What Is Financial Literacy?

Financial literacy is the understanding of financial concepts that lead to informed money decisions. These concepts include saving, investing, and budgeting for short- and long-term goals.

Being financially literate can take various forms. It can involve saving up for retirement, investing in your child's college fund, staying on top of your credit card bills, or planning to buy a house.

Financial literacy not only helps people manage their money better, but keeps them prepared for the unexpected ups and downs of life.

Americans have room to improve financial literacy. The National Financial Educators Council' s 2021 National Financial Literacy Test measured the earning, investing, and saving abilities of over 70,000 participants from 50 states. The average American score was only 67.5%.

Increasing financial literacy often begins with free resources: books, magazines, blogs, and newsletters. For one-on-one guidance, meeting with a financial coach could help.

Why Is Financial Literacy Low?

Financial management has become complicated and harder to grasp over the decades, leaving the general public confused and unprepared.

Lack of financial knowledge is an equalizer across the income classes. Financial illiteracy exists among the educated and the wealthy, too. Those with wealth to manage often rely on financial advisors.

Financial advisors focus more on investment strategies, whereas financial coaches help set basic financial goals and keep their clients on track.

Fewer Educational Resources

According to a report by the National Financial Educators Council, teaching personal finance in school and college would benefit 100% of the students, while only 19% need high-school algebra in their daily lives.

Yet, personal finance is not a part of general education, which results in more students growing up to be financially ignorant adults.

There is a racial gap in financial literacy. Indigenous American, Black, and Hispanic groups have a far lower rate of financial knowledge than white and Asian demographics. Members of minority groups often get denied access to sources of financial skills. This lack of access comes in addition to trying to overcome historical injustices that make stable finances an uphill battle.

More Financial Products

From credit cards to stocks and bonds to cryptocurrency, newer financial instruments keep entering the market and leaving a large percentage of the population confused and susceptible to fraud and fatal financial errors.

While some financial products contribute to quality of life, others add confusion. The complexity of essential products like mortgages, taxes, and retirement funds also make the average consumer feel stressed and lost.

Complex Retirement Planning

In past decades, retirement funds were entirely taken care of by the employer or by the government in the form of pensions and Social Security benefits. Today, consumers are expected to know all about complex retirement savings vehicles, asset allocation, diversification, and more.

People are tasked with creating a retirement plan of their own, on their own. According to a CNBC report, 63% of Americans are clueless about 401(k) plans, the most common employer-sponsored retirement fund in the country.

Key Concepts for Managing Your Finances

The following are some of the basic, core elements for boosting financial literacy. For an in-depth understanding of these concepts, check out the resources linked later in this guide.

Credit

The difference between a debit and a credit card can be confusing. When you use a debit card to make a payment, the payment amount is drawn directly from your checking account. But when you use a credit card, the funds are charged to your line of credit and it requires you to pay the bill at a later date.

Applying for a credit card is more complicated than getting a debit card from your bank.

When you apply for a credit card, the issuer will consider your annual income and your history of making timely payments. This determines if you are eligible for the card. If you are applying for credit for the first time, a popular option is a secured credit card, which requires you to put a deposit down to open the account.

The higher your debt, the lower your credit score and creditworthiness. Low creditworthiness negatively affects not only your future financial decisions, but other aspects of life, such as employment and property purchase.

People rely on credit cards for even the most basic expenses because of the extra time credit cards allow to make payments. Relying on credit cards contributes to significant debt. Nearly half of the adult American population today have credit card debt, with some people owing more than $10,000.

Interest

If you have credit — or you owe money in any form — higher interest rates make your debt higher. Interest exists outside of credit. Whether you are getting a mortgage or taking out a student loan, the amount you owe will accrue interest over time. This interest means you pay significantly more than the original amount you borrowed.

However, high interest rates are a good thing when it comes to savings accounts. If you are saving your money, higher interest rates make your money grow faster.

Investing

Your savings offer you security, but smart investments have the potential for growth over time. The most important difference between saving and investing is that saving has lower return and zero risk, while investing promises high returns — at a greater risk of loss.

For beginners, a high-yield savings account or a certificate of deposit could be the first step toward investment, because there is virtually no risk of losing money. A retirement fund is considered a type of investment since it grows your money. Income, age, risk tolerance, and financial goals together determine the best investment option for you.

Budgeting

The fundamental element of financial literacy is budgeting. Budgeting involves taking money you might make over a certain period and making a plan to spend it on needs, wants, and debt payment.

Making a budget involves allocating money for basic expenses, bill payments, savings, investments, emergency needs, and discretionary expenses. While there is no right or wrong way for budgeting, keeping track of how much money you have coming in and how much you have going out is a good start. If there are more expenses than income, then you need a tighter budget.

Budgeting beginners can use personal finance software, finance management tools provided by banks and credit card companies, and budgeting apps that guide them through the process.

When making a budget, ask yourself if you are aware of your monthly expenses, if you have an emergency fund, or what your financial goals are for the next six months.

How You Can Become More Financially Literate

Money can often seem too complex and daunting, but by taking small steps and choosing the right resources, anyone can boost their financial literacy. To start, log into your bank account and check if there is a bank-provided tracker for your spending habits.

You may also check with your employer to see if you get free financial counseling as part of your benefits. Many agencies and nonprofit organizations offer free resources for consumers, which can grow your financial literacy at your own pace. Some popular organizations include:

• Consumer Financial Protection Bureau: This is a federal agency that provides free guides and resources covering major financial topics, such as getting a loan or saving up for a college fund.
• Federal Reserve Education: The Federal Reserve offers free financial resources for K-12 students and adults, to encourage learners to take personal financial responsibility and teach them the importance of financial literacy.
• National Foundation for Credit Counseling (NFCC): One of the largest and oldest financial counseling organizations, the NFCC has member agencies and certified counselors that offer coaching for individuals and small businesses, provide help with retirement planning, and guide people toward a healthy financial life. Free resources include financial planning calculators, military veteran programs, and debt management options.
• Jump$tart Coalition: The Jump$tart Coalition for Personal Financial Literacy is a nonprofit organization that consists of over 100 national organizations committed to youth financial literacy. On its website, there are free financial education resources for parents, students, and everyone in between.

What Does Financial Literacy Mean in Accounting?

For a career in accounting, students and professionals must possess in-depth knowledge of financial concepts far more complex than those in basic financial literacy. Some of the most common accounting concepts include bookkeeping, money measurement, business entity, accounting period, generally accepted accounting principles (GAAP), appreciation and depreciation, and accruals.

Advanced programs and certifications such as certified financial planner or chartered accountant require extensive study of more sophisticated concepts like estate planning, investments, and professional conduct and regulations.

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