Financial literacy – what is it and why does it matter?
Tools And Guides  blog tag

Financial literacy – what is it and why does it matter?

Over fifteen years ago Congress designated April as Financial Literacy Month in an effort to improve Americans’ financial and economic knowledge. The campaign is designed to highlight the importance of financial literacy and teach people of all ages how to manage their money wisely, though most programs that run during this month are geared towards young adults.

Financial literacy is the knowledge to manage your money well.

Financial literacy comprises, at the most basic level, understanding the basics of budgeting, how to borrow and save money responsibly, and why and how to plan and invest for the future. If you’re thinking, I’ve got this, try testing yourself with these questions:

  1. Suppose you have $100 in a savings accounts earning 2 percent interest a year. After five years, how much would you have?
    a.) More than $102  b.) Exactly $102  c.) Less than $102  d.) Not sure

  2. Imagine that the interest rate on your savings account is 1 percent a year and inflation is 2 percent a year. After one year, would the money in the account buy more than it does today, exactly the same or less than today?
    a.) More  b.) Less  c.) Same  d.) Don't know

  3. If interest rates rise, what will typically happen to bond prices?
    a.) Rise  b.) Fall  c.) Stay the same  d.) No relationship  e.) Don't know

  4. True or False: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest over the life of the loan will be less.
    a.) True   b.) False

  5. Suppose you owe $1,000 on a loan and the interest rate you are charged is 20 percent per year compounded annually. If you didn't pay anything off, at this interest rate, how many years would it take for the amount you owe to double?
    a.) Less than 2 years b.) 2 to 4 years c.) 5 to 9 years d.) 10 or more years.

Answers: 1.) A; 2.) B; 3.) B; 4.) True; 5.) B

If you found that tough, you’re not alone. The FINRA Investor Education Foundation has used these questions to test American’s financial literacy since 2009, and when they last conducted their survey 61 percent of respondents were unable to answer more than three of the five questions correctly.

Although money plays an integral part of people’s lives, managing money is a skill that not everyone learns. In fact, despite the growing responsibility of individuals to secure their own financial well-being, fewer and fewer are required to learn about money.

Source: Council for Economic Education

According to the Council for Economic Education, only 17 states now require students to take a personal finance class, and not one state has added personal finance to their teaching standards in the past two years. This is in spite of research that shows financial education earlier in life correlates with better financial decisions later.

Source: Bosshardt, William, and William B. Walstad. 2017. "Some Lasting Effects of Undergraduate Economics on Retirement Planning." American Economic Review, 107(5); Bosshardt, William and William B. Walstad. 2017. “Does Studying Economics Influence Loan Decisions In Later Life?” Paper prepared for presentation at the Developments in Economics Education annual conference, London, UK, September 7, 2017; de Bassa Scheresberg, Carlo. 2013. “Financial Literacy and Financial Behavior among Young Adults: Evidence and Implications.” Numeracy 6(2) Article 5; Lusardi, Annamaria and Carlo de Bassa Scheresberg. 2013. “Financial Literacy and High-Cost Borrowing in the United States.” National Bureau of Economic Research Working Paper 18969.

Personal financial decisions, such as making investments, buying a car, saving money, borrowing money, buying a house, and even choosing a career, can be daunting because they can have a long-term impact on our lives and also our ability to reach our most important goals. For most people, financial literacy is not a natural skill, it’s something that must be learned.

The core concepts of financial literacy

To be financially literate, you need to understand the following

  • Earning

  • Saving

  • Investing

  • Spending

  • Borrowing

  • Protecting

Earning refers to income, which can come from a job, investment returns, or other such sources. At first glance, earning is a pretty simple concept since most of know how much we get in each paycheck. But do you know your federal and state tax rates? Do you know what’s deducted from your gross income? Being clear on these things is just as important to understanding the cash that goes into your pocket. It’s also important to understand the longevity and potential growth of your earnings, which can help you plan for your future.

Saving is another well-known notion. But if you’re like most Americans, you put more effort into thinking about what you should be saving than actually saving. According to GoBankingRates, 58 percent of Americans have less than $1,000 in savings. Part of saving is the act of doing it and part of it is understanding how compound interest benefits you.  

Spending could be the most important concept of financial literacy because it reflects your personal values and lifestyle. Differentiating between needs and wants is the most crucial aspect of controlling spending. Budgeting is a powerful way to drill into this. An accurate monthly budget is a tool that can help you reach your financial goals.

Investing has become more and more important as the number of Americans responsible for their retirement has grown, but it can feel complicated and overwhelming. Investing has many layers and can get quite complex, but there are many tools and platforms now available that make it easy for anyone to invest. Still there are some areas you should be on top of to make the most of your investments; they are risk and diversification; fees; and performance.

Borrowing is an area that financial literacy has a strong impact on. Research has shown that people with lower financial literacy are more likely to do things that result in higher fees and charges like going over their credit limit or only making the minimum payment. There is a lot that goes into borrowing smart, so much so that we’ll be dedicating an entire post to it next week.

Protecting yourself and assets are just as important as anything else in personal finance. Protection includes emergency savings, insurance, and identity theft prevention. Most experts agree, your emergency fund should have enough money to cover three to six months’ worth of living expenses. There is insurance to cover all types of outcomes; to understand what you need, it’s best to speak with a professional.

Why we care about financial literacy

Figure has two primary goals: create innovative financial solutions for homeowners and provide financial tools and information that everyone can use to make smarter financial decisions.

We know better financial decisions come from better education, and we want to empower you to make the best financial decisions you can. That’s why we’re promoting Financial Literacy Month and are regularly providing content designed to help you appreciate your wealth.

Find my rate  Opens in a new window.

Related articles

  • Guest PostHELOC Debt Consolidation Tips and Tricks - Lauren Cobello

    Lauren Cobello, Budget Coach  article author

  • Home EquityWhy a HELOC Makes Financial Sense

    Figure Technologies  article author

  • Home EquityWhat is a HELOC?

    Figure Technologies  article author

Join our newsletter

See the latest trends and get insights to further your finances.