By Frank Conway
Financial I.Q. is about essential money knowledge
Broadly, financial I.Q. is simply having a good understanding of how money works in general. But there are several issues that are particularly important from a financial wellbeing perspective. Specifically, when it comes to long-term financial wellbeing, having a good working knowledge of topics such as inflation, compound interest, credit card debt and even personal credit reports are key to good financial planning and long-term financial wellbeing.
If we take the topic of inflation, while it was not a major factor in financial planning for almost a decade, it has recently resurfaced. Today, across the Eurozone, inflation is estimated to be about 3%. Many people in Ireland have significant amounts of money held on deposit earning little or nothing by way of interest. As inflation increases, the real value of that money falls. If we take someone with €10,000 on deposit earning no interest, with inflation at 3%, it means the ‘buying power’ of that money over a 12-month period will fall to €9,700, a drop of €300. This will continue to compound every year.
Impact of inflation on financial wellbeing
To counter the corrosive impact of inflation, one should explore ways to grow the value of money and today, there are a number of options; to enroll in a pension or invest outside of the pension structure. Both harness the power of compound growth over time brilliantly. However, the pension route is more efficient due to the many tax advantages.
While not all investments are the same, the general objective is to invest so that the investment return is greater than the prevailing rate of inflation. This should at least maintain the buying power of money during periods of higher inflation. Simply leaving your money sit in a zero-interest account is not an option if one’s goal is to protect the real value of their money.