Why is financial literacy important?
March 22, 2023
Blueprint Income Team
Financial literacy is an important skill that helps you stay on top of your finances. That means learning to pay your bills, save, borrow, invest, and plan for retirement. Taking the initiative to educate and expand your financial knowledge is critical but not difficult. You can start with basic money management as you mature into becoming a smart spender and money manager. Putting more time into your financial development improves your investment decisions and saving practices.
What is financial literacy?
Financial literacy is the ability to understand and implement various financial skills such as budgeting, investing, and managing personal finances. It is a lifelong journey that leads you to invest and save wisely while avoiding debt. Financial literacy requires a fundamental understanding of your individual credit and a willingness to embrace personal responsibility. Sacrificing some comforts and desires for long-term gain demonstrates restraint, which is crucial in becoming financially stable and increasing wealth.
While there's no wrong time to make efforts to improve your financial literacy, the earlier you start, the better. The more financially literate you become, the more frequently the money actions you take will improve your overall financial well-being.
Why is financial literacy important?
Financial literacy allows you to make smart financial decisions that ensure you put an adequate amount into your retirement savings while avoiding debt levels that may result in foreclosures, defaults, and bankruptcies. You can manage money with greater ease and less stress when you're financially literate. You have to put in the time and effort to strengthen your understanding of how the basics of personal finances work and empower yourself to make choices that help you achieve your goals.
That means you're more prepared when you experience drastic changes in your life, such as a divorce, chronic illness, or loss of a spouse. It's also easier to identify financial opportunities that best suit your needs and recognize warning signs that can damage your financial growth when you know how your finances work.
How do I know if I'm financially literate?
While there are many skills that constitute financial literacy, the main ones include budgeting, evaluating tradeoffs between investment and credit products, and learning how to manage and pay off debts. These skills require working with key concepts such as compound interest and the value of money. Other products such as student loans, mortgages, insurance policies, and self-investment accounts are also important, and you must use them wisely and responsibly. To help you determine whether you're financially literate, here are a few questions to ask yourself to see how aware you are of your own money:
- Do you regularly create a monthly budget that includes all your expenses, debts, bills, and sinking funds for future purchases?
- Do you know how much money you spend to cover living expenses for a period of six months?
- Are you currently debt-free or taking active steps to reduce your debts?
- Do you know the difference between an investment and insurance?
- Do you have an emergency fund that allows you to fix a sudden life event, such as settling in a different town, without borrowing money?
- Do you know the various kinds of insurance that you need to protect your investments and finances?
- Do you know how compound interest grows your investment money over time?
What are the main concepts every financially literate individual must master?
It's almost impossible to claim you're financially literate until you can regularly do the right things with money that lead to good financial outcomes. When you're financially literate, you're able to understand the major financial issues people face, including emergencies, debts, and investment problems. Here are the main concepts to understand about financial literacy:
Many Americans live paycheck to paycheck because they don't have a budget or fail to stick to one. Budgeting requires applying principles like discipline to ensure you don't spend more than you need to. If you're a habitual budgeter, you can save for your goals and delay gratification for peace of mind today and in the future.
Debt and borrowing
Mortgages, credit cards, car loans, and student loans are the most common forms of debt that weigh people down. Debt directly affects daily living, as it means shelving your investment plans to pay money borrowed — and including interest. Part of being financially literate means knowing how debts work and how they prevent people from investing. Good debt should help you generate income in the future, while bad debt drains you financially.
Financially literate individuals learn how to build and grow their emergency fund. You also learn how to use your emergency funds and replace them in a short amount of time so that you can save for the next situation. Emergency funds can take care of unexpected problems such as medical bills, a totaled vehicle, a fire, and other emergencies.
Learning about different forms of taxation and how they affect an individual's net income is important in financial literacy. Whether it's for investment, employment, inheritance, or business, every source of income is taxed differently. Knowing what to expect and preparing the paperwork leads to better economic stability and improves your own financial performance through income management.
To be financially literate, you must learn key investing concepts such as price levels, interest rates, diversification, indexes, and mitigation. Investment concepts allow individuals to make smarter financial decisions that may result in increased income flow.
Personal financial management
Personal financial management includes a combination of all the concepts mentioned above. To achieve financial security, individuals must balance the mix of all financial components to solidify and increase investments and savings while reducing debt and borrowing.
How can financial literacy benefit me?
Financial literacy has many benefits, including:
- Prevents devastating financial mistakes: When you're financially literate, you know how to identify investment opportunities that can multiply your money and the ones to avoid. You also learn to avoid bad debts or borrowing money for reasons other than investing.
- Prepares you for emergencies: When you save for rainy days, you're prepared to handle financial emergencies, which helps prevent unnecessary debts.
- Invokes confidence in yourself: Financial literacy equips you with skills that build your confidence in money matters. You can invest or make life-changing decisions without worrying about being surprised or negatively affected by unforeseen outcomes.
- Helps you reach your goals: By understanding how budgeting and saving work, you can create plans and set realistic goals. You may not be able to achieve everything instantly, but you can prepare using strategies that will help you achieve your future financial goals.
- Enhances financial growth: With proper finance management, discipline, and smart decisions, you can get out of debt and become more financially stable. Preparing for emergencies and saving money through good budgeting both lead to financial growth and success.
What strategies help improve financial literacy skills?
If you're not financially literate yet or need to streamline your money-management skills, there are steps you can take to get a better understanding of how money works. A finance course can be helpful. However, you must learn to implement the concepts and strategies appropriately to reap the results. Here are a few strategies that can help you improve your financial literacy skills:
Start an emergency fund
Whether you have debt or not, it's crucial to have an emergency fund. You can start by setting a little money aside at intervals like weekly or monthly and grow it slowly until it's three times your monthly expenses. This will help you stay afloat when inevitable expenses hit you.
If you're in debt, get out of it
Debt slows down your financial growth. If you want to be financially stable and achieve your money goals sooner, you need to clear your debts and avoid borrowing unless it's absolutely necessary. List your debts and determine which ones will benefit you most if you pay them off, and then start paying those down first. This could be the debts with higher interest rates or the ones you owe the most money on.
Create a budget
A budget can help you use money wisely and save some in the long term. Start by tracking the amount of money you receive each month and comparing it to how much you spend. A budget will help you know how much to set aside for expenses, which minimizes overspending.
Pay yourself first
Before paying your bills, set aside money for yourself. Decide how much you want to pay yourself each month . When you make it a habit to move money into your savings account every time you get paid, you may be less likely to spend it on your everyday expenses. This practice can also help you foster a saving habit , ensuring you're prepared for large, unexpected expenses.
Pay bills promptly
Stay on top of your bills so that payments consistently arrive on time. Take advantage of automatic debits from checking accounts, bill pay apps, and payment reminders.
Get your credit report
Your credit report is a crucial piece of information that helps banks and other lenders measure your credit risk level or the likelihood that you will pay your loan or bills on time. Once every year, you can request a free credit report and review it. If you find any errors like past addresses or how your name is spelled, inform the credit bureau of the inaccuracies for amendment.
Check your credit score
You must have a bank account to get a credit score. Your credit score can help build trust and increase your chances of getting approved for a loan. This score grows based on how well you take on and repay your loans.
By now, you have a good understanding of financial literacy. Your next step is to implement these tips into your daily finance journey . If you haven't started already, use the above strategies, and we're confident you will achieve more financial success in the future.
Blueprint Income Team
We are a team of finance, insurance, and actuarial professionals working to make it easier for everyone to achieve a steady and comfortable retirement. We write about annuities (the good and the bad) and provide strategies to help Americans prepare for retirement.