Basic Finance Principles That Can Help Secure Your Financial Future
Gaining financial literacy all begins with learning the basic finance best practices.
Contributing Writer at Tally
October 4, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
Financial security and independence are key life goals for many people. Attaining this goal begins with financial literacy. But where do you start on this path to financial literacy? It all begins with understanding basic finance best practices.
What basic finance best practices can lead you to financial literacy and eventual financial security? We cover the essential ones below.
Basic finance defined
Basic finance is the base personal finance knowledge you need to become financially literate and capable of handling your money properly. This broad-reaching term includes a wide range of money matters, such as budgeting, managing credit card debt, saving for emergencies, saving for retirement, investing and more.
Let’s look at the basic finance concepts, the best practices and how they help secure your financial future.
Build a budget as your foundation
Budgeting is the basis of any sound personal finance and money management strategy. Review your monthly spending and see how it stacks up to your monthly income. For expenses that aren’t monthly, such as quarterly or annual insurance payments, you can divide the quarterly payments by four or the annual payments by 12 to get their monthly amount.
If your monthly income exceeds your monthly expenses, you have a budget surplus and are in good shape. If your expenses are more than your income, you’re in a deficit and need to trim. If you need to trim your budget, start with things you’ll never miss, such as monthly subscriptions you rarely use.
If that’s not enough to get out of the deficit, move on to bills you can scale back by opting for lesser services. This can include downgrading your cellphone plan, opting for a slower internet speed or canceling the premium channels on your cable or streaming service.
If your budget is still out of balance, you can look into getting a side hustle — like freelancing, doing on-demand delivery or being a ride-share driver — to earn extra cash and close the gap.
With your budget in balance, you can now categorize expenses and see if you’re overspending in some areas to hone your budget further and increase your surplus cash. For example, if you’re spending hundreds per month at the local coffee shop, you may want to start brewing your own joe at home.
With your budget showing a cash surplus and your expenses categorized, you may want to opt for budgeting software, such as Mint, You Need a Budget or EveryDollar, to help automate your monthly budgeting. This is optional, and you can always stick with the tried-and-true pen-and-paper budgeting method or use an Excel spreadsheet.
Create a sufficient emergency fund
The next basic finance item is your emergency fund, which should be enough to cover three to six months of expenses. This fund will cover you in the case of extreme financial hardship, such as a sudden job loss, an income reduction or a major medical emergency.
With your new budgetary surplus, you can set it aside for your emergency fund. If you have credit card debt to pay off, which we’ll get to soon, you don’t need to save the entire three- to six-month fund yet. You can start with $1,000 and move to your debt after that. Once you are free of credit card debt, you can finish your emergency savings.
Place this emergency savings in an easily accessible high-yield savings account (HYSA) so it earns interest when you aren’t using it and continues growing.
Get out of and stay out of credit card debt
Clearing yourself of all credit card debt is another basic finance necessity, as credit cards generally come with high interest rates. This means even a small debt can take years to pay off when making only the minimum monthly payment.
You can handle debt repayment in many ways, including using the debt avalanche or debt snowball method and applying all your surplus income to pay off your debt quickly. You can also opt for a debt consolidation loan to pay off all your credit card debt with a lower interest rate and use your excess cash flow to cover the monthly payment or more if the funds are available.
Another option is to use a personal line of credit with a lower interest rate, such as the Tally† line of credit. On top of offering a lower-interest line of credit, the Tally app helps you manage your monthly credit card payments.
Once you’ve paid off your debt, you can stay out of debt by sticking to a budget and paying off the entire statement balance monthly. If you struggle to manage your credit card spending, you can stick to using a debit card instead.
Use credit cards responsibly and to your advantage
While getting into credit card debt is a liability, you can use cards responsibly and turn them into a good thing by taking advantage of rewards and cash back. Many credit cards offer reward points you can use toward things like travel, gift cards and other products. Others give you cash back that you can apply to your bill or have deposited in your bank account.
If you choose a credit card that offers rewards or cash back at the stores where you most frequently shop, then you can use the credit card to pay for things you already have budgeted. This can include groceries, gasoline, utility bills and even monthly rent.
You'll take advantage of the interest grace period if you pay the entire statement balance by the due date. Paying within this grace period prevents the credit card company from applying interest charges to your account. So, you reap the rewards and cash back without paying any interest charges.
Improve your credit score with on-time payments
Your credit score plays a huge part in your financial planning, as a higher credit score can help you find lenders willing to offer you good debt to secure assets. This includes a mortgage to buy a home or a car loan to purchase a reliable vehicle with a low interest rate.
Your payment history makes up 35% of your FICO credit score, and one late payment on your credit report can lead to your credit score falling dramatically. This is why making your monthly bill payments on time is critical. If possible, set up automatic monthly payments so you don’t risk forgetting.
If you’re not comfortable with automated payments, you can set up reminders on your smartphone or simply write all your due dates on a calendar you look at daily.
Stay on top of your credit report
Making on-time payments accounts for the largest portion of your credit score, but four other factors make up your FICO credit score: amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%). Any one of these can positively or negatively impact your credit score.
While you may manage every scoring factor well, you can’t control inaccurate reporting and fraudulent accounts being opened in your name. This is why you should stay on top of your credit report and dispute any transactions, reports or accounts you don’t recognize.
You’re entitled to one free credit report per year from each of the three major credit bureaus — Experian, Equifax and TransUnion — via AnnualCreditReport.com. You can also monitor your credit report from the many free credit score sites, like Credit Karma or Credit Sesame.
Save for retirement as early as possible
A key basic finance step that can lead to later financial health is retirement savings. Sure, it may take a significant portion of your income now, but starting as early as possible can add up over time, and you will appreciate it in the future.
This is thanks to the power of compound interest, which is when you earn interest on previously earned interest. For example, you invest $1,000 and earn $100 in interest over a 12-month period. Moving forward, you will earn interest on the full $1,100 balance instead of just your $1,000 principal investment. This compounding continues year after year, leading to significant gains over many years.
You can set up a retirement fund in many ways. If you work for an employer that offers a 401(k), this is a great starting point. Not only will the investments you make lower the taxes taken from each paycheck, but many employers also offer a match on your investments.
For example, say your employer offers a 100% match on up to 5% of your salary. If you earn $50,000 per year, this means your employer will match up to $2,500 per year of investments you make to your 401(k). This is basically free money.
As of 2022, you can invest up to $20,500 in a 401(k) according to IRS rules.
If you don’t have access to a 401(k) or have already maxed out your contributions, you can opt for an individual retirement account (IRA). Depending on your tax preferences, you can choose from a Roth IRA or a traditional IRA. The IRS allows you to invest up to $6,000 per year in an IRA, but it bases your exact limit on your income and your age.
If you’ve maxed out your 401(k) and IRA contributions or aren’t eligible for either, you can invest in other securities, such as stocks, bonds, mutual funds, exchange-traded funds (ETF), real estate investment trusts (REITs) and much more. You simply need to set up a brokerage account and start investing. With many micro-investing apps available today, you don’t need much money or investment knowledge to get into this type of investing.
You risk losing 100% of your principal balance with all stock market investments, so always consult an investment or financial advisor before diving in. They will help you with financial management and establishing an investment plan to meet your goals.
Insure what’s important, including you
Insurance goes beyond just health, dental and vision insurance. It also includes insuring things of value and importance to your financial security, including your car and home. You may also want to consider renter’s insurance to protect your belongings if you're a renter.
If you have people who depend on you financially, such as children or a spouse, you also want to consider life insurance and long- and short-term disability insurance. Disability insurance ensures you have enough income to pay bills if an injury or illness keeps you out of work for a long period or permanently. Life insurance ensures your loved ones have the funds they need to cover burial expenses and living expenses if you die.
Understanding basic finance is key to financial success
With an understanding of basic finance you’ll increase your financial literacy and be better prepared for future success. Basic finance best practices include budgeting, building an emergency fund, paying off high-interest debt and keeping out of debt, paying your bills on time, monitoring your credit report, saving for retirement, and insuring you and what’s important to you.
By following these best practices, you set yourself up for meeting future financial goals and help protect anyone who depends on you financially.
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†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 to $300.