What Is Financial Literacy? A Beginner's Guide

Financial literacy is a skill that enables a person to make informed decisions about personal finances, including credit, investing, and retirement planning. It lets an individual save for a rainy day, invest in pre-tax retirement accounts, or even save money for a new car.

Financial literacy can help consumers identify and avoid common scams and fraudulent schemes.

According to the Global Financial Literacy Excellence Center (GFLEC), only a third of the global population is financially educated.

Fortunately, it’s never too late to start improving your financial knowledge. This guide teaches the fundamentals of financial literacy, such as building a budget, understanding credit, and managing debt.

What is financial literacy and why is it important to learn?

Financial literacy is the ability to read, understand, and use financial information to make educated decisions about your personal finances. It’s more than just eyeing your checking account and vaguely knowing what a credit union is.

Learning about money and how to manage it can allow you to plan ahead and avoid debt. Investing in your future is essential to personal finance and financial literacy.

Without basic knowledge about debt and money management, it is possible to earn $100,000 or more a year and still struggle. According to CNBC, 36% of high-earners in this category were living paycheck to paycheck in 2022. By understanding the basics of budgeting, saving, investing, and credit, you potentially make wiser choices with your money.

Here are some other benefits of financial literacy.

Stay out of debt

Personal finance knowledge can help you avoid costly mistakes that lead to debt and poor financial health. In the United States alone, the number of American household debt is staggering, amounting to more than $15 trillion in 2021.

This total includes credit cards, mortgage payments, and student loans. If you know how to manage your money effectively, you are less likely to fall into the trap of credit card debt or other high-interest loans.

Save money

Those who are financially literate are more likely to be good at saving money. If you understand how to budget and invest your money wisely, you can reach your financial goals quicker than those who don’t know about personal finance.

Make informed decisions

When it comes to financial decision-making, knowledge is power. The more you know about personal finance, the better equipped you will be to make sound choices about your money.

From investing in stocks and mutual funds to buying insurance or taking out a loan, being financially literate will help you make intelligent decisions. Ultimately, financial literacy helps you live a fulfilling life and achieve financial security and peace of mind.

What are the basics of financial literacy?

Financial literacy aims to make wise financial decisions and save money to repay debts. Everyone should understand a few critical financial concepts and terms, including the time value of money, budgeting, saving, investing, and credit.

Learning about these topics can help you make better decisions with your money and reach your financial goals.

Time value of money

The time value of money is an essential concept in personal finance. Business Insider describes the TVM as the notion that money received today is worth more than money received tomorrow, due to the possibility for profit in the interim.

It is also a fundamental concept for investment decisions. By investing your money, you potentially receive a higher return in the future.

The concept of the time value of money is essential in investing, saving, and business. It determines how much money an individual should invest, when to spend it, and how to mix investment portfolios.

In a literal sense, the time value of money means that $5 today is worth more than a dollar tomorrow. This is because the value of time increases as time goes by.

Budgeting

Budgeting is one of the most critical aspects of financial literacy. It involves creating a plan for spending your money each month. This includes setting aside money for rent payments, food costs, and other necessary expenses, as well as savings and debt repayment.

Budgets are an excellent way to track your spending, save money, and plan for long and short-term financial goals. They also hold you accountable for your money, which makes it easier to make wise financial decisions and develop good financial habits.

Whether you use a spreadsheet or a financial app, staying organized allows you to see where your money comes from and goes in one place.

With a budget, you’ll be able to analyze how much money you earn each month and how much you spend it. This will help you ensure you can cover your monthly expenses and save for the future.

While most people think of budgets as a form of restriction, budgeting is a crucial component of financial literacy and provides a road map to achieve financial well-being.

Creating a budget requires awareness of your finances, keeping records of your income and expenses, and managing every penny.

If you’re spending more money than you earn, you might be forcing yourself into debt. In that case, rethink your budget and cut significant expenses, such as restaurant takeout or subscriptions you rarely use.

Saving

Whether for retirement or an emergency, saving is a critical component of financial literacy. An emergency fund to cover unexpected expenses and life events could mean the difference between reaching your financial goals and going into debt. Ideally, this fund should cover three to six months of expenses.

Saving money in a savings account has several benefits. The main advantage of many savings accounts is that you can quickly and easily access funds whenever you need them. Plus, the power of compound interest lets your bank account funds grow passively.

Traditional savings accounts also carry little risk since the Federal Deposit Insurance Corporation (FDIC) insures them up to $250,000 per depositor.

Savings account interest rates vary depending on the type and the bank or financial institution. Among the common types of saving accounts include traditional, high-yield, and money market accounts.

To find the best savings account for you, compare interest rates and other significant details, such as the minimum deposit requirements and fees.

If you plan to use your money for a long-term goal, investing might be better. Savings account interest rates are often low, and the amount accumulated over time will decrease as inflation eats away at your money. Investing can earn higher returns, but it also carries risk.

Investing

Investing is another way to save for the future. When you invest, you are putting your money into something that has the potential to grow over time. Investing in the right types of assets is key to increasing your wealth. Place funds in diverse investment vehicles to yield the most benefit.

Take the Vanguard Group, an investment management company that manages more than seven trillion in assets.

The Vanguard Group created a range of low-cost index funds that have been proven effective in generating adequate returns. This investment strategy focuses on cost management, diversification, and patience.

Financial literacy includes learning the basics of tax-deductible investments and retirement savings accounts.

For beginners, the easiest way to invest is through an employer-sponsored 401(k) plan. It can be particularly beneficial if your employer matches your contributions. Another common retirement account type is a Roth IRA, which also offers tax advantages for contributions.

To begin investing, research and understand the fundamentals of investing. Then when you feel ready to invest, open an account with a brokerage firm and put your money into financial vehicles, ranging from bonds and mutual funds to exchange-traded funds (ETFs).

Credit

Credit is a crucial part of the financial literacy discussion. It is a form of debt that allows borrowers to pay for goods or services without immediate payment and repay them later.

The limit that credit lenders decide to extend to a borrower depends on their credit score and history.

Typical forms of credit include credit cards, mortgages, personal loans, and student loans. These types of credit typically come with specific terms and conditions to which the borrower has to agree, such as interest rates and repayment schedules.

It is essential to use credit responsibly by making sure you can afford the payments, pay off the balance before the due date, and stay within your credit limit.

When using a credit card, maintain a good credit history by keeping your credit balance low and making your monthly payments on time.

You can do this by using your credit cards for regular expenses like rent and gas, keeping track of your spending, and scheduling payments ahead of time. Certain credit cards, like Vital Card, provide personalized financial tracking tools.

If you accumulate overwhelming debt from one or more lines of credit, develop a strategy to pay off your debt, or consider getting professional help from a debt management counselor. These professionals can help you negotiate your creditors’ lower payments and interest rates.

Check your credit report to track the progress of this type of service.

A second method of managing debt is credit counseling. Find credit counselors in your area through the National Foundation for Credit Counseling. Be sure to check out reviews and understand the fees before enrolling.

How to improve your financial literacy

In this increasingly fast-paced world, financial literacy is becoming a necessity. Fortunately, there are many steps you can take to improve your financial literacy skills. Use a method that works for you, whether enrolling in a personal finance course or using a budgeting app.

Here are a few ways to build your financial education:

1. Read personal finance books or articles

A wealth of information is available on these topics, so take some time to educate yourself. Websites like NerdWallet and Investopedia offer free articles on various personal finance topics. If you prefer reading physical books, support your local bookstore or library.

2. Talk to someone who is financially literate

If you know someone good with money, pick their brain and ask for advice. Consider consulting with a professional financial planner or advisor.

3. Use online tools and resources

Many useful websites, blogs, videos, podcasts, and apps, such as Mint and You Need a Budget (YNAB), are dedicated to personal finance and budgeting. Explore these resources and more to learn about financial planning and managing money.

4. Take a class on personal finance

Enroll in a free online course on Coursera, Khan Academy, or another educational institution. Alternatively, you may also attend an in-person class at a local college. These can be a great way to learn about personal finance in a structured setting.

Key takeaways about financial literacy

While financial literacy may not be on the priority list for some, it is an essential life skill. Knowing how to manage your finances, from making a budget to understanding how to borrow money, is vital. You could be vulnerable to fraud and debt without knowledge of these topics.

Whether you’re saving for retirement or your first home, financial literacy can help you achieve your goals.

It involves various skills, including household budgeting, debt management, and evaluating the tradeoffs of different credit products. It is crucial to understand key financial concepts, including the time value of money, to master these skills.

Financial literacy has become increasingly important as credit cards and other financial products have become increasingly prevalent.

There are plenty of ways to become financially literate, including listening to personal finance podcasts, reading books, or speaking with a financial planner.

With the proper knowledge, you can make sound financial decisions that will benefit you in the long run. Ultimately, financial literacy is something everyone should strive for, regardless of their current financial situation.