3 Simple Financial Concepts People Just Don’t Get

Personal finance isn’t really all that complicated.  If you want to stay in control of your finances and not let your money get the better of you, there are only a few basic concepts that you need to understand.

Unfortunately many of these lessons are never taught in school so some people just never have an opportunity to learn them.  Sure, you could say that sort of thing should be learned in the home.  But if one generation misunderstands something they are likely to continue passing down misinformation to their children and grandchildren.

The cycle will go on and on until someone in the family finally learns basic financial lessons such as:

The Difference Between Saving and Investing

Saving is the process of putting money aside somewhere safe and accessible where it will be available when you need it in the near future.  Typically, you will have several things to save for at the same time.

For example, you might have some money set aside in an emergency fund in case of an unexpected illness or job loss.  At the same time you could be saving money to buy a new car, go away on a family vacation, or something else that means a lot to you.

The most important thing about your savings is that it is safe.  You want it in a CD or an online savings account where you can rest assured it won’t lose value.  If you’re saving for a down payment on a house, you wouldn’t want a sudden stock market dip to cost you the home of your dreams.

On the other hand, when you invest money you’re less concerned with safety and more concerned with growth.  You want that money to work for you and grow as much as possible.

Your retirement savings are an example of investing.  You sock a little money from each paycheck into your 401(k) and invest it into mutual funds in the hopes that it will grow well beyond the amount you initially deposited.  If you simply “saved” that money in a bank account or under your mattress, you wouldn’t even be able to keep up with inflation.

Net Income vs Gross Income

When you’re young and just starting out in your career you might be surprised at how small your first paycheck is.  After all, you know what your starting salary is and you divided that by 52 to determine what your weekly paycheck would be.  How come your actual check is so much less?

The answer is simply the difference between gross income and net income.  Gross income is your earnings before any taxes and other deductions are taken out.  If your salary is $26,000 a year, your gross weekly earnings equal $500.

But you won’t actually get paid that much.  Your employer is required to withhold taxes from your paycheck and you might also have deductions for health insurance, life insurance, and other expenses too.  The final amount you receive in your check is called your net income.

Tax Withholding

I used to work part-time at night in a retail store and most of the people I worked with were high school kids who had never worked before.  They had no understanding of taxes, how they’re calculated, or how they come out of your paycheck.

Think of tax-withholding as a way to pre-pay your tax obligation each year.  The amount from your check is an estimate based on your earnings. Depending on your individual circumstances, other earnings, deductions, and tax credits you may qualify for, you may end up underpaying or overpaying.

You don’t want to be in the situation of owing money at the end of the year, and you also don’t want to give the government a tax free loan all year by overpaying your taxes.  If that happens, you should ask your employer to adjust your tax withholding.

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