Financial Literacy: Definition and Key Issues

Financial literacy is an important concept to master, but many people fall short. In a 2019 financial literacy survey by Equifax, 32% of Americans said they’d give themselves a “C” for financial knowledge. Increasing financial know-how can help you get ahead. Here’s how to develop it.

Financial literacy, also referred to as financial capability, means having the capacity, based on knowledge, skills and access, to manage your financial resources effectively. In other words, being financially literate means understanding financial concepts, such as budgeting, saving and investing, and knowing how to apply them in your daily life.

Beyond that, financial literacy also means having an understanding of basic money operations and functions. Specifically, that includes:

• How to track your spending and why that’s important.
• How to create a basic budget and pay bills.
• The different types of bank accounts and how they work.
• What compounding interest is and why it’s important.
• How credit cards and loans work.
• What it means to pay interest on borrowed money and how to calculate APR.
• How paying taxes works and how to file taxes.
• The difference between saving money and investing it.
• What credit scores are, how to calculate them and why they matter.

Being financially literate means you know how to manage your money and make good decisions with it. It doesn’t necessarily require you to be a money expert. But it assumes a willingness to learn about financial concepts or strategies that you don’t understand. That way, you can apply them to your money situation.

Financial literacy and financial education aren’t a standard part of the typical school curriculum that elementary, middle and high school students complete. According to a 2019 survey from the National Financial Educator’s Council, 81% of Americans believe that financial education is something high school students should be taught. But that’s not the norm.

So where do people learn financial literacy? For many people, their financial education begins with their parents. In the Equifax survey, 48% of those who responded said they learn what they know about money from mom and dad. Only 14% said they learned about money from a class they took in high school. The rest learned about finances from these sources:

• Online blogs and news sources.
• Significant others.
• Banks or other financial institutions.
• Friends.
• An accountant or financial advisor.

Getting advice about money from different sources can offer different perspectives, which may be helpful. But it can be a problem if that advice isn’t uniform or it’s just plain wrong. For example, the advice you get about credit scores from your best friend might not be on the same level as the advice you get from a financial advisor or professional credit counselor.

And sometimes parents may not be the best people to learn from either. If parents have made poor decisions with money in the past, such as racking up large amounts of credit card debt or failing to save anything for retirement, then they may not set the best financial example for kids to follow.

The decisions you make with money can last for years.

For example, say you’ve just graduated college and you decide to open your first credit card. Only, you’re fuzzy on the details of how credit cards work. You run up a $1,000 balance, which doesn’t seem like much. Every month, you make the $25 minimum monthly payment, only the balance never seems to change. That’s because you’re paying a 17% APR, only you don’t realize it because you didn’t read the fine print.

With interest factored in, you’re going to pay much more than $1,000if you only make the minimum payments. The worst-case scenario is that you get frustrated with trying to pay down the balance and stop paying even the minimums. Then you land in default and wreck your credit score. As a result, means your dream of eventually buying a house gets put on hold because you can’t qualify for a mortgage.

Again, that’s a worst-case situation. But it’s a good example of how seemingly small decisions about money can have major impacts on your financial life. The more you know about money and the more financially literate you are, the better off you’ll be when it comes to things like planning your budget, coming up with a plan to save and invest for retirement, paying off student loans or other debts and working toward big financial goals.

If your financial literacy isn’t where you want it to be, there are some things you can do to change it. These tips can help boost your money IQ and feel more confident about managing your finances:

• Choose the right resources to learn from. If you’re starting from square one when learning about money, educational or government websites can help you get your bearings. You can take advantage of free resources online through organizations like the Consumer Financial Protection Bureau, the National Financial Educator’s Council and MyMoney.gov when learning about basic money concepts.
• Use free online money management tools. Aside from reading about money, it helps to get hands-on with it. That’s where online tools such as free budgeting apps and financial calculators can help. You can use these tools to track your spending, set and work toward financial goals and see how making different decisions with your money could impact your progress.
• Consider taking a financial literacy class. While you may not have learned about money in school, it’s not too late to take financial education 101. Check your local community college or look online for financial education courses taught by certified instructors that cover various aspects of money management.

Financial literacy is something that everyone can use. The sooner you learn about money, the better. It’s tough to develop financial know-how when you don’t learn it in school or at home. You may learn it on your own, but be selective when seeking out and listening to advice about money.

• Consider talking to a professional financial advisor about what it means to be financially literate and what you can do to expand your financial knowledge. Finding an advisor to work with doesn’t have to be difficult. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
• An important financial literacy concept to grasp is what it means to save money versus investing it. Saving is something you typically do when you have a shorter-term goal, such as building an emergency fund or a down payment fund to buy a home. Investing means putting your money into the market so you can potentially earn higher returns. Investing is riskier than saving but both matter for achieving your money goals, including planning for a comfortable retirement.

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