What Is Financial Literacy?
Financial literacy is the ability to understand and make use of a variety of financial skills, including personal financial management, budgeting, and investing. It also means comprehending certain financial principles and concepts, such as the time value of money, compound interest, managing debt, and financial planning.
Achieving financial literacy can help individuals avoid making poor financial decisions and help them become self-sufficient and achieve financial stability. Key steps to attaining financial literacy include learning how to create a budget, track spending, pay off debt, and plan for retirement. Educating yourself on these topics also involves learning how money works, setting and achieving financial goals, becoming aware of unethical/discriminatory financial practices, and managing financial challenges that life throws your way.
The Importance of Financial Literacy
Trends in the United States indicate that Americans’ financial literacy is declining. In its National Financial Capability Study, conducted every few years, the Financial Industry Regulatory Authority (FINRA) poses a five-question test that measures consumers’ knowledge about interest, compounding, inflation, diversification, and bond prices. In the latest study, only 34% of those who took the test answered at least four out of five questions correctly.1
Yet making informed financial decisions is more important than ever. Take retirement planning: Many workers once relied on pension plans to fund their retirement lives, with the financial burden and decision-making for pension funds borne by the companies or governments that sponsored them. Today, few workers get pensions; some are instead offered the option of participating in a 401(k) plan, which involves decisions that employees themselves have to make about contribution levels and investment choices. Those without employer options need to actively seek out and open individual retirement accounts (IRAs) and other tax-advantaged retirement accounts.
Add to this people’s increasing life spans (leading to longer retirements), Social Security benefits that barely provide enough for basic survival, complicated health and other insurance options, more complex savings and investment instruments to select from—and a plethora of choices from banks, credit unions, brokerage firms, credit card companies, and more. It’s clear that financial literacy is a must for making thoughtful and informed decisions, avoiding unnecessary levels of debt, helping family members through these complex decisions, and having adequate income in retirement.