FINANCIAL LITERACY

Without the understanding of basic financial concepts, people are not well equipped to make decisions related to financial management. People who are financially literate have the ability to make informed financial choices. According to research conducted, worldwide only one out of three adults show an understanding of basic financial concepts.

What exactly is financial literacy? Financial literacy is the ability of an individual to understand and efficiently use different financial tools and skills, it includes personal financial management, budgeting and investing. It is the cognitive understanding of financial components and skills such as budgeting, investing, borrowing, taxation, and personal financial management. The absence of such skills is referred to as being financially illiterate. It is the foundation of a relationship with money, a strong financial literacy can help various life endeavors, such as saving for retirement or higher education, using debt responsibly, efficiently allocating resources while running a business. Financial knowledge is especially important in times where increasingly complex financial products are easily available to a wide range of the population. For example, with governments in many countries pushing to boost access to financial services, the number of people with bank accounts and access to credit products is rising rapidly. Financially literate consumers not only manage money with more confidence, but also have a better chance of handling the inevitable ups and downs of their financial lives by understanding how to prevent and manage issues as they arise. That can mean keeping a close eye on their bank and credit card accounts so they’re aware of potential fraud as soon as possible, or being able to recover from a costly unexpected car repair quickly thanks to ample cash savings. On the other hand, financial literacy can help consumers save diligently for things that matter to them, such as a vacation or their child’s college education. Here are the ways financial literacy can affect your life:

• Understand how much you earn and spend – When building financial literacy, making a budget is one important way to establish a true understanding of your income and expenses. Once you have a budget, you can continue to track spending and revisit your spending plan regularly. There are many budgeting methods—such as the zero-based or 50/30/20 plans—so choose the one that you’re most likely to stick to.
• Repay and avoid debt – Seeking out the lowest interest rates when comparing loan terms can save a substantial amount over time, and so can paying off credit card balances each month so you don’t accrue interest charges. If you already have debt, financial literacy can help you choose the best methods to get out of debt, either on your own or with the help of a reputable expert like a nonprofit credit counselor.
• Protect yourself from debt and bankruptcy – A crucial way to prevent debt from building is to create an emergency savings account. A financially literate saver knows how much to set aside—ideally three to six months’ worth of expenses—and aims to keep it at that level at all times.
• Work toward a secure retirement – Whatever your other short-term plans, save for retirement at the same time. When you’ve become financially literate, you’ll have a better idea how much to save, what type of retirement you want and how to get there.

Fundamental Components of Financial Literacy

Financial literacy consists of several financial components and skills that allow an individual to gain knowledge regarding the effective management of money and debt. Below are the fundamental components of financial literacy that should be learned.

• Budgeting – In budgeting, there are four main uses for money that determine a budget:

spending, investing, saving, and giving away. Creating the right balance throughout the primary uses of money allows individuals to better allocate their income, resulting in financial security and prosperity. In general, a budget should be composed in a way that pays off all existing debt while leaving money aside for saving and making beneficial investments.

• Investing – To become financially literate, an individual must learn about key components in regards to investing. Some of the components that should be learned to ensure favorable investments are interest rates, price levels, diversification, risk mitigation, and indexes. Learning about crucial investment components allows individuals to make smarter financial decisions that may result in an increased inflow of income.
• Borrowing – In most cases, almost every individual is required to borrow money at one point in their life. To ensure borrowing is done effectively, an understanding of interest rates, compound interest, time value of money, payment periods, and loan structure is crucial. If the criteria above are understood sufficiently, an individual’s financial literacy will increase, which will provide practical borrowing guidelines and reduce long-term financial stress.
• Taxation – Gaining knowledge about the different forms of taxation and how they impact an individual’s net income is crucial for obtaining financial literacy. Whether it be employment, investment, rental, inheritance, or unexpected, each source of income is taxed differently. Awareness of the different income tax rates permits economic stability and increases financial performance through income management.
• Personal Financial Management – The most important criteria, personal financial management, includes an entire mix of all of the components listed above. Financial security is ensured by balancing the mix of financial components above to solidify and increase investments and savings while reducing borrowing and debt. Achieving an in-depth knowledge of the financial components discussed above guarantees an increase in an individual’s financial literacy.

Benefits of Financial Literacy

Holistically, the benefit of financial literacy is to empower individuals to make smarter decisions. More specifically, financial literacy is important for a number of reasons:

• Financial literacy can prevent devastating mistakes – Floating rate loans may have different interest rates each month, while traditional IRA contributions can’t be withdrawn until retirement. Seemingly innocent financial decisions may have long-term implications that cost individuals money or impact life plans. Financial literacy helps individuals avoid making mistakes with their personal finances.
• Financial literacy prepares people for emergencies – Financial literacy topics such as saving or emergency preparedness get individuals ready for the uncertain. Though losing a job or having a major unexpected expense are always financially impactful, an individual can cushion the blow by implementing their financial literacy in advance by being ready for emergencies.
• Financial literacy can help individual reach their goals – By better understanding how to budget and save money, individuals can create plans that set expectations, hold them accountable to their finances, and sets a course for achieving seemingly unachievable goals. Though someone may not be able to afford a dream today, they can always make a plan to better increase their odds of making it happen.
• Financial literacy invokes confidence – Imagine making a life-changing decision without all the information you need to make the best decision. By being armed with the appropriate knowledge about finances, individuals can approach major life choices with greater

confidence realizing they are less likely to be surprised or negatively impacted by unforeseen outcomes.

How to gain Financial Literacy

Don’t let the fear of jumping into the financial world, or a sense that you’re “just not good with money,” prevent you from improving your financial knowledge. There are small steps you can take, and resources that can help you along the way.

• Look for free resources – To start, take advantage of free tools that might already be available to you. For example, your bank, credit union or credit card issuer might track your spending patterns on its website or app. Several banks and Experian also offer free credit score monitoring. You can use these tools to get an initial grasp of where your money is going and where you stand with your credit.
• Check with your employer – Find out whether the company you work for offers free financial counseling or an employee financial wellness program. You may be able to speak with a financial professional as part of your suite of workplace benefits, which can give you early insight into the areas you most need to focus on (like saving, retirement, budgeting or debt reduction).
• Look into credit counseling – Expert help is also available from credit counseling agencies, which employ counselors certified in budgeting and debt payoff techniques. If you have the means, you could also consider working with a financial advisor such as a certified financial planner. They can help with financial goal-setting, tax planning, saving for college and retirement, and paying down debt. Search for a certified financial planner in your area or one you can work with remotely using databases like the XY Planning Network or the Garrett Planning Network.
• Seek out resources from well-regarded nonprofits and agencies – They can teach you the basics about finance on your own time.

How to Improve Financial Literacy?

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, 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.

• 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 score, 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.
• 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 individual retirement account (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 develop strategies to reach your goal.

Way Forward

Overall, financial literacy affects everything from day-to-day to long-term financial decisions, and this has implications for both individuals and society. Low levels of financial literacy across countries are correlated with ineffective spending and financial planning, and expensive borrowing and debt management. These low levels of financial literacy worldwide and their widespread implications necessitate urgent efforts. Results from various surveys and research show that the Big Three questions are useful not only in assessing aggregate financial literacy but also in identifying vulnerable population subgroups and areas of financial decision-making that need improvement. Thus, these findings are relevant for policy makers and practitioners. Financial illiteracy has implications not only for the decisions that people make for themselves but also for society. The rapid spread of mobile payment technology and alternative financial services combined with lack of financial literacy can exacerbate wealth inequality. To be effective, financial literacy initiatives need to be large and scalable. Schools, workplaces, and community platforms provide unique opportunities to deliver financial education to large and often diverse segments of the population. Furthermore, stark vulnerabilities across countries make it clear that specific subgroups, such as women and young people, are ideal targets for financial literacy programs. Given women’s awareness of their lack of financial knowledge, as indicated via their “do not know” responses to the Big Three questions, they are likely to be more receptive to financial education. The near-crisis levels of financial illiteracy, the adverse impact that it has on financial behavior, and the vulnerabilities of certain groups speak of the need for and importance of financial education. Financial education is a crucial foundation for raising financial literacy and informing the next generations of consumers, workers, and citizens. Many countries have seen efforts in recent years to implement and provide financial education in schools, colleges, and workplaces. However, the continuously low levels of financial literacy across the world indicate that a piece of the puzzle is missing. A key lesson is that when it comes to providing financial education, one size does not fit all. In addition to the potential for large-scale implementation, the main components of any financial literacy program should be tailored content, targeted at specific audiences. An effective financial education program efficiently identifies the needs of its audience, accurately targets vulnerable groups, has clear objectives, and relies on rigorous evaluation metrics. There are three compelling reasons for having financial education in school. First, it is important to expose young people to the basic concepts underlying financial decision-making before they make important and consequential financial decisions. Financial literacy is very low among the young and it does not seem to increase a lot with age/generations. Second, school provides access to financial literacy to groups who may not be exposed to it (or may not be equally exposed to it), for example, women. Third, it is important to reduce the costs of acquiring financial literacy, if we want to promote higher financial literacy both among individuals and among society. There are compelling reasons to have personal finance courses in college as well. In the same way in which colleges and university offer courses in corporate finance to teach how to manage the finances of firms, so today individuals need the knowledge to manage their own finances over the lifetime, which in present discounted value often amount to large values and are made larger by private pension accounts.