Financial Literacy 101: A Guide for Millennials and Gen Z

Financial literacy is the key to unlocking your financial potential. This piece delves into the heart of financial literacy 101, providing in-depth knowledge across some of the most important topics you need to understand: budgeting financial literacy, understanding debt and credit, basic money literacy, investment literacy and saving financial literacy. The fast-track to managing your finances and getting ahead financially! Be sure to also remain aware of these big financial mistakes to avoid.

Financial Literacy 101: Budgeting and Money Literacy
financial literacy 101

Budgeting Financial Literacy

Creating an effective budget begins with an honest assessment of your income and expenses. It’s essential to account for all sources of income and list all your monthly expenditures, from essential bills to discretionary spending. Knowing what’s essential vs. nice to have is key. Start with all the essentials – rent or mortgage, insurance, car payments, school fees, food. Then list all your discretionary or nice to haves – subscriptions, eating out, that daily cappuccino, and all the places/ways you spend money without realising. Track like a hawk for 3 months. Find a method that works for you – whether it’s an app or spreadsheet. Then examine how to improve/optimise. The better you get at this the more money you’ll have for investing and spending on things that matter (like travel and cool experiences) – compared to wasting money on stuff you don’t need or make you any happier.

Pro-Tip: The most important metric for the success of any bluechip corporation, small business, or household – is free cashlow. You can increase free cashflow one of 2 ways. Increase income or decrease expenses. The faster you are able to increase free cashflow, the faster you’ll achieve financial freedom.

Financial Literacy 101: Understanding Debt and Credit

Understanding how to use credit effectively is vital to financial health and is a key component of financial literacy 101. For instance, using a credit card wisely can be one of the best ways to build a good credit score. This might involve only using your credit card for budgeted expenses, paying off your balance in full each month to avoid interest, and not exceeding 30% of your credit limit. Differentiating between good and bad debt is another crucial aspect. Good debt, like a home loan or student loan, can be seen as form of investment that can lead to long-term benefits. Conversely, bad debt, such as high-interest credit card debt incurred for unnecessary expenses, can hinder financial progress. Never over-extend yourself when taking out a loan – always make sure that if interest rates go up 5% (like they have done these last 18 months) – you’ll still be able to afford your home loan payment. The fastest way to financial ruin is taking on more debt that you can handle and not living within your means. Some people like to use leverage to invest. We recommend being very careful with this strategy, unless you’re a pro and absolutely know what you’re doing.

Money Literacy: Time Value of Money

Money literacy is understanding that money’s value isn’t static. Due to inflation, the purchasing power of a Rand decreases over time. In South Africa that means the value of every Rand halves roughly every 12-14 years, assuming inflation of between 5-6% per year. We’ve all lived this – especially since the pandemic – when buying our weekly groceries we’ve seen how much more expensive food and the like have become. So to get ahead financially or become wealthier, we need to be investing in things that grow at faster than the rate of inflation over time. A “real return” is the return on an investment after adjusting for inflation. If you have an investment that yields a 7% return, but the inflation rate is 2%, your real return is 5%. In South Africa, assuming a long-term inflation rate of about 5%, you need a large portion of your investments to be growing at 10%+ (or Inflation Plus 5) if you want to achieve financial independence. And related to this is understanding the power of compounding and how wealth is generated over time through consistent investing. This is the surest way to ‘get rich’ or achieve financial freedom. Start young and invest consistently for decades and you’re almost guaranteed to become financially secure. A basic example. R5,000 p.m. generating an average annual return of 8% p.a. over 30 years gives you about R7.5 million. Keep going another 10 years and now you have almost R17.5 million (almost 60% more) – the snowball effect of compounding in action.

Investment Literacy: Your Wealth Generator

A diversified investment portfolio spreads out risk while maximizing returns. Investment literacy involves understanding the different asset classes and the role they play in helping you grow your wealth over time. Equities or shares are the asset that have provided the best real returns over the long-term. The easiest way to invest in equities is via ETFs or unit trust funds (unless you know what specific shares you want to buy). Property or real estate has also been a popular wealth generator for many, particularly because you can use debt or ‘other people’s money’ like Robert Kiyosaki likes to teach, to help finance it. In South Africa, that’s not as easy though due to higher interest rates, a bigger risk of rental delinquency, and property values in many parts of the country not really growing in real terms anymore. Bonds and cash are more conservative asset classes and are less likely to provide real returns over the long-term but still have a role to play in a well-diversified investment portfolio. Investing is also understanding that you need to be looking forward. Not what happened before. Just because something was a good investment before, doesn’t mean it will be in future. The world is changing rapidly. Anticipate where the puck is going, not where it has already been.

Investing vs Speculating

Clearly, crypto is a new asset class that has delivered returns well above any of the traditional ones. But that comes with a lot more risk and volatility. If you bought Bitcoin in the early days, you’re one of the lucky ones. Do we think Bitcoin and Ethereum have a place in a well-diverisifed portfolio? Yes! But it’s also important to understand the difference between investing and speculating or gambling. Investing is a deliberate strategy to build wealth over time customised to your needs and what you want to achieve. Speculating is just hoping the value of something goes up and you’ll make a profit or quick buck. The meme stock craze of a couple of years ago and many of the crypto tokens would for example fall into this category. If you’re speculating – be prepared to lose everything so only trade a small amount that won’t impact you financially if it all goes belly up. Investment literacy will fast-track you to financial independence so it’s worth spending time on.

Investment Literacy: Examples of different investment returns
Comparing returns over the last 5 years

The illustration merely aims to show how investing in different assets leads to different returns. The benefits of diversification means that if a share like Nvidia falls, that will hopefully be offset by the returns of another asset (which could be a share or ETF/index, or a different asset class altogether). If all your money is invested in a share like Nvidia, and it goes bankrupt – you risk losing all your money. But by diversifying or spreading your investment across different shares, assets etc. – even if one fails or does badly – you don’t risk losing everything.

Savings Financial Literacy: Create that Emergency Fund

Savings form the bedrock of your financial security. Life happens – and when things go wrong – your savings are the difference between riding out the storm and getting financially crushed. Consistently saving a portion of your income helps build a buffer against unforeseen expenses. An emergency fund should ideally be six months’ worth of living expenses and act as a financial lifeline when you need it. This should be the first thing you do – build up that emergency fund. And this is a totally seperate and independent step from investing. Savings should be in an account that is liquid, easy to access and isn’t volatile like your investments. Money market funds are perfect for this.

To Buy or Rent Property?

The decision to buy or rent property isn’t black and white and depends on your financial readiness, lifestyle preferences, and long-term goals. The boomer generation had it easy in comparison. Home ownership was on a relative basis far more affordable which made it a no-brainer. A R3 million family home today has a monthly bond payment of about R33,000 per month. To qualify for that kind of loan you need an income of upwards of R100,000 per month. Plus from a lifestyle perspective, not everyone wants to necessarily be tied down to one place anymore. We see home ownership more as a lifestyle asset rather than an investment asset. It’s nice to own a home and not to pay rent – but its not necessarily for everyone depending on your lifestyle, aspirations and longer-term plans. Weighing up all the costs and benefits of home ownership vs renting is something worth doing, particularly when you’re younger.

Closing Remarks

Financial literacy 101 is a lifelong learning journey. It involves not just gaining knowledge but also applying that knowledge to shape your financial decisions and behaviours. From budgeting financial literacy, to money literacy, investment literacy and savings financial literacy – you will develop a rock solid foundation to master the world of finance by understanding these subjects. Regardless of where you are on this journey, remember that every step brings you closer to financial security and independence.

Carl-Peter Lehmann

Carl-Peter Lehmann

Carl-Peter is a Director and Partner at Henceforward. He is a CERTIFIED FINANCIAL PLANNER™ with over 20 years experience. He believes financial literacy should be taught to everyone at school in order to avoid many of the mistakes we all end up making with our finances and money later in life.

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