What is Financial Literacy?

Financial literacy is a term that is used to showcase the level of understanding an individual has on their finances and the first step to reaching financial freedom. Many people assume that if they are not in debt, they are financially literate, but that is not always the case. Experts say that only 57% of adults in the United States are fully financially literate, as most of them only understand bits and pieces of the bigger picture.

So, what makes up that bigger picture? Let’s look at the main parts of financial literacy and what they mean:

Navigating Debt

Debt describes the money someone owes another person or institution. And while many assume all debt is bad debt, that is not the case. Debt is a necessary part of life—if someone wants to take out a mortgage to buy a house, get an installment loan to buy a car, or open a credit card to pay off expenses, they will be incurring debt. Household debt is on the rise with credit card debt being a primary factor.

Borrowing money is still very helpful for those bigger expenses in life, but it is not free. It’s important to understand that when money is being loaned out, a debt is also being incurred, along with interest that must be paid back on time to avoid having bad credit. That is why it is so important to understand what debt is, how it works, and how it can be managed healthily.

Managing Your Credit Score

When someone misses paying back a debt on time, their credit score will likely be negatively impacted, which can cause future lenders to not be able or willing to loan to them. This kind of scenario may lead to bad credit. Credit bureaus like Experian and TransUnion calculate your credit score by looking at various factors, such as credit history, repayment history, and the debt you’re carrying. Here’s how importance is distributed to determine a credit score:

• Payment history (35%)
• Amounts owed (30%)
• Length of credit history (15%)
• Types of credit (10%)
• New credit (10%)
  

Budgeting Matters:

Housing, transportation, food, utilities, insurance, medical, saving/investing/debt, personal spending, entertainment, and miscellaneous/emergency—these are the top 10 things an individual should be budgeting out for each month. It seems like a lot, and it can be overwhelming at first, but there are lots of simple ways to start tracking these different categories. A popular budgeting methodology is the 50/30/20 budget rule, which has followers allocate money into certain buckets of spending and saving.

One of the easiest ways to create and track a monthly budget is by using a free online budgeting tool. These apps allow the user to enter all of their spending, and it then breaks all of that out into the different categories noted above. This gives the user an overall idea of how much they are spending versus how much they should be spending in each category. When things are budgeted out it is easier to decide what is a want and what is a need in one’s life, and that will help push them toward financial freedom.

Saving Money & Reducing Expenses:

When it comes to saving money and money management, many people feel that they have too many expenses to deal with and cannot begin to build up their savings. However, just making simple changes in one’s life can add up to huge savings. For example, if someone spends as little as $3 a day on a cup of coffee, that ends up being a whopping $1,095 a year. For many, it can be very eye-opening to see where their money is going each month, and how small things can add up. Creating a budget you can stick to can help with avoiding some spending and increasing your savings.

It is also important to remember that having savings can lead to financial freedom and security. For example, having money saved up gives one the ability to put a down payment on a house, buy a car, and build up an emergency fund for when you need money urgently. Without that initial money set aside, accomplishing that kind of goal is going to be incredibly difficult.

It is also important to point out that when someone puts money into a savings account, they start to earn money via interest. Most people should not leave money sitting in a checking account—when money sits there it does not build up any interest. There are different banks and different types of savings accounts, so one needs to schedule time with their banking provider to talk and figure out what the best savings account plan is for them.

Introduction to Investing:

In our busy society, most people tend to focus on the here and now and do not think about the future. However, making sure that one takes the time to invest in oneself and their future (both financially as well as health-wise) is incredibly important.

A fundamental way someone can invest in their future is by checking to see if their company offers a 401(k) retirement fund match. Many businesses invest a certain percentage back into their employees when they contribute to their 401(k). For example, if an employee puts in 10% of their pay each pay period, the company might match it at another 5%, and this is all pre-taxed money.

There are lots of other ways that people can financially invest, such as the stock market, real estate, bonds, etc., but those types of investments are not for everyone. People should focus on the investments that best fit their needs, and they should always talk to a financial advisor before making any big investments.

Financial Literacy Education

Now that the definition of financial literacy has been broken down, let us talk about who it should be taught to and when:

Financial Literacy for Kids:

First off, it is never too early to start education on the importance of saving, budgeting, investing, and debt. Many parents begin teaching their children about finances early on through the concept of allowances. When kids complete a chore, they then get an allowance and can spend the money or save it up. Through these simple lessons, kids learn the importance of hard work, how money is earned and spent, and what saving can accomplish.

Schools also start the financial education process early on, and if parents are educating their children as well, learning it in school just reinforces any ideas that have already been instilled in them. Many high schools now have mandatory financial literacy classes that help students learn the basics—how to write a check, what debits and credits are, how a mortgage is taken out, etc. Skills that may seem basic to many people tend to be complex when they are not taught in school.

Financial Literacy for Adults:

And while educating early on about financial literacy is the best option, not every person is taught as a kid. Adults should not feel alarmed if they do not learn about finances early on because there are lots of ways they can catch up. Financial literacy courses, financial advisors, and even the internet are great resources to access this information. Also, learning how to properly set goals is a great way to start strong with one’s financial wellness journey. Having milestones set out allows people to prioritize how they spend their money so they can save and accomplish their long-term financial goals.

To summarize, there are several different things people need to understand to be financially literate. It might be difficult to remember all of them, so an easy way to remember it is DIBS: debt, investing, budgeting, and savings. Making sure that one has a basic understanding of those four categories will ensure that they are able to make informed decisions when it comes to their finances.

It is also very important that education is focused on, no matter a person’s age. Individuals need to make sure they have access to accurate information so they can educate themselves and their children to make responsible financial decisions. They also should take time and think about what they want to accomplish in the future so they can then set appropriate financial checkpoints to meet those goals.

Being financially literate is the gift that keeps on giving, so everyone should take the time to assess where they are at in their financial journey. No one can predict the future, but it is guaranteed that financial literacy is going to be around for the long haul, so everyone should take the time to make sure they are set up for financial success.  

Financial Literacy FAQs

Why is financial literacy important?

Financial literacy, like other forms of education, gives you the power to make informed decisions. It’s important because it leads to monetary confidence, decreased stress, and an improved quality of life. Financial literacy can equip you with the right budget, a healthy savings, and less debt.

What is the 50/30/20 budget rule?

The 50-30-20 rule has followers spread their income into three groups by percentage. Needs should be the largest part of your budget at 50%. Needs are usually unavoidable like rent/mortgage, healthcare, and groceries. The next largest bucket at 30% is dedicated to “wants.” This is where movie tickets, streaming subscriptions, and frappuccinos come in. Everything that’s left over, the last 20% of your income, should go towards your savings.

How to get a loan?

There are two options for getting a loan, online and in-person. Getting a loan online has been increasing in popularity in the last couple of decades. You should research lenders, making sure they’re registered with the Federal Trade Commission in your state. Next, review your credit score to have an idea of what you may be qualified for. Then gather the necessary documents, which could include a valid ID, income details, and social security number. Complete your lender’s online installment loan application. Funds are usually deposited right into your bank account.