What Is Financial Literacy?
Financial literacy refers to the capacity to comprehend and use a variety of financial concepts and abilities, such as personal financial management, budgeting and investing.
Financial literacy is the foundation of your financial relationship, and it is a lifelong process of learning. The sooner you begin, the better off you will be, because education is the key to financial success.
Continue reading to learn how to become financially literate and capable of navigating the difficult but crucial waters of personal finance.
And once you’ve educated yourself, attempt to pass on what you’ve learned to your family and friends. Many individuals find financial problems scary, but they don’t have to be, so educate and guide others.
KEY TAKEAWAYS
- The term “financial literacy” refers to a variety of important financial skills and concepts.
- People who are financially literate are generally less vulnerable to financial fraud.
- A strong foundation of financial literacy can help support various life goals, such as saving for education or retirement, using debt responsibly, and running a business.
Understanding Financial Literacy
Financial products and services have been more widely available in society in recent decades. Whereas previous generations of Americans may have purchased goods primarily with cash, credit and debit cards, as well as electronic transfers, are now widely used.
Indeed, according to a 2019 survey by the Federal Reserve Bank of San Francisco, customers preferred cash payments in only 22% of purchases, while debit cards were favored by 42% and credit cards by 29%.
Mortgages, student loans, health insurance, and self-directed investment accounts have all become increasingly important. As a result, it is even more important for people to understand how to use them safely.
Household budgeting, knowing how to handle and pay off debts, and evaluating the tradeoffs between different credit and investment products are just a few of the abilities that go under the banner of financial literacy.
These abilities frequently necessitate at least a basic understanding of essential financial concepts like compound interest and the time worth of money.
Given the importance of finance in today’s society, a lack of financial literacy can be extremely detrimental to one’s long-term financial success. Unfortunately, according to a study, financial illiteracy affects 66 percent of Americans, according to the Financial Industry Regulatory Authority (FINRA).
Being financially illiterate can lead to a number of pitfalls, such as being more likely to accumulate unsustainable debt burdens, either through poor spending decisions or a lack of long-term preparation. As a result, poor credit, bankruptcy, foreclosure, and other undesirable repercussions may occur.
Thankfully, there are now more resources than ever for those wishing to educate themselves about the world of finance. One such example is the government-sponsored Financial Literacy and Education Commission, which offers a range of free learning resources.
Financial literacy can help protect individuals from becoming victims of financial fraud, a type of crime that is becoming more commonplace.
Strategies to Improve Your Financial Literacy Skills
Developing financial literacy to improve your personal finances involves learning and practicing a variety of skills related to budgeting, managing and paying off debts, and understanding credit and investment products. Here are several practical strategies to consider.
- Create a Budget—Using an Excel sheet, paper, or a budgeting tool, track how much money you receive each month vs how much you spend. Income (paychecks, investments, alimony), fixed expenses (rent/mortgage payments, utilities, loan payments), discretionary spending (non-essentials like eating out, shopping, and travel), and savings should all be included in your budget.
- Invest in yourself first— This reverse budgeting approach involves deciding on a savings goal (for example, a down payment on a house), selecting how much you want to contribute each month toward it, and placing that amount aside before dividing up the remainder of your costs.
- Pay Your Bills On Time — Keep track of your monthly invoices and make sure your payments are always made on time. Consider using automatic debits from your checking account or bill-pay applications, as well as setting up payment reminders (by email, phone, or text).
- Get a copy of your credit report: Through the federally sponsored website AnnualCreditReport.com, customers can get a free credit report from each of the three main credit bureaus—Experian, Equifax, and TransUnion—once a year. Examine these reports and dispute any discrepancies by notifying the credit bureau. Because you can get three, try spreading your requests out over the year to keep track of your progress.
Due to the COVID-19 pandemic, the three major credit bureaus are offering free weekly credit reports thru April 2022.
- Check Your Credit Score. Having a good credit score helps you obtain the best interest rates on loans and credit cards, among other benefits. Monitor your score via a free credit monitoring service (or, if you can afford it and want to add an extra layer of protection for your information, use one of the best credit monitoring services). In addition, be aware of the financial decisions that can raise or lower your score, such as credit inquiries and credit utilization ratios.
- Manage Debt—Use your budget to stay on top of debt by reducing spending and increasing repayment. Develop a debt-reduction plan, such as paying down the loan with the highest interest rate first. If your debt is excessive, contact lenders to renegotiate repayment, consolidate loans, or find a debt-counseling program.
- Invest in Your Future: If your employer offers a 401(k) retirement savings account, be sure to sign up and contribute the maximum to receive the employer match. Consider opening an individual retirement account (IRA) and creating a diversified investment portfolio of stocks, fixed income, and commodities. If necessary, seek financial advice from professional advisors to help you determine how much money you will need to retire comfortably and develop strategies to achieve your goal.
An Example of Financial Literacy
Emma is a high school teacher who uses her curriculum to teach her students about financial literacy. She instructs students on the fundamentals of a wide range of financial topics, including personal budgeting, debt management, education, retirement planning, insurance, investing, and tax preparation.
Although these disciplines may not be particularly relevant to Emma’s students during their high school years, she believes they will be beneficial throughout their careers.
Understanding concepts like interest rates, opportunity costs, debt management, compound interest, and budgeting, for example, might help her students manage their student loans and avoid accumulating dangerous levels of debt and jeopardizing their credit ratings.
Similarly, she expects that certain topics, such as income taxes and retirement planning, will eventually prove useful to all students, no matter what they end up doing after high school.
Why Is Financial Literacy Important?
A lack of financial literacy can lead to a number of pitfalls, such as accumulating unsustainable debt burdens, either thru poor spending decisions or a lack of long-term preparation.
This, in turn, can lead to poor credit, bankruptcy, housing foreclosure, or other negative consequences.
How Do I Become Financially Literate?
Learning and practicing a number of skills linked to budgeting, debt management, repayment, and credit and investment products are all part of becoming financially literate.
Creating a budget, keeping track of costs, being attentive to regular payments, being sensible about saving money, periodically monitoring your credit report, and investing for the future are all basic actions to enhance your personal finances.
What Are Some Popular Personal Budget Rules?
The 50/20/30 and 70/20/10 rules are two famous personal budgeting approaches that are popular because of their simplicity. The former requires splitting your take-home salary after taxes into three categories: needs (50 percent), savings (20 percent), and wants (20 percent) (30 percent).
The 70/20/10 rule follows a similar plan, advising you to divide your after-tax take-home income into three categories: spending (70 percent), savings or debt reduction (20 percent), and investments and charity donations (10 percent) (10 percent ).