Increase Your Financial IQ In 10 Minutes
April is Financial Literacy Month. As a personal finance coach, it is one of my favorite months. I get to talk about the power of financial literacy and by default, the cost of financial illiteracy. In working with women, I have noticed they stay in financial ignorance — not because they are resistant to improving their finances. They stay ignorant and broke because they are afraid to ask basic questions for fear of looking dumb, afraid to voice uncertainty or confusion.
But when it comes to elevating our financial acumen, we have to ask questions. And the more basic, the better. A solid financial foundation that is built on the mastery of rudimentary concepts and facts will allow you to easily incorporate the more complex ideas into your fiscal schema.
So, in honor of Financial Literacy Month, here are answers to some of the questions that I get on Twitter, Facebook, and via email. There is no shame in not knowing because when you know better, you feel and do better.
Q. What type of economy does the United States have?
A: Technically, the United States is said to have a mixed economy because both privately-owned businesses and government play key roles in its growth. It, however, moves and acts like a free market or market economy. A market economy is characterized by an emphasis on private ownership rather than government ownership; private business produces and distributes the majority of goods and services in the country. What also makes the American economy free market in nature is its belief in the power of supply and demand to determine the prices of goods and services. The prices of goods and services, in turn, inform businesses what should and should not be produced, making way for the entrance of businesses “competitive enough” to produce and the exit of businesses unable to compete in the free enterprise system.
Q: What is the Federal Reserve? Why is it so important?
A: The Federal Reserve System is the central banking system of the United States. The Federal Reserve is responsible for the country’s monetary policies and decisions, which include monitoring, managing, and controlling the supply of money and trading it in the foreign exchange markets. The former Chairman of the Federal Reserve was Ben Bernanke. The current Chairman of the Federal Reserve is Janet Yellen, the first woman to hold the position.
Q: What is difference between and stock and mutual fund?
A: A stock (also known as an equity or a share) is a portion of the ownership of one corporation or business entity. When you buy stock in a company, you have the right to a portion of the company’s earnings and are subject to mitigating its losses. Mutual funds, on the other hand, is an investment made through fund managers who are responsible for a group of investors’ pooled money. Mutual funds provide diversity because it allows for investment in a number of investment tools (i.e. stocks, bonds) and allow the investors to have ownership in several companies.
Q: What is an IRA? What is the difference between a traditional IRA and a Roth IRA?
A: IRA stands for “individual retirement account.” A traditional IRA is an account that allows individuals to make investments with tax-deductible contributions. This money can be invested in stocks, bonds, mutual funds, or other investment vehicles and grow tax-free until the person is 59 1/2 years old. Penalties are imposed for withdrawals made before this time. After 59 1/2, account owners are permitted to make withdrawals, but must make withdrawals by 70 1/2 years old. The withdrawals will be taxed at your current tax rate.
On the other hand, contributions to the Roth IRA are made with after-tax dollars. They also are not deductible on your tax returns. Since you have paid tax on your money upfront, withdrawals from the Roth IRA will be tax-free. Additionally, unlike traditional IRAs, there is no distribution requirement (i.e. withdrawals) and individuals can make contributions to their IRA after they are 70 1/2 years old.
Q: What is a “rule of thumb” in terms of creating a budget?
A: There are different ways to allocate money for a budget. The most basic I have come across is the “50/30/20” budget. Fifty percent of your income goes to “must-haves” (i.e. food, shelter, education, transportation), thirty percent goes to “wants” (i.e. clothes, travel, entertainment), and twenty percent goes to savings. (i.e. retirement, emergency fund, college fund)
As black women, we tend to be the heads of households, chief breadwinners, and decision makers in our communities. If we have all of this power, we have to ensure that we have the know-how and financial expertise to lead our people in the right direction.
Kara Stevens is the founder of the personal finance and lifestyle blog The Frugal Feminista, an online home for financial empowerment, girl power, and juicy living. Connect with her on Twitter@frugalfeminista