What is Financial Literacy? image

The Four Foundations of Financial Literacy

What we should really be teaching people during Financial Literacy Month

Happy April! Believe it or not, this month is Financial Literacy Month. You’ve probably heard about it as much as you heard about financial education during high school. But the reality is that it exists, and it was established by the US in 2003.

Is the US financially literate?

Champlain College recently released the results of its study looking at the state of financial literacy in the US (by state, in fact). The study’s methodology looked at, in some cases, 71 different data points in five categories: financial knowledge, credit, savings and spending, retirement readiness and other spending, and protect and insure.

The results? Not good.

As Vermontbiz.com reports, the study “shows that more than three-quarters of adults live in states with poor grades. This means that too many American adults are deficient in financial knowledge and skills, which leads them to make uninformed and often poor decisions about their money…The number of financial decisions an American citizen has to make continues to increase, and the variety and complexity of financial products continue to grow. Adults often do not fully understand debit and credit cards, mortgages, banking, investment and insurance products and services, retirement planning, and many other financial topics.”

In another interesting, though much less informal survey, The Financial Educator’s Council asked 3006 people this question: “Across your entire lifetime, about how much money do you think you have lost because you lacked knowledge about personal finances?”

The cost of financial ignorance

As CardTrack.com reports, the of lack financial knowledge is collectively costing Americans more than $2.3 trillion dollars over their lifetime. “Respondents estimated that their lack of financial knowledge cost them an average of $9,724.83 (calculated by averaging the total number of respondents choosing each category, using the lowest number in each spread).”

Personally, I’d say these folks are low-balling. After all, how can you expect people with no financial knowledge to accurately guess how much that lack of knowledge is truly costing them? As they say, “You don’t know what you don’t know.”

At Rich Dad, we’ve seen folks grow their financial knowledge to make more in a month in passive income than the respondents estimated lifetime loss. Indeed, a little bit of financial education put into practice goes a long, long way—and so does a lack of financial education.

What is financial literacy?

I do appreciate that we set aside an entire month to focus on this pressing issue of financial literacy. After all, even Bernie Sanders recognizes what a problem the growing gap in incomes represents: "The issue of wealth and income inequality is the great moral issue of our time, it is the great economic issue of our time, and it is the great political issue of our time.”

But much like I don’t agree with Bernie on how to fix the problem, much of what is labeled out there as financial education leaves a lot to be desired. From my experience, it centers on concepts like saving, investing in a 401(k), getting a college degree, paying down debt, and home ownership. In short, it centers on the old ideas about money.

I’ve said it before, when you follow the old rules of money, you’re screwed financially.

So, given the huge costs of financial illiteracy, and the lack of true financial education in America, I thought I’d briefly offer what should be the four foundations of financial literacy.

These four foundations are the baseline for a truly comprehensive financial education.

1 - The Difference Between an Asset and a Liability

Many people think they know what an asset is. For instance, you probably think your house is an asset—but it’s not. The truth is that just as there are two definitions of an asset.

Accountants use one definition that requires lots of financial calisthenics to make people and companies feel richer than they really are. This keeps them employed and their clients blissfully ignorant.

The rich use another definition grounded in simplicity and reality. An asset is anything that puts money in your pocket and a liability is anything that takes money out of your pocket.

Your house is not an asset because it takes money out of your pocket each month. Even if you own your house outright, you still have to pay for the taxes, maintenance and more out of your own pocket.

But if you own a rental property, that can be an asset—if it puts money in your pocket each month in the form of cash flow. When your tenant pays rent, they cover your mortgage, maintenance, taxes, and more.

2 - Cash Flow Versus Capital Gains

Most people invest for capital gains. The rich invest for cash flow.

Simply put, investing for capital gains is like gambling. You invest your money and hope the price goes up. For instance, many people buy a house hoping they’ll be able to sell it for more money later. In the meantime, they have to pay their mortgage and home expenses. Money goes out of their pocket. It becomes a liability.

The problem is that when you invest for capital gains you have no control over whether the price goes up or down, and the bigger issue is, if you do make a profit, you pay the highest rate in taxes.

Conversely, the rich invest for cash flow. So, for instance, they buy investment real estate with other people’s money, find tenants to pay the expenses, and collect rent each month. It becomes an asset. And if there’s capital gains, that’s a bonus.

By investing for cash flow instead of capital gains, the rich have control over their income and pay the lowest rate in taxes—and sometimes nothing in taxes.

But investing for cash flow, while a simple concept, requires a strong financial education in order to make your own financial decisions.

3 - Using debt and taxes to get richer

Your financial adviser will tell you that debt is bad and taxes are inevitable. But the rich understand that both debt and taxes can be used to create immense wealth.

When it comes to debt, there are two kinds—bad and good. When your financial adviser tells you to stay out of debt, she means stay out of bad debt.

Bad debt comes in the form of borrowing money for liabilities such as using credit cards to buy TVs and take vacations, borrowing a line of credit on your personal home, and more.

Staying out of bad debt is good advice, but the problem is that your financial adviser won’t tell you about good debt.

Good debt is debt used to purchase assets like rental property.

When you use the bank’s money to purchase cash-flowing real estate, you use less of your own money to secure an asset by paying only a down payment instead of full price, and your tenant’s rent pays off your debt while you own the asset and pocket the profit.

When it comes to taxes, the rich understand that governments write tax codes to encourage specific types of behavior. If governments want you to build affordable housing, they give you a tax cut. If they want to encourage oil exploration, they give you a tax cut. If they want to see higher employment, they give you a tax cut.

The secret is that most tax benefits are made to help entrepreneurs and investors. With the right financial education, you too can utilize the tax code to not only get richer, but also pay nothing in taxes.

Utilizing good debt and getting richer through taxes takes a high level of financial intelligence. But everyone can learn and put these principles into practices.

4 - Making your own financial decisions

When you’re not confident about your knowledge of money, you let others make your financial decisions for you.

You let your broker decide how your money should be invested. You let your bank tell you what interest rate is worthy of your money. You follow whatever investing trend is popular in the news.

The rich don’t follow the crowds. They set the trends and are gone by the time the trends become mainstream. What’s their secret? They think for themselves about money and make their own financial decisions because they have a high financial intelligence.

The key to building great wealth is having great knowledge to act on and great wisdom to know which course of action is the best.

This kind of knowledge and wisdom only comes through a high financial intelligence gained from applying yourself to financial education.

Are you ready to increase your confidence about money by increasing your financial education? Are you ready to start making your own financial decisions?

Check out our free, financial education community here, and start your journey to financial literacy today.

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