Table of Contents:
- Why financial literacy is important
- Financial literacy example
- Characteristics of financial literacy
- An introduction to financial products
- Improving financial literacy
- Financial illiteracy risks
- Financial literacy benefits
- Getting a lesson in financial literacy
- The bottom line
If the thought of managing your finances gives you a feeling of anxiety and dread, you’re not alone. According to FINRA Investor Education Foundation, only 34% of Americans can answer 4 out of 5 basic financial literacy questions, significantly contributing to a lower standard of living and the ability to attain financial security.
An example might read: True or false? A 15-year mortgage requires a higher monthly payment than a 30-year mortgage, but interest over the life of the loan will be less.
As you can see, the question is directly related to the experience of purchasing a home, something so many of us strive to do in our lives. Without the understanding of how interest rates are calculated, you could easily fall prey to unethical practices by lenders.
So, what is financial literacy? It’s having the knowledge and skills that allow individuals to use all their financial resources to make informed decisions about their financial life.
There’s no doubt that a lack of financial education causes a lot of problems for people.
But, whether we like it or not, our world runs on money. Those who have it enjoy a lifestyle where they not only have their basic needs met, but they can also enjoy the comforts of the things that bring them joy. Whereas those who struggle with money seem to have more difficulties in other areas of their lives.
In celebration of April’s Financial Literacy Month, Public, along with state and federal governments, financial experts, and companies alike, aims to shine a spotlight on financial literacy and the benefits of educating ourselves so we can all live prosperous lives.
Key takeaways
- Financial literacy is the ability to understand and utilize various financial tools and skills.
- Although we have more ways to learn about finances available to us, financial literacy is declining in the U.S..
- Without the basic knowledge of finances, Americans are unable to escape the unending cycle of debt.
- Basic financial knowledge includes learning how to pay bills, pay off debt, understand credit, and invest.
- Learning about finances isn’t as difficult as one might expect. It can offer the opportunities we need to manage money effectively and save for the future. There are a variety of financial services available online to help.
Why financial literacy is important
Financial literacy starts when we have our first exposure to money. That may have been as a child, earning an allowance for doing chores around the house or that first job, such as babysitting, dog walking, or mowing lawns.
What most of us don’t realize at the time is that our relationship with money will be a lifetime commitment and will affect every aspect of our lives. While some people grow up in families that educate their children about money, many do not. Either way, we form ideas about money that can shape every decision we make about managing it, including not managing it at all.
Unfortunately, turning our backs on financial literacy can lead to a variety of problems, such as poor spending habits that lead to unending financial burdens like high-interest debts, credit issues, inability to save for a house, lack of retirement savings, and a variety of additional negative consequences.
To be clear, the term “financial literacy” doesn’t mean knowing everything about money. Instead, it empowers us to find the answers we need to make sound financial choices.
As you gain more knowledge about finances and how to utilize the money for your own benefit, you begin asking yourself important questions before you so readily spend it, including:
- Do I really need this?
- Can I find lower prices elsewhere?
- Are there additional costs associated with this decision that I may not be expecting?
- How will interest rates affect the total cost?
- How will spending money on this benefit me over the long term?
- Can I really afford this now?
Once you begin to ask yourself these questions, you’ll start to improve your awareness.
While the ability to understand basic financial concepts is vital, building a foundation also includes your thoughts and feelings that surround the subject of money.
We have to remember that not everyone views money the same way. For some, it’s been the cause of some type of negativity, and the thought of dealing with money makes them want to bury their head in the sand. While others can see the possibilities it can offer and embrace all that comes with it.
Although our feelings about finances may not seem to affect how we manage our money, a poor relationship with it can do more harm than good. It’s important to evaluate those feelings and understand that financial education can be a game changer. When we feel empowered, we want to learn more, and ultimately, we make better decisions.
Since it’s a lifelong journey, when it comes to learning about finances, the earlier we start, the better. If you think about some of the unnecessary things you’ve spent money on, I’m sure you’ll agree that if you had only known more about the options, maybe you would have chosen to do something differently. That’s why the importance of financial literacy can’t be understated.
A few of the key components of financial literacy include:
- Personal money management
- Budgeting
- Paying bills
- Saving
- Investing
Becoming financially literate will not only take the stress out of financial planning but will give you the ability to navigate all the financial decisions and the tools to manage them effectively.
Financial literacy example
To give kids the best opportunities for success, it’s vital to weave conversations about finances into everyday life and include kids in those discussions. Yet, according to a survey by T. Rowe Price, 41% of parents of 8 to 14 year olds have “some resistance” to discuss money with their kids.
Financial literacy doesn’t always come easy, and with so many adults living paycheck to paycheck, teaching our kids about money is more important than ever. After all, it’s the one thing we all need to survive and thrive as a member of society.
With that understanding, some parents have made it a daily practice to start teaching their kids about money as early as 7 years old by implementing a few techniques that include:
- Pay an allowance – A regular allowance instills in kids that they need to work to earn money. Doing chores for pay will help them understand that money must be earned.
- Teach them about savings – Teaching kids to save the money they earn and watch it grow can be an introduction to the benefits of investing. Parents can help them to set goals for saving, open a savings account, and pick out a piggy bank to save on their own.
- Talk about money – When out with the kids, discuss what you’re buying and why. Show them how much it costs and have them look at receipts to see how the purchase was made.
- Explain wants vs. needs – Discuss the difference between what we need to live and what we may want. Explain that needs include the basics such as food, housing, clothing, education, and health, and wants are extra things that cost money, such as toys, eating out, and phones. Spend time asking them about different items and whether they are a need or a want, so they fully understand.
- Prioritize spending – Explain why determining what to spend money on is important and why when it’s cold outside, a winter coat is a better choice than a new toy.
- Don’t give kids more than what they earn – To learn the value of money, it’s helpful if kids understand that if they earn money and spend it all, it’s gone until they make more. They can’t learn that lesson if you hand out money every time they ask.
- Track spending – To know where they spend, have your kids keep track of everything they spend each day, and add it up at the end of the week. Ask them about their purchases and how important they were. This can be an eye-opening experience and a great teaching moment for the value of saving.
- Give them the freedom to make mistakes – We want to protect our kids from mistakes, but it’s one of the best ways to learn valuable lessons.
- Teach them to budget – Showing kids how to create a budget allows them to use and save their money wisely. If they have an expensive item such as a new cell phone or video game they want, teach them how a budget can get them to their goal faster.
- Match savings – To encourage kids to save, parents can offer a matching program, much like an employer match program in a 401(k) savings plan. You can either match dollar for dollar or decide on a percentage. Seeing their money grow can be very encouraging, and teaching them the importance of saving will create good habits.
- Make it fun – By making it fun to learn about money, their first exposure is positive, which can create an empowering attitude surrounding it. Also, kids learn and remember more when it’s fun. With kids so connected, you can even make paying them fun by using apps that assign a dollar value to chores and where they can receive payment and watch their money grow.
As kids become young adults and reach high school, some teachers also prioritize finances. For example, a home economics teacher may weave lessons on financial literacy into classes on budgeting for groceries and household finances.
Also adding discussions about income and expenses, personal budgeting, managing debt, saving for college, buying a home, and even saving for retirement.
Even though the class is focused on how to take care of a home and other necessary life skills such as meal planning, shopping, and cooking, finances are directly related to all of those things. Therefore, it’s a great opportunity to pass on that knowledge to students, so they have the financial capabilities needed as they move through life.
Characteristics of financial literacy
Although we know financial education is essential to help us make sound financial decisions so we can enjoy financial stability and become self-sufficient, it’s equally important to avoid the pitfalls that bad financial choices can lead to, such as bad credit and bankruptcy.
Building financial literacy involves some basic money management skills, such as budgeting, saving, and investing, but there are additional principles that are equally important to rounding out our knowledge.
Things such as learning how to set and achieve goals, managing debt, the power of compound interest, and being informed about dishonest financial practices, such as lending schemes, unethical lenders and financial institutions, high-interest loans, fraudulent transactions, and any other challenges that emerge.
Even though, thanks to the Internet, Americans have more access to financial information than ever before, financial literacy is not improving. And the need to grasp basic financial concepts is more critical than ever. For example, as retirement planning has moved from employee pension funds, where the companies or government sponsors decide on funds, to 401(k) plans where employees choose their own investments, understanding the principles of how stocks work is even more important now.
But not all employers offer retirement savings plans, so individuals need to seek out other options for saving, such as individual retirement accounts (IRAs). And with people living longer, Social Security benefits just won’t cut it, so having a financial education is no longer a luxury we can live without.
Learning financial literacy isn’t as complicated as you might think. It comes down to a couple of basic principles. The first is to gain control of your personal finances, which involves how you manage your money, set goals, and meet them.
These objectives may include buying a home, saving for children’s college fund, retirement savings, enjoying vacations, and any other goals you and your family may have. Of course, you’ll also need to understand banking, paying bills, budgeting finances, credit, interest rates, and investing.
An introduction to financial products
One of the first financial tools you’ve used was, most likely, a savings or checking account at your local bank. Familiarity with the various bank accounts is the first step in preparing for your financial future.
Most people today have some type of bank account with access to a variety of resources available through their accounts, such as:
- Debit and credit cards
- Checking accounts
- ATMs
- Direct deposit
- Loans
- Mortgages
- Interest earning accounts
Although many of us still like to have a local bank, online banks have gained popularity and offer the same services as your local branch. Another option for banking is credit unions, which, unlike banks, are non-profit organizations owned by the members. One major benefit of using a credit union is that it sometimes offers lower fees, as well as low interest rates and personalized customer service.
Basic accounts
Whether you choose a local bank, credit union, or online banking, there are 3 basic types of accounts you should consider when thinking about how to organize your funds.
- Checking accounts – These are liquid accounts, meaning you can easily manage your money by making deposits and withdrawals without any limits. They don’t earn interest, but you have access to your money through banks, ATMs, checks, and debit or credit cards. Although you can find accounts without fees, many charge some sort of fee. You’ll also have access to direct deposit and bill pay options that can simplify banking tasks.
- Savings accounts – These are interest-earning accounts that make short-term saving easy. They are flexible and an ideal solution to save for emergencies and short-term goals, such as a vacation or education.
- High-yield savings account – These accounts usually pay higher interest rates than regular savings accounts but require larger deposits and high minimum balances.
An emergency fund
An emergency fund can be set up at any financial institution and is an important asset to help to prepare for any unplanned financial needs, such as car repairs, medical expenses, employment gaps, and household expenses. Building up an emergency fund can eliminate the stress of unexpected expenses.
Understanding debit and credit cards
These days when making any type of purchase, we reach for the plastic card in our wallets and swipe, insert, or tap them to check out. Although debit cards attached to our checking accounts are a popular option, not everyone has left credit cards behind.
While debit cards are an easy option and look like a credit card, the money comes straight out of your account, unlike credit card purchases, where you borrow money that you pay back over time. With credit cards, if you don’t pay the balance in full each month, you’re charged interest on any remaining balance due.
How debit & credit cards differ
Debit cards – Are attached to your checking account, and any money spent using the debit card comes right out of your account, so you can’t spend more than what’s in your account. They don’t offer any type of credit-building opportunities for the user.
Credit cards – Allow the user to borrow money in any amount as long as it doesn’t exceed their credit limit. They can be used for unexpected expenses if you haven’t established an emergency fund. Still, you’ll pay interest on any remaining balance that’s not paid off in full.
Although credit cards can help the user build up their credit history, which can be useful to make larger purchases, such as buying a house, they can also be a source of financial troubles for those who don’t pay off the balance each month. If interest charges pile up, repayment can feel impossible.
Credit cards are a leading problem when it comes to debt for Americans. According to Fortune.com, in 2021, there was over $860 billion owed in credit card debt alone, which gives you a good idea of how interest payments can snowball out of control.
When applying for a credit card, it’s a good idea to consider the APR, which is the annual percentage rate of interest. The higher the interest rate, the more you’ll pay over and above the unpaid balance on charges. These interest rates can be as high as 16% or higher and add up quickly.
Types of credit cards
Good credit can offer a variety of options when looking to obtain a credit card. Although many of them can offer low introductory rates, no annual fees, and other perks, late payments and time limits can change what you get, so it’s essential to read the fine print to understand the terms. Some options include:
- Zero-interest rates – These cards don’t charge annual interest on purchases made, but if payments are late, many charge high interest, which can get you in trouble.
- Cashback – The terms on this type of card are that you’ll receive a small portion of cashback each month in cash or a credit on your monthly statement.
- Travel rewards – These cards give points that can be redeemed when traveling for flights, rental cars, and hotels.
- Balance transfers – Transferring high-interest rate balances from another card can save thousands of dollars and help pay it off faster.
When evaluating credit cards, it’s essential to check all options and be aware of your protections under the Equal Credit Opportunity Act (ECOA), which prohibits discrimination in lending and all aspects of credit transitions.
Improving financial literacy
Financial literacy comes down to mastering a set of skills that can improve your financial life and give you the tools necessary to plan for the future. Here are some things you can do to improve your financial literacy.
- Pay yourself first – You’ve heard it before, and it’s because it’s one of the most important things you can do to ensure you save. To get started, set a savings goal and decide how much to save each month toward that goal, and put that money away before utilizing it for expenses.
- Pay bills on time – Bills have a way of creeping up on us each month, and for some, that can mean late payments and additional late fees. Setting up bills on autopay where they are deducted from your checking account by the due date will eliminate late payments and keep your credit score high.
- Manage debt payments – It’s vital to stay on top of any debt payments and make sure they are paid on time. Of course, paying it off is always a good idea to relieve unnecessary financial stress.
- Review your credit report – You are entitled to a free credit report that shows all credit accounts and their status every year. Review these reports to ensure they are correct and report any discrepancies to the credit bureau(s). To receive your report, contact any of the 3 major credit reporting agencies, Equifax, Experian, or Transunion, through the website www.annualcreditreport.com.
- Review your credit score – Credit scores are measured on a scale from 300 to 850 points. The higher your score, the better chance you have of getting low-interest loans and the ability to show your creditworthiness.
- Save for retirement – Regularly investing in stocks or any type of retirement account is a positive step in preparing for your future. Whether through your employer’s 401(k) or an individual retirement account (IRA), automating it is key to make the most of compound interest. If you’re a beginner investor, take a look at the Public app, which allows you to invest with no minimum. You can get started today.
- Budget your money – The only way to know where your money is going each week is to track spending and income. Include paychecks and all other income, such as side gigs, alimony, or rental income in your budget. Add all expenses such as rent, utilities, and other living expenses, and savings, and track it over several months.
Creating a budget
The best way to gain control of your financial situation is to create a detailed budget of all income and expenses. There are several ways to organize the information, such as using an app, an Excel spreadsheet, or money management software, so use whatever works best for you. Follow these steps to get started organizing your funds into a budget:
First, first all your income sources:
- Paycheck
- Side hustles
- Alimony
- Settlements
- Hobby income
- Etc.
Then, list all your expenses:
- Fixed expenses – Mortgage payments or rent, utilities, car payments, student loan payments.
- Discretionary expenses – Dining out, shopping, travel, entertainment, clothing, and gifts (all non-essential expenses).
- Savings – Money you save each month.
With all the numbers in front of you, add up income and then subtract the expenses to see how much you have available. Any funds available could go into creating or building an emergency fund, or if you are in debt, you may consider making extra payments to pay them down.
Budgeting rules
Once you have a sense of how much is coming and going out of your budget each month, you might want to be more strategic about your saving and spending. When it comes to budgeting, 2 common strategies can simplify the process: the 50/20/30 rule and 70/20/10 rule.
The 50/20/30 budget rule – This rule tells us to take your after-tax income and divide it into 3 categories: needs, wants, and savings where 50% is allocated to needs, 30% is assigned to wants, and 20% is allocated to savings.
The 50% assigned to needs includes funds that go toward bills that must be paid each month. This includes your mortgage or rental payment, insurance, healthcare, car payments, utilities, minimum debt payments, and groceries.
The general rule is that the 50% should cover all your needs, and if it doesn’t, you may want to evaluate your spending and reduce those payments.
The 30% allocated to wants includes non-essential items such as shopping, eating out, vacations, entertainment, and gym memberships. Upgrades are also considered in this category. These are things such as a more expensive vehicle, movie channels, extravagant dinners, and designer clothing. They are things you can live without.
The 20% allocated for savings includes retirement contributions such as to a 401(k), IRA, or other investment accounts, emergency fund(s), and college funds. Remember, it’s recommended to have 3 months of living expenses saved for emergencies.
The 50/20/30 rule is intended to help keep track of finances and help prepare people for life’s unexpected expenses and the future.
The 70/20/10 budget rule – This budgeting method allocates 70% to spending, 20% to savings and investing, and 10% to debts and donations.
The 70% includes mortgage or rental payments, utilities and insurance, healthcare, car, bills and debts, groceries, shopping, recreation, vacations, and any other expenses that would be considered needs and wants.
The 20% is allocated to investment and retirement accounts such as a 401(k), IRA, or other retirement accounts. This can also include what’s called a sinking fund, which is a type of savings account for larger expenses that may occur, such as a new car, planning for a wedding or college, a vacation, household repairs or a swimming pool, or any other large purchases.
The 10% goes toward paying additional debt payments, donations, or gifts such as birthday, baby, or wedding gifts, charities, or lending money.
The 50/20/30 rule and 70/20/10 rule are both simple methods for managing money and budget planning that keep finances organized and easy to understand due to the streamlined use of fewer categories.
Using them doesn’t take much time and can make what can be an overwhelming task something that can be done in less time, especially if you dread the idea of creating a detailed budget. It’s also an easy way to learn more about financial literacy for beginners.
Financial illiteracy risks
Unfortunately, in the U.S., many adults don’t possess the basic financial skills needed to make sound decisions about everyday financial issues. Despite the fact that money is a vital part of our society, it’s not routinely taught in schools, and for so many, that’s where any possibility of a financial education ends.
Without any type of financial knowledge, any lessons learned may come from inaccurate advice passed down from families or costly mistakes often discovered after the damage has been done.
But it goes even deeper than that. For those who are financially illiterate, a lack of understanding can mean debilitating credit card debt, high-interest loans, substandard living conditions, little to no retirement savings, and an inability to thrive.
Parents who don’t have knowledge of the basic principles of finance can’t educate their kids, and the cycle may continue. And of course, add on to that the ever-changing rules of finance in lending industries, the unending credit card offers, and fraudulent companies calling us to extract our personal financial information for their gain, and it can feel like a losing battle.
The only way to combat each of those issues is to educate ourselves and continue to learn and practice financial literacy.
Financial literacy benefits
The ability to manage our money is one of the most empowering skills we have. It gives us the awareness to make informed decisions about all aspects of our finances, including saving, investing, spending, borrowing, and budgeting.
The knowledge we gain offers us the opportunity to reach short-term and long-term financial goals and gives us the financial stability and well-being to thrive in all areas of our lives.
A few direct benefits of personal financial literacy is the ability to:
- Budget effectively
- Understand loan terms
- Get the proper insurance
- Track healthcare expenses
- Purchase a home or other real estate
- Manage the use of credit
- Understand interest rates
- Save for retirement
- Understand financial aid options
When we understand the basics of our finances, we tend to make better money decisions overall, maintain healthy spending habits, and save for retirement, which leads to lower stress levels and happier lives.
Without the financial skills needed, individuals may find themselves living paycheck to paycheck, drowning in debt, paying high-interest rates, and unable to save for the future.
Getting a lesson in financial literacy
No matter where you are in your knowledge of financial literacy, there’s always a way to learn and grow that understanding to benefit yourself and your family. Here are a few places to help:
- Financial podcasts – A great way to learn as you go through your day. Whether you’re doing yard work, driving, or running errands, podcasts can help you learn what you want to know when you’re ready. To get a list of personal finance podcasts for 2022, check out this U.S. News & World Report list.
- Subscribe to financial newsletters – They are sent right to your inbox, and you can carve out time in your daily routine to read them and learn.
- Read books on the subject – There’s no shortage of financial experts who have books out. Choose a few that you enjoy and take time to read a few chapters each day.
- Online courses – Online courses have exploded and can be accessed through a variety of learning platforms.
- Financial websites – A quick search will give you plenty of options for financial websites to visit. Find experts you admire and spend some time learning from them via their website. Many offer free courses you can sign up for as well.
The bottom line
Understanding how money works is a vital part of life, and learning even the basics of financial literacy can offer us opportunities to make our lives better and avoid pitfalls that can so easily occur without that knowledge.
The basic pillars of financial literacy include banking, understanding how credit works, interest rates, budgeting, spending wisely, the use of debt, and investing for retirement. Knowledge of these will help us navigate all the financial decisions we will make throughout a lifetime.
Saving for retirement doesn’t have to be complicated. To learn more about getting started, download the Public app today.