Financial literacy is the possession of skills that enable people to make smart decisions with their money. While it’s good to understand the statistics and facts about money, no one has truly understood financial literacy until they can consistently do the right things with money that lead to the right financial results. .
When you have these skills, you are able to understand the main financial problems that most people face: emergencies, debts, investments and much more.
People with financial literacy know their way around a budget, know how to use sinking funds, and know the difference between a 401(k) plan and a 529 plan. Here are some of the concepts that consumers with financial knowledge master:
Most Americans live paycheck to paycheck, and that’s largely because of the discrepancy between what the math says they can afford and what they actually spend. Financial literacy can turn people into habitual budgeters who are willing to save for their goals and delay gratification for peace of mind now and in the future.
Only 44% of Americans would be able to cover a $1,000 emergency today. About 40% would not be able to cover a $400 emergency. People who become financially literate understand the wisdom of saving for the times when life unfolds.
In addition to mortgages, which amount to nearly $9 trillion in debt nationwide, Americans are burdened with car loans, credit cards and student loans. The Federal Reserve Bank of New York reported in 2018 that total consumer debt in America had reached $3.95 trillion.
To see how this indebtedness affects daily life, consider the fact that Northwestern Mutual reported that 40% of Americans spend up to half of their monthly income paying off debt. A big part of financial literacy is understanding how the time and money people spend paying down their debts hurts their ability to invest in their future.
While there is no sure way to measure how financially literate people are, the lack of certain skills would confirm this assumption. For example, if you were to use the number of people who don’t live paycheck to paycheck as an estimate of financial literacy, only about 20% of people would qualify.
Do you have financial knowledge?
To help you decide if you should include yourself as a financially literate person, consider the following questions:
- Do you know how to create a monthly budget that includes all of your basic expenses, bills, any debts, and sinking funds for future purchases?
- Are you currently debt free or taking active steps to reduce your debt?
- Do you know how much you spend to cover your living expenses over a period of three to six months?
- Do you have an emergency fund in place that would get you through a sudden and unexpected life event without borrowing money?
- Do you understand how compound interest allows the money invested to grow over time?
- Do you know the different insurances needed to protect your finances and investments?
- Do you understand the difference between an investment and an insurance?
I hope you were able to answer “yes” to all of the evaluation questions, or at least to some of them. But in case you find yourself answering “no” to some, don’t be discouraged. You can follow some steps to better understand how money works:
1. Start a beginner’s emergency fund
Start by saving $1,000. This is to save you from being disoriented when these inevitable and difficult financial events hit you. Don’t worry if that doesn’t sound like a lot of money. You will increase this emergency fund very soon.
2. Pay off your debts
To get rid of your debts, start by listing them from smallest to largest. Then use the debt snowball method to pay them back. As you pay off the smaller debt, transfer what you used to pay to the next larger debt. Repeat this process until all of your debt, except your mortgage, is gone.
3. Finish your emergency fund
To complete this step, move all the money you freed up while paying off debt toward growing your emergency fund to three to six months of spending.
4. Invest 15% of your income for retirement
It’s never too late to plan for retirement. Eighty-seven percent of students who take a finance course agree that they feel confident about investing. You can look to the future with hope when you have a plan that includes smart retirement investments.
Use good growth stock mutual funds in a tax-efficient retirement savings plan like a 401(k) or a Roth IRA. Investing 15% can help you fight inflation in the long run, while still having enough income to pay for your home.
5. Save for college
More than half (51%) of students learning finance in high school plan to pay for their education themselves. Two of the best methods are education savings accounts (ESA) and 529 plans.
6. Pay off your mortgage sooner
This monthly housing payment is one of the biggest expenses for most people. Imagine owning your home free and clear!
7. Create Wealth and Give Generously
The goal of financial literacy is not just head knowledge. The real purpose is to be able to use your money to do the things you want to do, such as retiring with dignity, spending time with your family, and giving to worthy causes.
By now, you might have a pretty good idea of where you stand in terms of financial literacy. You may have a lot to learn, but I hope it’s encouraging to know how increasing financial literacy could transform you, your community, and perhaps the entire nation!