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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.
● Key aspects to financial literacy include knowing how to create a budget,
plan for retirement, manage debt, and track personal spending.
● Financial literacy can be obtained through reading books, listening to
podcasts, subscribing to financial content, or talking to a financial
professional.
Given the importance of finance in modern society, lacking financial literacy can
be very damaging to an individual’s long-term financial success. Even so,
research shows 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 U.S.
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.4
This also includes knowing which investment vehicles are best to use when
saving, whether for a financial goal like buying a home or for retirement. This is
not to add the novelties in finance such as e-wallets, digital money, buy now/pay
later, P2P lending, and other new financial products that can be convenient and
cost-effective but require potential consumers to be educated to assess them
adequately to their advantage.
Why Financial Literacy Matters
From day-to-day expenses to long-term budget forecasting, financial literacy is
crucial for managing these factors. It is important to plan and save enough to
provide adequate income in retirement while avoiding high levels of debt that
might result in bankruptcy, defaults, and foreclosures.
Note
If you are a younger individual, retirement may seem years away. While it is a
ways in the future, it is also one of the best goals to start saving for, because the
earlier you start, the more you’ll have compounded down the line. One
investment vehicle to start with is an employer-sponsored retirement account,
such as a 401(k).
In its Economic Well-Being of U.S. Households in 2020 report, the U.S. Federal
Reserve System Board of Governors found that many Americans are
unprepared for retirement. More than one-fourth indicated that they have no
retirement savings, and fewer than four in 10 of those not yet retired felt that
their retirement savings are on track. Among those who have self-directed
retirement savings, more than 60% admitted to feeling low levels of confidence
in making retirement decisions.5
Low financial literacy has left millennials—the largest share of the American
workforce—unprepared for a severe financial crisis, according to research by the
TIAA Institute. Even among those who report having a high knowledge of
personal finance, only 19% answered questions about fundamental financial
concepts correctly. Forty-three percent report using expensive alternative
financial services, such as payday loans and pawnshops. More than half lack an
emergency fund to cover three months’ expenses, and 37% are financially
fragile (defined as unable or unlikely to be able to come up with $2,000 within a
month in the event of an emergency).6
Millennials also carry large amounts of student loan and mortgage debt—in fact,
44% of them say they have too much debt.6
Though these may seem like individual problems, they have a wider effect on
the entire population than previously believed. All one needs is to look at the
financial crisis of 2008 to see the financial impact on the entire economy that
arose from a lack of understanding of mortgage products (creating a vulnerability
to predatory lending). Financial literacy is an issue with broad implications for
economic health.
Benefits of Financial Literacy
that, no matter where you are in life and financially, it’s never too late to start
practicing good financial habits.
Here are several practical strategies to consider.
Create a Budget
Track how much money you receive each month against how much you spend
on 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.
In a 2021 survey by the Federal Reserve, 22% of adults in the United States
reported not being OK financially and not living comfortably financially.8
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 to 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 scores,
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.
Being financially literate from a young age gives an individual the tools and
resources they need to be financially secure later in life. The lack of financial
literacy can lead to a number of pitfalls, such as accumulating 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, or other negative consequences.
There are five broad principles of financial literacy. Though other models may list
different key components, the overarching goal of financial literacy is to educate
individuals on how to earn, spend, save, borrow, and protect their money.
What Are Some Examples of Financial Literacy?
As a high school student transitions to college, they may be faced with the task
of deciding which school to attend and how to finance their education. This may
including how much money they should be saving from their after-school job,
how the terms of their loan will work, and what opportunity costs exist throughout
their decision-making process.
In this example, the student will make more financially responsible decisions if
they are more financially literate. Financial literacy in this example extends to
savings, employment, budgeting, loans, and financial planning. Using financial
literacy and making smart decisions, the student can set themselves up for
long-term success.
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