Financial literacy is a cognitive perception of economic or financial and skillscomponents such as investing, budgeting, borrowing, personal financial management, and taxation. While being financially illiterate means ignorance of these skills. Understanding whether people can successfully navigate the complexity of daily financial decisions is crucial, given the rapid changes and ongoing advancements in the financial industry and the larger economy. Let us discuss below the tried and true concepts of financial literacy.
How can one be financially literate?
To give individuals the resources for improved financial decision-making, one must first determine what people already know and what they still need to learn. Then one must estimate the gap between those two knowledge sets. The majority of financial decision-making is based on a few basic ideas. These ideas are general and apply to all situations and economic climates. For example, the ability to calculate interest rates and comprehend how interest compounded are three concepts, along with a comprehension of inflation and risk diversification.
(1) Numeracy in terms of being able to calculate interest rates and comprehend how interest compounded; (2) Awareness of Inflation; and (3) Knowledge of Risk Diversification. It is challenging to translate these ideas into quantitative measures of financial literacy. Still, Lusardi and Mitchell (2008, 2011b, 2011c) have developed a series of standardized questions based on these ideas and used them in various surveys in the USA and other countries.
On the report of the Financial Industry Regulatory Authority (FINRA), The American population has about 66% of people are financially illiterate.
The Foundations of Financial Literacy
Several financial concepts and abilities make up financial literacy, enabling someone to learn about efficient money management and debt management.
The core concepts of financial literacy should be learned and are listed below.
- Budgeting- The four primary uses of money in budgeting—spending, investing, saving, and giving—determine the size of the budget.
People can better utilize their income and achieve financial stability and prosperity by striking the correct balance among the primary uses of money.
Generally speaking, a budget should be created in a way that pays off all current debt while setting away money for savings and wise investments.
- Investing- To be financially literate, an individual must learn the critical element of investing. For example, one must learn interest rates, price levels, diversification, indexes, and risk mitigation to guarantee beneficial investments.
Individuals can make clever decisions by learning these key elements, which might increase income inflow.
In most situations, almost every one of us needs to borrow money at some point in our life. Understanding interest rates, compound interest, the time value of money, payment terms, and loan structures is essential to ensuring that borrowing is done efficiently.
Financial literacy requires understanding the many types of taxation and how they affect an individual’s net income. Every source of income is taxed differently, whether it comes from a job, investments, rental income, inheritance, or an unplanned windfall.
- Management of personal finances
The most fundamental criterion of these key components is personal financial management—an overall mix of all the elements mentioned above.
Having financial security is to solidify and increase your savings and investments while cutting off your borrowing and debts.
Attaining a complete knowledge of these elements ensures increased financial literacy.
After a better understanding, Financial literacy enables one to better prepare for particular financial obstacles, which, in turn, lowers the likelihood of experiencing personal financial difficulty.
Today’s society places a premium on financial literacy because of commonplace issues like student loans, mortgages, credit cards, investments, and health insurance.