Knowing how to balance your budget, how to save up for big purchases, and how to manage financial tools like credit cards or loans are all major aspects of financial literacy: a concept that describes how well you can understand and leverage smart financial strategies. Although financial literacy is incredibly important for long-term success and sound money management, many Americans aren’t financially literate enough to always make the best decisions.
Indeed, financial literacy often seems more complex or tough to grasp than it actually is. In reality, everyone can learn the basics of financial literacy and cultivate greater money management skills with time and practice. If you’re asking, “what is financial literacy?” let’s break it down so that you can start on a path to financial wellness.
What is Financial Literacy?
At its core, financial literacy is just the ability to both understand and use financial skills or tools for the betterment of your financial situation. These skills and tools can include personal financial management techniques, investing topics and strategies, budgeting tools and strategies, and much more. In a way, financial literacy is the foundation of a positive relationship with money. Although it takes a lifetime to master, financial literacy can be learned and leveraged almost immediately for short-term, positive results.
Here’s a basic example: Say that a basically financially literate person knows that their monthly budget is $2000 a month. They also know they can’t spend more than $2000 each month without taking out some kind of debt. A more financially literate person may also realize the importance of saving up for a rainy day or for big purchases in the future. So they come up with strategies to tuck away a little cash here and there. An even more financially literate person might follow something called the 80/20 budgeting rule (essentially spending 80% but saving 20% of their income every month). In this way, they will set aside $400 out of every $2000 paycheck they receive. The above example demonstrates the different levels of financial literacy and how important it is to increase your financial knowledge if you want to see long-term success with financing and budgeting.
Why is Financial Literacy Important?
In short, financial literacy is important since those who have it manage their money with more confidence and have a better chance of weathering any future economic storms. No matter how careful you are with your money, there will always be unexpected expenses in the future, whether it’s a broken car, home repairs, or an emergency medical bill. Financially literate people can handle these crises without cleaning out their bank accounts. Furthermore, financially literate individuals can also purchase expensive items wisely without taking on too much debt. Even better, they’ll benefit from better loan and credit card offers as a result of higher credit scores. Bottom line: cultivating financial literacy is essential if you want to make the most of each dollar you earn and avoid facing significant financial challenges in the future.
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Example of Financial Literacy
Let’s break down another example of financial literacy in action. Alice only has a basic level of financial literacy. She knows how credit cards and loans work but has never signed up for either. As a result, she is limited by her monthly income and does not make purchases greater than what she can afford However, Alice needs to purchase a car so she can commute to work at her new job, which will also pay her more money if she can make it each day. To pay for the car, Alice takes out a car loan after doing a lot of research and improving her financial literacy. She understands what she needs to be approved for a car loan, as well as what a car loan means for her budget and how to keep the interest rate for the resulting loan in mind. By taking her financial literacy lessons to heart, Alice can pay down the car loan on time without accruing a lot of interest. As a result, she can pay for the car, and her credit score rises. In these ways, Alice’s financial literacy directly allowed her to take out a good loan, buy a car, and boost her credit score all at the same time. This situation is repeated every day across America by financially literate individuals who use their knowledge to take intelligent, efficient steps toward their financial goals.
4 Ways to Become Financially Literate
You, too, can become financially literate, even if you don’t have a lot of financing know-how under your belt quite yet. In fact, there are four cheap or free ways to improve your financial literacy level ASAP, including:
Get financial literacy education for free
Utilize free financial resources
Get employer financial counseling
Consult credit counselors
1. Get Financial Literacy Education for Free
These days, there are many highly regarded and well-reviewed agencies or nonprofit organizations that are more than willing to teach you about financial basics whenever it’s convenient for your schedule. These free resources can give you the basic info you need to begin your journey to greater financial literacy.
Some of the best organizations include:
The CFPB or Consumer Financial Protection Bureau, a federal agency that has a wealth of online consumer resources to help you approach financial decisions with wisdom. Jump$tart Coalition for Personal Financial Literacy, a network of national nonprofit organizations offering literacy education for K-12 students. Financial Planning Association, a membership organization that hosts guides and helpful information posted by financial planning professionals, especially for complex topics like real estate, investment, and divorce. The NFCC or National Foundation for Credit Counseling, a group of member organizations that offer credit counseling services both locally and remotely, along with free financial planning tools and calculators
2. Utilize Free Financial Resources
There are lots of free tools and resources that are already available to you if you know where to look. For instance, your credit union, bank, or even credit card issuer might be currently tracking your spending patterns on its proprietary app or website. You can use these to get an idea of your purchasing habits and start working toward better ones. Many companies or organizations, including the major credit bureau Experian, offer free credit score monitoring. These give you a quick look at your current credit score and can help you take steps to improve it over time.
3. Financial Counseling From Employers
Similarly, contact your employer and see if they offer any financial counseling courses or tools. Many employers these days offer employee financial wellness programs or financial counseling incentives. These allow you to connect with a financial professional as a workplace benefit. These professionals can help you plan and budget for major financial goals, like retirement, or help you develop strategies to save money or reduce your debt level.
4. Consult Credit Counselors
If you’re in a lot of debt, you might consider consulting credit counselors. Credit counseling agencies employ certified professionals to help you budget and pay off your debt using proven strategies. Credit counseling can be extremely important if you have multiple debts that you are trying to juggle simultaneously, which can be quite stressful.
How to Practice Financial Literacy in 6 Steps
Once you’ve learned some basic financial literacy strategies and acquired some free tools, you’ll need to consistently practice financial literacy to see real results and financial improvements. Luckily, there are six steps you can take starting today to practice good financial literacy, which will pay dividends for your financial wellness in the future.
Make a budget and start saving
Pay your bills on time
Get a credit report
Improve your credit score
Make a debt reduction plan
Start investing in your future
1. Make a Budget & Start Saving
You won’t be able to save money or make smart purchases without a budget, so make one! To do this, start tracking how much money you get every month from your job using budgeting apps, Excel sheets, or even paper notebooks. Regardless, your budget should include things like your:
Income from your job, investments, or alimony payments
Fixed expenses, such as rent or mortgage payments or loan payments
Any discretionary spending you make, such as fun shopping, eating out, and travel expenses
Any savings you put into a savings account
Once you have a budget, start by paying yourself first. It sounds counterintuitive, but paying yourself first is an effective reverse budgeting strategy. To do this, pick a savings goal (like the amount you need to afford a down payment for a home) and decide how much you can comfortably contribute toward it every month. Then, as soon as you get your paycheck, “pay yourself” that amount by putting it into a savings account. This allows you to reach your savings goals while using the rest of your pay for any other budgeted expenses.
2. Pay Your Bills on Time
No matter which bills you have, be sure to pay them promptly. There are two big reasons for this:
Pay your bills on time and you’ll avoid paying more money because of interest rates
Pay your bills on time and your credit score will gradually improve (or at the very least not go down)
Any monthly bills you have, such as utility payments, credit card payments, car payments, and so on, should be paid ASAP. For the best results, use automatic payment features or tools, which you can usually access using your online bank’s app or website. You can also sign up for payment reminders, which can be received via text, phone call, or even email message.
3. Get a Credit Report
Your credit score is a calculated assumption of your creditworthiness, which the major credit bureaus and lending institutions use to determine whether they will approve you for a credit card account, loan, or other borrowing need.
While you normally have to pay for your credit report, every consumer has access to a free credit report from all three credit bureaus, including Experian, TransUnion, and Equifax. You should access your credit report so you can know whether you need to work on improving your credit score soon. It also allows you to identify any potential discrepancies or errors that may be improperly dragging your credit score down.
4. Improve Your Credit Score
A good credit score is one of the best financial boons you can have. A high credit score lets you:
Get loans with excellent terms, such as low interest rates and no fees
Get access to higher lines of credit through loans or credit cards, which lets you make bigger purchases
Get special offers from credit card companies and lenders, such as cashback reward credit cards
Furthermore, a high credit score is necessary if you want to purchase a home, an expensive vehicle, or otherwise be approved for a lump sum of cash.
To that end, take steps to improve your credit score by:
Making on-time payments for bills or loans. This will impact the payment history for your FICO score, which is the most commonly used score by lenders
Keeping your number of open credit accounts low (i.e., don’t open up more credit card accounts for no reason)
Paying off credit card balances in full at the end of every month
5. Make a Debt-Reduction Plan
Once you’ve made a budget, you can use that budget to create a debt reduction plan. In a nutshell, a debt reduction plan involves reducing your spending and funneling that extra money toward more and more debt repayment.
By paying down your debts as quickly as possible, your credit score will rebound more quickly, and you’ll free up more income for yourself in the long run/overall than you would if you just made minimum monthly payments or credit card and other debts. Your debt reduction plan should account for the unique debts you have. For example, if you have one credit card with a high interest rate, you should pay down that credit card’s balance in full as soon as possible, then move to the loan or debt with the next highest interest rate, and so on. You can also use other debt repayment tools or strategies, such as debt consolidation loans, or try to renegotiate payment with a lender or credit card company.
6. Start Investing in Your Future
The last major part of financial literacy doesn’t look backward or toward present debts, but instead looks toward the future. You should start investing in your future ASAP, especially by using common savings accounts and strategies like:
An employer-matched 401(k) retirement savings account. Contribute as much as you can to your 401(k) account to get as much money as possible when you retire. Open an individual retirement account or IRA if you are self-employed. Save money besides these means by tucking away some cash in a separate savings account. You can use this in the event of a medical emergency or another “rainy day” situation. No matter what, saving smartly and consistently will do wonders for your financial health as you get older and as you encounter unexpected costs. Most Americans don’t have even $1000 in their savings account to cover unexpected emergencies. Financial literacy can help you avoid getting into this precipitous situation.
In the end, financial literacy is a vital skill set for everyone to develop. But it’s especially important for individuals who have limited budgets and need to make every dollar count as much as possible. Asking “What is financial literacy?” is a great first step and, fortunately, the above strategies will go a long way toward boosting your financial literacy and helping you apply that knowledge practically to see immediate and long-term benefits alike.
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