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Financial Literacy

 

Financial Literacy

 
Reviewed by 
EBONY HOWARD
 
 
Updated Apr 1, 2021

What Is Financial Literacy?

Financial literacy is the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing. Financial literacy is the foundation of your relationship with money, and it is a lifelong journey of learning. The earlier you start, the better off you will be, because education is the key to success when it comes to money.

Read on to discover how you can become financially literate and able to navigate the challenging but critical waters of personal finance. And when you have educated yourself, try to pass your knowledge on to your family and friends. Many people find money matters intimidating, but they don’t have to be, so spread the news by example.

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

In recent decades financial products and services have become increasingly widespread throughout society. Whereas earlier generations of Americans may have purchased goods primarily in cash, today various credit products are popular, such as credit and debit cards and electronic transfers. Indeed, a 2019 survey from the Federal Reserve Bank of San Francisco showed that consumers preferred cash payments in only 22% of transactions, favoring debit cards for 42% and credit cards for 29%.1

Other products, such as mortgages, student loans, health insurance, and self-directed investment accounts, have also grown in importance. This has made it even more imperative for individuals to understand how to use them responsibly.

Although there are many skills that might fall under the umbrella of financial literacy, popular examples include household budgeting, learning how to manage and pay off debts, and evaluating the tradeoffs between different credit and investment products. These skills often require at least a working knowledge of key financial concepts, such as compound interest and the time value of money. Given the importance of finance in modern society, lacking financial literacy can be very damaging to an individual’s long-term financial success. Unfortunately, research has shown that financial illiteracy is very common, with the Financial Industry Regulatory Authority (FINRA) attributing it to 66% of Americans.2

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. This in turn can lead to poor credit, bankruptcy, housing foreclosure, and other negative consequences. 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.3

 

Financial literacy can help protect individuals from becoming victims of financial fraud, a type of crime that is becoming more commonplace—especially during the COVID-19 epidemic, which has caused customers to move online in high numbers.4

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—Track how much money you receive each month against how much you spend in an Excel sheet, on paper, or with a budgeting app. Your budget should include income (paychecks, investments, alimony), fixed expenses (rent/mortgage payments, utilities, loan payments), discretionary spending (nonessentials such as eating out, shopping, and travel), and savings.
  • Pay Yourself First—To build savings, this reverse budgeting strategy involves choosing a savings goal (say, a down payment for a home), deciding how much you want to contribute toward it each month, and setting that amount aside before you divvy up the rest of your expenses.
  • Pay Bills Promptly—Stay on top of monthly bills, making sure that payments consistently arrive on time. Consider taking advantage of automatic debits from a checking account or bill-pay apps and sign up for payment reminders (by email, phone, or text).
  • Get Your Credit Report—Once a year, consumers can request a free credit report from the three major credit bureaus—Experian, Equifax, and TransUnion—through the federally created website AnnualCreditReport.com.5 Review these reports and dispute any errors by informing the credit bureau of inaccuracies. Because you can get three of them, consider spacing out your requests throughout the year to monitor yourself regularly.
 

Due to the COVID-19 pandemic, the three major credit bureaus are offering free weekly credit reports through April 2022.6

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