It’s alarming how many people enter adulthood without knowing why financial literacy is important. Financial literacy is a crucial skill that helps individuals make informed decisions about their money and achieve their financial goals. Luckily, you have the opportunity to play a valuable role in helping your family and friends gain a better understanding of personal finance.
Here is some insight to help you accurately define what financial literacy is and how to improve financial literacy for those you care about.
What Is Financial Literacy?
Financial literacy is the ability to understand and effectively manage personal financial matters. It revolves around understanding financial concepts and developing skills that will help you set and reach financial goals. This includes having a basic understanding of financial concepts such as:
- Borrowing/Using credit
- Tracking spending
Essentially, financial literacy is anything that has to do with earning, saving, or spending — namely, making smart decisions in those areas.
Why Is Financial Literacy Important?
Having financial literacy skills can help individuals achieve their financial goals and build monetary security. Those who have this skill are more likely to avoid financial pitfalls such as high-interest debt and scams, allowing them to make the most of their financial resources. Additionally, poor financial decisions can have a negative impact on a person’s creditworthiness, making it difficult for them to do things like secure a mortgage loan.
Financial literacy is important for people of all ages and income levels. It's never too early (or too late) to start learning about personal finance and developing good money management habits. By gaining financial literacy skills, individuals can take better control of their present and secure a stable future.
How to Improve Financial Literacy
The first step to improving financial literacy is by seeking out education to better understand personal finance. It’s also important to accept that you and your loved ones will probably still make financial mistakes. The world around us and its economy is constantly changing and evolving, so personal finance is not a journey with a clear stopping point. However, using the core strategies below can help you find the starting point.
At the most basic level, budgeting helps track how much money you actually have, which is how much is left from your paycheck after paying bills, putting money into savings, and other financial obligations. This allows you to make sure bills are paid on time and adjust spending as needed.
A budget also provides valuable information that allows you to separate fixed versus discretionary spending, plan for goals like paying down debt or making a big purchase, and work on building up savings, putting money into retirement and investments, and more.
Understanding How Credit Works
When someone takes out a loan or charges something to a credit card, they’re borrowing money that has to be paid back. They typically do so over a certain period of time, paying installments until the debt (and its interest) is paid off. Their credit score measures how well they do this, and is what their future lenders will look at when determining their loan terms. A higher credit score generally indicates the borrower is a low credit risk, so they may be offered more favorable terms.
Using credit wisely helps you develop a good credit rating, which makes borrowing in the future easier. Abusing your credit by overspending, carrying a lot of debt, or failing to pay can leave you mired in debt and destroy your credit rating. It’s so important to understand credit and use it responsibly.
Tracking Spending, Paying Debts, and Saving
Some people never look at a bank statement until their accounts are overdrawn. Some are stuck in an endless cycle of debt, living paycheck to paycheck and never really paying down credit card balances. Others are totally unable to save because every penny goes to paying monthly expenses and accumulated debt and interest.
Financial literacy provides the groundwork that helps you to track your personal finances effectively, learn to pay down debt as quickly as possible (without racking up more), and start to make meaningful contributions to savings, retirement, and investment accounts.
Financial Literacy for Kids
You may be surprised to learn how early kids can understand the concept of saving for a reward. The earlier a person learns financial literacy, the better their spending habits will be as an adult. Here are a few key concepts and strategies that can help kids learn about financial literacy:
- Having an allowance gives kids the opportunity to make their own financial decisions.
- Encouraging them to save some of their money rather than spending it all can help them build a financial cushion for emergencies as an adult.
- Budgeting exercises such as giving your child $20 to spend at the store and helping them keep track of how much they have left can help them develop financial tracking skills.
- Explain the concept of credit and how it works, including the importance of paying bills on time and avoiding overspending.
- Teach about investments so they can learn the concept of growing their money over time.
- Open a bank account for them when they’re ready to start saving for more expensive things like a new gaming console, a bike, and eventually a car.
Learn More About Improving Financial Literacy
By taking the time to learn and teach others why financial literacy is important, you begin a journey toward developing good money habits. Financial literacy is an invaluable tool that helps people achieve financial stability and success.
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