Core Competencies of Financial Literacy

Earning and Spending

Earning

Employment Income: Working for Others

Most individuals earn income through employment, working for companies, governments, or non-profit organizations. Education, training, and experience are crucial for developing specific talents and general employability skills. Employability skills are essential for securing and maintaining a job, while enterprising skills can be applied by anyone, regardless of their employment status.

• Employability Skills: Skills that help you get and keep a job.

• Enterprising Skills: Skills that can be developed and applied by anyone, whether employed or self-employed, such as identifying opportunities, taking initiative, and being creative.

These skills are highly valued by employers. The labor market operates on the principles of supply and demand. Employers often provide benefits in addition to wages or salaries, including group insurance (health, dental, life), retirement benefits, education loans, housing and vehicle loans, sick leaves, vacations, and flexible work arrangements.

Self-Employment: Working for Yourself

Self-employment involves setting up and operating a venture, often starting a business. Success leads to profit, calculated as revenue minus costs. If the result is positive, it's a profit; if negative, it's a loss.

• Profit: Revenue - Costs (positive result)

• Loss: Revenue - Costs (negative result)

Entrepreneurs may sell their shares of ownership, leading to large companies owned by numerous shareholders who receive dividends (a share of the profits). Shareholders are people who invest in the company and receive a share of profits called dividends.

Investment Income

Capital Gains

Investment income can be earned through capital gains. Capital gains occur when an asset is sold at a higher price than its purchase price. Conversely, a capital loss occurs when an asset is sold at a lower price. Professionals in financial areas offer advice and assistance for a fee.

Interest

Interest is income received for providing someone with the use of your money for a specific period, such as a loan.

Inheritance

An inheritance is money or assets received from the estate of a deceased person. These amounts can be substantial, accumulated over a lifetime of savings and investments.

Government Transfers

Government programs provide financial assistance, such as welfare, to those in need. Employment insurance is also provided to those who become unemployed, funded by contributions from workers and employers.

Lotteries and Gambling

Lotteries and gambling offer opportunities to win money, but the chances of losing are much higher than winning.

Spending

Tracking your Spending

Tracking your Spending is critical to understand where your money is going. A budget is a plan for managing money on a monthly basis. It helps cover expenses, save money, and achieve financial goals. Tracking expenses is the first step in taking control of your finances.

Major Expenses

Spending allows us to acquire essential items for survival and major expenses. Three common major expenses include:

1. Education and/or training

2. Buying or leasing a car

3. Housing

Another significant expense for young people is cell phones or handheld devices.

Education and Training

Education and training expenses include tuition, application fees, textbooks, supplies, transportation, and living costs. A good education can significantly impact job opportunities and income levels.

Housing

When moving out, individuals decide whether to live alone or with roommates. Sharing costs with roommates can be more affordable, but living with others can present challenges.

Smartphones and Plans

Smartphones are common among young people for various purposes. Payment for these devices and plans can be the responsibility of the individual or someone else.

Monthly Expenses

Example of a college student's monthly expenses:

• Food: 25%

• Housing: 15%

• Transportation: 15%

• Education: 8%

• Savings: 8%

• Power: 13%

• Others: 16%

Monthly Budget Sample

Example of a combined income of $P20,000$ per month:

• Fixed expenses: $P8,500$ (House, Electricity, Internet, Tithe, Savings)

• Variable expenses:

  • Water: $P500$

  • Food/Groceries: $P5,000$

  • Family Support: $P1,000$

  • Miscellaneous/Kids: $P500$

Budgeting

Budgeting is a fundamental step toward financial literacy, security, and freedom. It involves creating a plan to spend and invest money wisely to achieve personal and financial goals. Budgeting should be viewed as a self-assessment of one's relationship with money and a roadmap to improve the standard of living.

Setting SMART Goals

• Specific: Clearly define the goal.

• Measurable: Quantify the goal.

• Achievable: Ensure the goal is realistic.

• Relevant: Align the goal with values and needs.

• Time-Bound: Set a deadline for achieving the goal.

Example: Paying off credit card debt

1. Identify the credit cards (specific).

2. Verify the amount owed (measurable).

3. Decide how much extra payment to send each month (attainable).

4. Calculate how much can be spared from the budget (realistic).

5. State when to reach the goal (timely).

Collecting Financial Information

Collect and organize financial information to save time and avoid missing payment deadlines. Designate a personal financial space and create a secure personal financial directory with a list of all financial accounts protected by a username and password. Use a secure internet connection for electronic transactions.

Tracking Money Coming In

Document all incoming sources of cash flow to track income and spending trends. Differentiate between net income and borrowed money, and be mindful of accumulated debt and its interest.

Tracking Money Going Out

Focus on spending and saving habits, and analyze spending decisions. Differentiate between needs and wants.

Methods for Tracking Expenditures

Keep all receipts or record every transaction daily using a tracking application. Budgets are commonly done monthly, based on net income.

Review Cash Flow and Set up a Budget

Analyze cash flow to trim "wants" and revisit "needs." Strip expenditures to the bare minimum to make ends meet.

Interest Rates

Time Value of Money (TVM)

TVM is the concept that money available now is worth more than the same amount in the future due to its potential earning capacity. A peso today is worth more than a peso tomorrow.

• Present Value (PV): The current starting amount.

• Future Value (FV): The ending amount at a point in time in the future.

• Number of Periods (N): The timeline for the investment, usually in years.

• Interest Rate (I): The growth rate of money, stated as a percentage.

• Payment Amount (PMT): A series of equal, evenly-spaced cash flows.

PV < FV

PV vs FV Example

If $P100,000$ is invested at 12% interest per annum, the future value at the end of the year will be:

$P100,000 \times 1.12 = P112,000$

Interest Rate Types and Terminology

1. Simple Interest: Computed on the original amount for one time period.

2. Compound Interest: Computed on the original amount plus all unpaid interest accumulated to date.

3. Fixed Interest Rate: Remains constant during the life of the loan or investment.

4. Variable Interest Rate: Changes during the life of the loan and is usually tied to the prime rate.

5. Mixed Interest Rate: Changes from fixed to variable or vice versa.

Annual Percentage Rate (APR)

APR includes the interest rate, points, mortgage broker fees, and other charges. It is usually higher than the stated interest rate.

Credit Card Interest Calculation

Credit card companies divide the APR by 365 days to derive the daily periodic rate (DPR). They then multiply the DPR by the days in the billing period times the balance to calculate the interest due each month.

Amortization

An amortized loan is a loan with scheduled, periodic payments that consist of both principal and interest. Interest is based on each month's unpaid principal balance. Amortization involves establishing a series of equal monthly payments that will pay the interest expense for the period before any principal is reduced.

Example: A loan of $P100,000$ with a term of 24 months and an interest rate of 10% per annum.

• Interest for the first month: $(0.10 ÷ 12) \times 100,000 = P833.33$
  How to Compute Monthly Amortization in the Philippines
  Formula: M = P [ i(1 + i)^n ] / [ (1 + i)^n – 1]

M = Monthly Payment
P = Principal Loan Amount
i = Monthly Interest Rate
n = Number of Months

IMPACT OF THE TIME VALUE OF MONEY

Impact on Debts

Understanding TVM helps in making financial decisions regarding debts, such as credit card debt. Consider the opportunity cost of choosing a certain decision over another possible choice.

Impact on Investments

TVM is used to compare investment alternatives and solve problems involving loans, mortgages, leases, savings, and annuities. Calculate the present and future value of a single sum of money or a series of equal payments.

In any investment scenario, you can calculate an unknown value if you possess any four of the parameters such as:

• Interest rate (simple or compounded)

• Number of periods (years, months, and/or days)

• Payment amount (inflow or outflow)

• Present value (single amount or annuity)

• Future value (single amount or annuity)