Financial Literacy Definition, Importance and Key Principles

Financial literacy is the ability to comprehend and apply basic economic principles, such as personal finance management, investing, and budgeting. Financial literacy is essential for making wise financial decisions, achieving financial goals, and preparing for retirement. A person with solid financial literacy understands financial concepts such as debt management, compound interest, interest rates, and financial planning.

Consider these five essential pillars of financial literacy:

The first step in achieving financial literacy is knowing how much money you make. If you receive a regular paycheck, this step is straightforward. Your paycheck should note your gross net income and relevant deductions, like employer-sponsored health insurance and retirement savings.

Contractors, freelancers, and entrepreneurs should learn how to calculate their net and gross income based on historical earnings.

Although spending money is often the key motivator for making it, saving is vital to your long-term financial well-being. You should open a savings account to set up an emergency fund, save for retirement, and pay off personal debt (like student loans or credit card debt).

Think of saving as “paying yourself first.” It might not feel great now, but you’ll thank yourself later.

Those with good financial sense budget their money toward reaching their financial goals. It’s wise to create a personal budget that helps you keep track of where and how much you spend.

Even the most financially secure people have to borrow money to make big purchases, such as a new home or car. Lenders often require borrowers to have a credit history. College students often rely on financial aid or student loans, which is why young people must understand the ins and outs of loan repayment.

Good money management involves knowing how to compare loans, analyze a credit report, maintain a healthy credit score, and make loan payments on time.

Protecting your income involves regularly reviewing your bank accounts and financial statements to check for errors, discrepancies, or fraud. Most financial institutions offer protection services, but it’s wise to know how to review your financial activity and history yourself. You should also keep your financial information secure, especially account numbers and passwords.

Financial literacy is crucial for making informed financial decisions, avoiding unnecessary debt, and planning retirement. The global economic landscape is constantly fluctuating, necessitating the need for financial knowledge and skills.

For example, an increasing number of employers are transitioning from offering pension benefits to 401(k) retirement plans, which require financial decision-making on the part of the employee. Employees need financial education to understand social security benefits and retirement savings.

A financially literate person prioritizes their savings, limits unnecessary spending, lives within their means, and prepares for the future. For example, you are financially literate if you:

• Maintain a steady flow of income into your checking and savings accounts
• Manage a monthly spending budget
• Rely on cash more than credit
• Pay all your credit card debt on time
• Regularly contribute to a retirement account.

Here are five steps you can take toward financial literacy:

1. 1. Budget your finances. Budgeting your finances is the first step to reaching your short-term and long-term financial goals. If you don’t know where to start, consider downloading a budgeting app or researching budget strategies.
2. 2. Open a bank account. Opening a savings and checking account at a bank or credit union will enable you to use a debit card, which makes it easier to manage your spending. You can also apply for a credit card and start building a credit history.
3. 3. Understand how credit scores work. Lenders use your credit score to assess the amount of risk associated with lending you money. Credit scores range from 300–850. Making mortgage payments and paying off your credit card debt on time is essential to maintaining a healthy credit score.
4. 4. Research investment strategies. Before investing in the stock market, you should first invest in your retirement and savings accounts. Learn more about the stock market and cryptocurrency.
5. 5. Plan for emergencies. Preparing for emergencies is one of the most critical functions of a savings account. You need a cushion should you lose your job, experience a natural disaster, or become sick or injured. It’s wise to start a savings account as a young adult before you incur many “real world” responsibilities. However, it’s never too late to start, and no amount is too small.

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