out a loan to fund it will usually benefit you in the long run due to higher wages.
Consider the wages of most college graduates compared to high school graduates. On average, college graduates tend to earn more than high school ones. Even though those college grads had to pay to attend college, their higher wages mean they’ll be able to make up for it later on.
Now consider buying a home. This is often considered another type of good debt but in a slightly different way.
Yes, it’s always possible for your home to increase in value, in which case you’ll earn a profit when you decide to sell it. But, even if your house doesn’t increase in value, you still benefit.
If you buy your home for $100,000 and live in it for ten years before selling it to someone else for $100,000, you’ve essentially gotten to live somewhere for free for the last decade! That’s still a major benefit, even if it’s not as immediately obvious.
Ultimately, good debt boils down to borrowing to pay for things that will either grow in value in the future or provide enough benefit to offset any depreciation.
Money Skill #3 – Making Smart Investments
This is where most people start to get either very nervous or very excited. On the one hand, you get to grow your wealth and make your money work for you. On the other hand, investing can seem very complicated from the outside.
If you’re interested in a more in-depth breakdown of how to start investing, we’ve got you covered. But for now, let’s talk about why investing is so important and a few easy things you can do to get started.
First, let’s define what the word ‘invest’ even means. At a basic level, to invest is simply to spend money with the expectation of getting more money in return. That’s it. To invest, you simply buy something, hoping that you’ll earn more money later in investment returns.
This is important because it explains why it’s so important to invest. Let’s say you are worried about having enough money for retirement. You might be stocking away every dollar you can into your bank account so that it’s there when you turn 65.
But the problem with that is that your typical checking account or savings account pays virtually (or literally) nothing in interest. So your money is actually losing value due to inflation (the gradual increase in the prices of things at stores). A hundred years ago, a can or bottle of Coke or Pepsi cost 5 cents. Today, a bottle of Diet Coke could cost you $1.99. This increase in price is inflation.
So, if your money isn’t invested and growing, it’s actually losing value, since the prices of things will increase over time.
Another concern we’ve heard a few people say is that they don’t want to invest because they are afraid of paying more taxes. This is nonsense because you will usually only pay taxes on profits, so in the end, you will still have more money (after taxes) than if you hadn’t invested at all!
Investing is an excellent way to grow your money over time (hopefully it will grow much faster than inflation does) so that when you are ready to retire, you won’t have anything to worry about besides which new hobby you want to try out.
The Power Of Compound Interest
So, now we’ve established investing is a good way to grow your money. But to put into perspective just how powerful a tool it is, let’s take a look at compound interest.
To give you a broad overview, compound interest is so valuable because it lets your money grow exponentially. Over time, your original investment grows in value, and compound interest makes it grow faster and faster as it accrues interest.
Putting some hard numbers to it, here’s a breakdown of how much a $1,000 investment would be worth over the course of 30 years. The interest rate is based on the average historical returns of the stock market.
|Years Since Initial Investment||Current Balance|
Choosing How Long To Invest For
One thing to note from the table above is that the latest years are the ones with the most growth. This is again due to the power of compound interest, and it should factor into how long you choose to invest for.
To make things simple, the longer you choose to invest, the more money you’ll probably end up with. If you’re currently 23 years old and want to buy a house by the time you’re 35, then plan to invest over the next 12 years.
While this doesn’t mean you should always sock away all of your money and not touch it for the next 50 years, it does mean thinking ahead now about your future financial goals will give you a head start on achieving them.
Different Investment Account Options
Equally important as how long you invest for are the accounts you put those investments into. For most people looking to develop their investing money skills, we recommend using IRA accounts for long term investments like ETFs and index funds.
IRAs are tax-advantaged accounts, which means you’ll save money by lowering your tax bill at the end of the year if you invest using them. If you’re curious to learn more about what an IRA is and if it’s best for you, check out our guide to IRAs.
Money Skill #4 – Boosting Your Income
Sometimes, knowing how to spend less isn’t enough. If you’re only making $15,000 a year, it’s going to be hard to save for retirement and other long term goals, no matter how good your other money skills are.
With that in mind, let’s talk about the fourth type of money skill—boosting your income. While there are a few obvious methods like renegotiating your salary to ask for a raise, let’s talk about a more creative way to earn some extra cash.
Getting A Side Hustle
One of the best and fastest ways to boost your income is to get a side hustle. This can be anything from pet sitting to opening an Etsy shop to graphic design.
A good place to start thinking about what you want your side hustle to look like is to consider what you’re passionate about. Do you love music? Try performing in a nightclub or lounge on weekends. Or maybe you love sports? You could work as a referee for a local sports team.
Whatever your passion, there’s probably some way you could use it to make a few extra dollars. If you’re struggling to get enough money to save, consider side hustles.
Finally, if you are in a crunch to save money, you can always try a money saving challenge to reach your goal!
Lucas is a personal finance expert, an undergraduate student at Harvard University and the founder of the Personal Finance and Consulting Group at Harvard College (an officially recognized student organization). He has spent much of his life working to increase financial literacy in his surrounding communities through independent financial research and curricula design, and he is currently studying economics with a secondary in music.