Episode Details

Episode 51 – Can you pass the financial literacy test

Want to minimise the chance of living off nothing but a meagre age pension in later life?

There's a great proverb that I heard many years ago and have never forgotten "a fool and his money are easily separated".

So how do you ensure you're not the fool? The solution is to have at least a basic understanding of the financial world. We call this Financial Literacy. That doesn't mean you need to become an expert – you can hire people for that. But you need to know enough to be able to sniff out a bad deal, and to avoid those big missteps. You need to be able to understand the risks you are taking, and gauge whether the likely return adequately compensates for that risk.

So, today's post takes on a question and answer format. Let's see how you fare when it comes to financial literacy.

Question 1

You log onto your internet banking and your credit card shows an available balance of $7,400 and an account balance of $2,600. Should you make any repayments on this account?

The answer is YES. The account balance is the key element here – this is what you owe, and if you don't repay it, you will pay significant interest.

Many, many people look at the available balance and think in terms of "well I've got that much still to spend". I very much suspect banks present this figure hoping you will do exactly that. This available balance mentality is what traps a lot of people when it comes to credit cards. Focus on what you owe, and get this down.

Question 2

Let's stick with credit cards for a moment longer. Say you have a credit card where you owe $2,000, with an interest rate of 18% and you pay only the minimum repayments each month. Assuming you don't spend any more on that card, how long will it take you to fully pay it off: less than 5 years, between 5 and 10 years, or more than 10 years?

The answer is that it will take you over 15 years to pay off your credit card if all that you do is make the minimum repayments each month. You'll pay a fortune in interest too.

Just like with the available balance mind tricks, the banks requirement for a minimum repayment is not because they are your friend. They want you paying as much interest as possible for as long as possible.

Ideally you would repay your credit card every month in full so that you avoid paying any interest. If you aren't able to do that, then certainly ensure you pay considerably more than the minimum suggested by your bank.

And of course if you find credit card debt to be a problem, have your limit reduced to minimise the potential damage. You could have the limit reduced to $1,000 for instance – enough capacity to buy some concert tickets online, or deal with a short term emergency, but not so much room that you could dig yourself into a really deep hole. You could go the whole hog and do without a credit card altogether, though in the modern online world I would certainly find that challenging.

Question 3

Your Gross salary last month was $6,000 and your Net salary was $4,500 - how much was paid into your bank account?

The answer is $4,500. I find a lot of people get confused between gross and net salary, and I guess they are quite jargon sounding terms.

Your gross salary is what you employer pays out. If you're sitting down for a pay review and your boss talks about giving you a pay rise, they'll be talking about your gross salary – how much they pay to have you on the team.

But what is more interesting to you is your Net salary – how much actually goes into your bank account. The difference between Gross and Net salary is mainly deductions for tax and superannuation, though you may have other deductions as well, which leads nicely into the next few questions on the most common other form of deduction from your gross income – Sal