1 October 2020
By Jessie Connor
The term “financial literacy” is often mentioned in personal finance news, vlogs, and other resources. But, what does it mean to be financially literate? Simply put, it means to be able to understand the basic concepts of personal finance and use solid financial management skills.
Your financial literacy can dictate your whole financial wellbeing. It includes your ability to manage a budget, plan for retirement, calculate interest on savings and loans, and track spending.
The problem is, according to a FinLit report, only 33% of adults worldwide are financially literate. Let’s see why financial literacy matters and how you can improve yours.
In this article.
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Why is Financial Literacy Important?
The better you can handle your money and find your way around the world of finance, the better decisions you can make with your earnings.
No matter what job you have or how old you are, you face financial decisions every day. You need to pay for your mortgage, budget for your expenses and savings, pay for college expenses, get insurance, and plan for retirement.
Moreover, financial literacy includes the ability to calculate whether something is a liability or an asset and the time value of a purchase. When you are financially literate, you can better understand your rights as a consumer.
Like any other skill, financial literacy gets better over time—provided that you are applying it in your daily life. It helps you manage debts, develop a financial plan, and understand how your decisions will affect you down the road.
Still, even though it is a very important skill, financial literacy isn’t taught in schools. If you don’t make an effort to improve your financial literacy as an adult, you risk getting exploited by predatory lenders who can trick you with subprime mortgages, high-interest rates, and even fraud.
People who are financially illiterate can easily fall victim to bad credit, high debt, and bankruptcy. So that this won’t happen to you, here are a few things you can do.
Improving your financial literacy.
Learn to budget.
The first step to becoming financially literate is learning how to budget. With a solid budget plan in place, you’ll be able to make the most of every penny you make.
The principle is pretty straightforward—you need to balance the money you make with the money you spend. For starters, add up all of your monthly income. Next, look at and review your expenses.
You can review your credit card and bank statements for the past 3 months. Be sure to look at both regular and irregular expenses. Group them in categories such as car-related expenses, energy bills, clothing, groceries, debts, etc. Be sure to include less frequent expenses, such as auto insurance and property tax.
Many financial experts advise adults to follow the 50/30/20 budget rule. The plan dictates that you should allocate 50% of your budget for your needs (housing, insurance, healthcare, etc.). Then, you should allocate 20% of your after-tax income to investments and savings. The rest of your budget (30%), can go on your wants, such as dining out, Starbucks, Netflix, etc.
This simple plan will allow you to feel secure about your financial future. It will also give you some financial breathing room.
Plan for emergencies.
Counting on the unlikeliness of emergencies happening is sort of a gamble, and gambling is the direct opposite of being financially literate. As a rule of thumb, you should set aside 3 to 6 months worth of necessary living expenses (rent, food, bills), for emergencies.
The bigger your emergency fund is, the more leeway you will have in case you get “financially cornered”. For instance, if you have a large enough emergency fund, not only will you be able to support yourself in case you experience some serious health problems or lose your job, but you will be able to afford to change your job or career, or move house, without having to worry about supporting yourself during the process.
If you can’t afford to set aside a lot of money for emergencies at the moment, start small. Even if you add just $25 each week to your emergency fund, it will steadily grow. Consider adding any unexpected money, such as bonus cheques or refunds, to the fund.
One of the truest marks of being financially literate is knowing how to protect your savings against inflation. And, investing is one of the best ways to do this. When it comes to investing, you have many options, including, bonds, stocks, and annuities.
Due to their popularity and simplicity, most investors start off with stocks. But, while the principles of trading and investing in stocks are simple, how to learn trading or investing is a mystery to most beginning stock traders and investors.
Before you invest even one dollar in anything, you need to make an effort to learn as much as you can about it. So, if you are interested in stocks, it’s a good idea to enrol in a relevant course.
Naturally, all investments come with inherent risk. But, the risk can vary greatly. For instance, investing in cryptocurrency is far riskier than investing in government bonds. So, before you start investing, you also need to learn about your risk level tolerance.
Manage your debt.
Learning how to manage debt is a very important aspect of financial literacy. This includes personal loans, mortgages, auto loans, credit cards, etc.
Don’t take on more debt than you can handle comfortably. Naturally, it’s best to avoid borrowing money. But, if you have to, you need to learn the difference between bad debt and good debt.
Debt that increases continually is bad. The number one bad debt among consumers is a credit card. The items people buy with credit cards usually decrease in value over time. But, with each month you don’t pay off the credit card, the interest you must pay increases.
A mortgage, on the other hand, is good debt. As the debt decreases, the value of your home increases. By the time you pay off your mortgage, your home will be more valuable than it was when you bought it.
Generally, student loans are good debt as well because the degree you earn can deliver a great return on investment.
The more you learn about managing personal finances, the less you will stress about money. Undoubtedly, dedicating some time and effort to developing financial literacy is a smart investment. It will allow you to be in control of every dollar you make.