Financial literacy refers to the ability to understand and apply a variety of financial concepts and skills, such as personal financial management, budgeting, and investing. Financial illiteracy is the lack of these skills.
About Financial Literacy
Financial products and services have become more widely available in society in recent decades.
Unlike previous generations of Americans, who may have bought goods mainly with cash, credit cards, mortgages, and student loans are now widely used.
Health insurance and self-directed investment accounts, for example, have become increasingly important. This has made it even more imperative for individuals to understand how to use them responsibly.
Also, household budgeting, learning how to handle and pay off debts, and assessing the tradeoffs between various credit and investment products are just a few of the skills that fall under the umbrella of financial literacy.
However, these abilities often necessitate at least a basic understanding of fundamental financial concepts such as compound interest and the time value of money.
More Details about Financial Literacy
Furthermore, given the importance of finance in modern society, lacking financial literacy can be very damaging for an individuals’ long-term financial success.
Unfortunately, research has shown that financial illiteracy is very common, with the Financial Industry Regulatory Authority (FINRA) estimating that some 66% of Americans lack financial literacy.
Therefore, the lack of financial literacy can lead to a number of pitfalls. Financially illiterate individuals may be more likely to accumulate unsustainable debt burdens, for example, either through poor spending decisions or through a lack of long-term preparation.
This in turn can lead to poor credit, bankruptcy, housing foreclosure, or 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.
Easy Way to Assess Your Financial Literacy
An easy way to assess your financial literacy is to ask yourself some questions about your own personal finances.
- Do you know how to create a personal budget?
- Do you have an emergency fund that covers at least three months of basic living expenses?
- Also, Do you have a plan for retirement?
- If you have debt, do you have a plan to pay it off?
- Do you know your credit score and how to improve it?
Ways to Improve Your Financial Skills
However, to improve your personal finances, you’ll need to learn and practice a variety of skills such as budgeting, debt management and repayment, credit, and investment product understanding.
Here are the ways to consider:
1. Earn – Understanding your paycheck
You need to know how much money you make so you can start buying, saving, and investing. This part is simple if you make the same amount every month.
Take a good look at your paycheck to identify your gross and net income, and note any other deductions, such as employer-sponsored health insurance or a retirement plan.
Once you’ve determined your monthly net income, you’re ready to spend (responsibly!) with a personal budget.
3. Create a Personal Budget
A personal budget is just a plan for how you want to spend your money, but it’s also the most useful tool for achieving your financial goals.
Hence, track how much money you receive each month against how much you spend in an excel sheet, on paper, or in a budgeting app.
Note that your budget should include income (e.g., paychecks, investments, alimony), fixed expenses (like rent/mortgage payments, utilities, loan payments), discretionary spending (non-essentials such as eating out, shopping, travel), and savings.
4. Pay yourself First
To build savings, this “reverse budgeting” approach 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.
5. Manage your Bill Paying
Stay on top of monthly bills so that payments consistently arrive on time. Consider taking advantage of automatic debits from a checking account or bill-pay apps, and sign up for email, phone, or mail payment reminders.
6. Get your Credit Report
Once a year, consumers can request a free credit report from the three major credit bureaus, Experian, Equifax, and Transunion. Review it and dispute any errors by informing the credit bureau of inaccuracies.
7. 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 and be aware of the financial decisions that can raise or lower your score, such as credit inquiries and utilization rates.
8. Try to 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 highest interest rate first.
If your debt is excessive, contact lenders to renegotiate repayment, consolidate loans, or find a debt-counseling program.
9. 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 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 to develop strategies to reach your goal.
10. Prevent Fraud and Buy Insurance Policies
Once you’ve set yourself up with a solid budget and investment strategy, it’s important to protect the money that you’ve made.
This means regularly reviewing your bank accounts and credit card statements for mistakes or suspicious activity; keeping documents and passwords secure to prevent scams and identity theft, and buying the right kind of insurance to protect yourself in the event of an emergency.
Frequently Asked Questions
1. Is Financial Literacy Important?
Financial illiteracy can lead to a variety of pitfalls. Individuals who are financially illiterate are more likely to accumulate unsustainable debt burdens as a result of poor spending decisions or a lack of long-term planning, for example.
As a result, you may experience bad credit, bankruptcy, foreclosure, or other negative consequences.
2. How can I Become a Financially Literate Person?
To become financial literate involves learning and practicing a variety of skills related to budgeting, managing and paying off debts, and understanding credit and investment products
Basic steps to improve your personal finances include creating a budget, keeping track of expenses, being diligent about timely payments, being prudent about saving money, periodically checking your credit report, and investing for your future.
3. Is there a rule in budgeting?
There are two commonly used personal budgeting methods are the 50/30/20 and 70/20/10 rules and it’s their simplicity is what makes them popular.
The former entails dividing your after-tax, take-home income pay into three areas namely needs, wants, and investments and/or payments to reduce your debt load.
The 70/20/10 rule also follows a similar blueprint. It recommends that your after-tax, take-home income be divided into segments that cater to expenses, savings or reducing debt, and investments.
In conclusion, financial literacy is the possession of the set of skills and knowledge that allows an individual to make informed and effective decisions with all of their financial resources.