Financial Literacy

Written by True Tamplin, BSc, CEPF® | Reviewed by Editorial Team

Updated on December 12, 2022

What Is Financial Literacy?

Financial literacy is the capability to understand financial concepts and apply this skill in decisions related to savings, investment, and debt management. 

It is a lifelong learning process that helps individuals to build wealth wisely, manage debt, and plan for a secure future. 

Financial literacy is the key to making informed financial decisions, managing risks, and maximizing opportunities associated with different financial products and services while meeting specific financial goals.

The Need for Financial Literacy

The need for financial literacy is evident in the number of people who struggle with finances.

According to CareerBuilder,  78% of Americans live paycheck to paycheck, which means they have little to no savings to cover unexpected expenses.

In fact, a  telephone survey conducted by Bankrate found that 56% of Americans do not have enough money saved to cover a $1,000 emergency.

This lack of financial literacy and awareness can have dire consequences, such as debt problems. In the year 2021, the total amount of U.S. consumer debt is $14.9 trillion. This consists of mortgages, auto loans, credit cards, and school loans.

While not all debt is bad, too much debt can lead to financial difficulties. High levels of debt can make it challenging to make ends meet, pay for unexpected expenses, or save for the future.

Financially literate individuals are better equipped to make sound financial decisions and navigate life's financial challenges.

Scope of Financial Literacy

The scope of financial literacy is extensive such as budget education, understanding available banking tools, and economic concepts. It includes but is not limited to the following: 

Understanding Personal Finances

A clear picture of your current financial situation entails knowing how much money you have, your assets, and your liabilities. It also involves knowing if you are spending your money in a way that meets your financial goals.

Setting Financial Goals

Determine what you want your money to perform for you, whether saving for a house downpayment or being able to have an early retirement. 

After identifying your objectives, you may create a plan to achieve them.

Managing Debt

Not all debts are bad. A general rule of thumb is that if debt generates income, increases your net worth, or has future value, it is considered good debt. However, when debt becomes too much, that is when it becomes a burden.

If you have debt, learn how to manage it properly by creating a budget and payment plan. 

Investing

When you understand financial concepts like the time value of money, you realize that it is never too early to start investing. Investing allows you to grow your money by understanding the risks and rewards associated with each investment option before engaging in one. 

Retirement Planning

Retirement is one of the most important financial goals that you will ever set. The earlier you start, the more time your money has to grow.

With the proper understanding of finances, you will be able to gauge how much money you will need to save to retire comfortably. It will also help you decide which retirement accounts to get that will best fit your needs.

Tax Planning

Taxes are inevitable but knowing their ins and outs can aid in understanding the tax implications of different financial decisions. It also teaches you how to maximize deductions and minimize tax liability.

Benefits of Financial Literacy

Financial literacy is a stepping stone toward achieving financial independence. Hopefully, its benefits will encourage individuals to give it the attention it deserves. Below are some of the benefits of financial literacy.

Improved Money Management Skills

Knowing when to save or splurge takes a lot of discipline, self-control, and financial knowledge. With improved money management skills, you can make informed decisions about your finances and better control your spending.

You can budget your money, track spending, and understand the importance of saving money for future goals.

Reduced Debt Levels

Debt management is crucial because it enables you to know how to use credit wisely.

With financial literacy, you can practice using credit responsibly and taking out loans only when necessary. You only spend what you can afford to pay back and make payments on time.

Improved Credit Score

Credit scores are typically influenced by factors such as credit utilization, payment history, and length of credit history. Financial literacy can help you improve your credit score by teaching you how to use credit responsibly and make timely payments. 

Increased Savings

For many people, saving is not a priority because they do not understand its importance. Financial literacy can help you see the value in saving money for emergencies, retirement, and other long-term goals.

Better Financial Decisions

You can create a balance between present living conditions and future financial goals. You weigh the pros and cons in both the short-term and long-term perspective in making financial decisions.

Wise Investing

When you understand matters like risk and return, you are able to make informed investment decisions. This can help you grow your wealth over time and reach your financial goals sooner.

Structured Budget

Financial literacy teaches you how to create and stick to a structured budget to help track spending, set financial goals, and make better decisions about where to allocate your money. 

Creating a budget can be daunting, but many resources are available to help you get started. You can find budget templates online or in personal finance books and magazines.

Two of the most common budgeting methods are illustrated below, which shows how monthly income is allocated into three main financial areas.

Common_Budgeting_Methods

Reduces Financial Stress

You are less stressed about money because you know how to manage it effectively. Thus, you can lead a higher quality of life.

Financial Literacy Example

Camilo Maldonado, a co-founder of The Finance Twins, grew up in poverty and was never taught how to manage money. Eventually, he took control of his finances using a money management program

Knowing where he was spending his money allowed him to be more mindful of his spending and helped him to understand better where he could save money.

How to Attain Financial Literacy

Developing financial literacy to enhance one's finances requires acquiring and using several skills. Consider the following tips:

Take a Financial Literacy Class

Taking classes on financial literacy can provide the opportunity to learn from knowledgeable instructors and receive reliable information. 

Such courses typically cover saving money, investing, using credit wisely, and budgeting. You can take them at community colleges, online, or even through some employers.

Use Free Online Money Management Tools

Some free online money management tools can help you monitor your spending, establish financial goals, and make informed decisions about where to allocate your money. 

Tools like Personal Capital and Mint can help develop a budget and gain insights into your spending patterns.

Take Advantage of Free Online Resources

A wealth of accessible free online resources can help you learn about personal finance and money management. 

Many of these resources are from reliable sources, such as government agencies or financial institutions like MyMoney.gov, Consumer Financial Protection Bureau, and the National Financial Educators Council.

Financial Literacy at Home and School

Financial education is vital for children and adults alike. It helps teach practical money skills that are necessary for everyday life. 

Parents are key role models for their children and must pass on positive money habits. It has been demonstrated that when children receive financial education at a young age, their spending habits change, and they can avoid problems such as bullying and aggression.

The Power of Financial Literacy

When it comes to financial literacy, the power is in knowledge. The more you know about personal finance, the better your chances of acquiring, managing, and retaining wealth throughout your lifetime.

Financial literacy can translate your efforts, time, energy, business, and money into a life of comfort and freedom from worrying about money. Even in economic crises, you can reduce the impact it will have on you.

Will you do something about the money problems you are facing now, or will you allow the poverty cycle in your family to perpetuate? 

You can start your journey to financial literacy by reaching out to a financial advisor.

FAQs

What is financial literacy?

Financial literacy is the skill and ability to comprehend and use financial information to make informed decisions.

Why is financial literacy critical?

It helps people make informed decisions about their money. Financial illiteracy may result in several risks, including poor credit, bankruptcy, home foreclosure, or other undesirable outcomes.

What are some financial literacy practices?

Reviewing expenses, developing a budget, tracking net worth, understanding credit, and saving for retirement are some of the practices of a financially literate individual.

How can one attain financial literacy?

There are numerous ways to improve your financial literacy. You can educate yourself through online resources or consulting financial experts.

What is an example of financial literacy?

An example of financial literacy is knowing how to develop and stick to a budget. You also need to understand income, debts, and expenses to make informed decisions about where to allocate funds.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.

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