What is Financial Literacy? Why is it Important?

Updated on: 2022-12-02 - 2 mins read

Financial literacy is understanding and using money concepts and skills well in everyday life. Everyone should know how to budget, invest, handle credit, and manage money. Financial literacy is your knowledge and skills about budgeting, investing, borrowing, paying taxes, and managing your own money. Being financially illiterate means not having any of these skills.

The Financial Industry Regulatory Authority (FINRA) says that about 66% of the population doesn't know much about money. If a person knows about money, they can be better prepared for some financial issues. It makes it less likely that they will be in financial trouble.

Knowing how to handle money is essential for student loans, mortgages, credit cards, investments, and health insurance.

Fundamental Components of Financial Literacy

Financial literacy is a set of skills and knowledge about money that help a person learn how to handle money and debt well.

Here are some of the most important things you should know about money.

1. Budgeting

When making a budget, there are four main ways to spend money: spending, investing, saving, and giving. Getting the right balance between the primary uses of cash lets people better spend their money, which leads to financial security and success.

A budget should be made to pay off all debts while still having money left for savings and suitable investments.

2. Putting money

To be financially literate, a person needs to learn about the most important parts of investing. Interest rates, price levels, diversification, reducing risk, and indexes are some things you should know about to ensure your investments go well.

When people know about essential parts of investments, they can make better financial decisions that could lead to more money coming in.

3. Getting loans

Most of the time, almost everyone needs to borrow money at least once. To borrow money well, you need to know about interest rates, compound interest, the value of money over time, payment periods, and the loan's structure.

A person's financial knowledge will increase if the above criteria are well understood. It will help them make better borrowing decisions and reduce long-term financial stress.

4. Taxation

For financial literacy, it is essential to learn about taxation and how it affects a person's net income. Each source of income is taxed differently, whether it comes from a job, an investment, a rental, an inheritance, or something else.

By knowing the different income tax rates, the economy can stay stable and financial performance can improve through better income management.

5. Personal Financial Management

Personal financial management, the most critical factor, comprises all the other elements listed above.

To ensure you have financial security, you must find a good balance between the different types of money mentioned above. For example, you can increase your investments and savings while decreasing borrowing and debt.

A person's level of financial literacy is sure to go up if they know a lot about the things we've discussed above.

How important it is to know about money

One of the most important things a person can do to ensure long-term financial stability is to learn about money.

Here are some real-world examples that should show how important it is to learn about money.

  • About 78% of Americans are said to live from paycheck to paycheck.
  • More than 189 million people in the United States have a credit card.
  • On average, each person with a credit card has four cards.
  • More than 44 million people owe about $1.5 trillion in student loans.
  • At $1.04 trillion, the amount of credit card debt is at an all-time high.
  • In total, the United States owes about $12.58 trillion.
  • The above numbers should clarify why financial literacy is crucial in today's economy.

Benefits of Knowing About Money

Being financially literate is a skill with several benefits that can help people live better lives by making them more economically stable.

Here are some of the many benefits of knowing how to handle money:

  • Ability to make better decisions about money.
  • Taking care of money and debts well.
  • More likely to reach their financial goals.
  • Through better regulation, one can cut costs.
  • Less worry and stress about money.
  • Increase moral decisions when choosing insurance, loans, investments, and how to use a credit card.
  • Putting together a structured budget.
  • Taking steps to learn about money is an integral part of life that can help you stay financially stable, reduce stress, and help you reach your financial goals.

What is an example of knowing how to handle money?

Taking care of day-to-day costs is an example of being financially literate. Think about a person who makes $3,000 each month. If they planned their money well, they would spend at most $3,000. It would keep them from going into debt.

In conclusion, any improvement in how people understand money will significantly affect their ability to plan for the future. Recent trends make it even more critical for people to know the basics of money since they now have to make more investment decisions for their retirement accounts and figure out how to use more complicated financial products and services. It's not easy to learn about money, but when you do, it can make your life a lot easier.