More than ever, people all around the world are searching the internet for ‘financial literacy’ according to Google Trends. Chances are, you also want to know what is financial literacy and why it’s important. This isn’t very surprising, though, is it? Most people are not rich or even living comfortably so it makes sense that many people are looking for ways to get a better understanding of financial concepts in order to handle money better.
Here are a couple of statistics on how the average American manages money:
- Almost 75% are in debt and most assume they always will be
- 1 out of 5 workers live paycheck to paycheck
- More than 25% never save any money
It’s clear we have a serious financial literacy problem.
Something tells me you are well aware of this problem and you’d like to do something about it. You may be wondering what skills, traits and best practices do financially literate people have. You may also wonder how those skills affect personal finance.
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What is financial literacy?
Financial literacy is the ability to use knowledge and skills to make effective and informed money management decisions.
When you have this skill set, you’re able to understand the major financial issues most people face: emergencies, debts, investments and beyond. Financially literate people know their way around a budget, know how to use sinking funds, and know the difference between a 401(k) and a 529 plan. Here are the concepts financially literate consumers have mastered:
Budgeting
Most Americans live paycheck to paycheck, and it’s largely because of a gap between what they can really afford and what they actually spend. A financially literate person has a habit of budgeting their money and are willing to save a percent of their money in order to reach short and long-term goals. They will sacrifice immediate gratification for their future security and happiness.
Emergencies
Only 39% of Americans would be able to cover a $1,000 emergency if one happened to them today.(1) Worse, about 40% of Americans wouldn’t even be able to cover a $400 emergency.(2) But people who become financially literate learn how to build a $1,000 emergency fund—and from there, learn how to grow their emergency fund to include three to six months of expenses for those more serious unexpected situations.
Debt
In addition to mortgages, which amount to nearly $9 trillion in debt nationwide, Americans are weighed down with auto loans, credit cards and student loans. The Federal Reserve Bank of New York reported in 2018 that the total consumer debt in America had reached $3.95 trillion.(3) To see how that debt load impacts daily living, consider the fact Northwestern Mutual reported that 40% of Americans spend up to half of their monthly income in debt payments.(4) A big part of financial literacy focuses on understanding how the time and money people spend on paying off debt hurts their ability to invest in their future.
How many people are financially literate?
Based on the stats that we’ve already considered, it’s fair to guess that the majority of people don’t know how to handle their money. And while there’s no one sure way to measure how many people are financially literate, the lack of certain skills would confirm that guess.
For example, if you used the number of people who don’t live paycheck to paycheck as an estimate of financial literacy, only about 20% of people would qualify!
Budgeting could be another skill for measuring financial literacy. And how do Americans stack up in that department? Sadly, not even a third of people earning a paycheck (32%) stick to a budget.(5)
Let’s look at the findings of the National Financial Capability Test given to over 17,000 people from all 50 states. The National Financial Educators Council (NFEC) reports that less than half (48%) of participants were able to pass the 30-question test that covered things like budgeting, paying bills, setting financial goals, and other personal-finance related topics.(6)
Fewer than half are passing a basic exam on financial literacy—and the average test taker only answered 63% of the questions correctly!
Are you financially literate?
To help you decide whether you should include yourself among the financially literate, think through the following questions and give yourself some honest answers.
- Do you know how to create a monthly budget that includes all of your basic expenses, your bills, any debts, and your sinking funds for future purchases?
- Do you know about how much money you spend to cover living expenses over a period of three to six months?
- Do you have an emergency fund in place that would allow you to get through a sudden large life event like a layoff or a totaled vehicle without having to borrow money?
- Do you have an understanding of how compound interest allows invested money to grow over time?
- Do you know the various kinds of insurance that are needed to protect your finances and investments?
What action steps can you take right now to become financially literate?
Hopefully you were able to answer “yes” to all—or at least some!—of the assessment questions. If so, congratulations!
But in case you found yourself answering “no” to some of the questions, don’t be discouraged! There are steps you can take to get a better understanding of how money works. Here are some introductory steps that can give you a boost into becoming financially literate.
Keep in mind, this is not an exhaustive list and it takes both skills and knowledge to become financially literate. That means it requires you to understand the what, how and why and once you do, that you actually do what you’ve learned.
1. Start an emergency fund.
Begin by saving $1,000. Keep it in savings for when the next inevitable emergency happens. This is your first challenge, if you can do this then you have what it takes to grow this exponentially. We’ll talk more about this later.
2. Clean up your credit.
You’re credit and FICO score is the gate between you and the “American dream”. It will follow you wherever you go and it can determine whether you get that new job, the new condo, new house, that business loan, that car note and if you do get any of those just how much more (or less) you’ll have to pay for it. If you have a poor credit score, you pay more for everything and other things you are denied from altogether.
3. Enroll in a financial literacy class.
People that take a class on good money habits save an average of $3,000 per year in personal earnings. Enroll in a class or course on or offline and expand your knowledge of finance. (7)
4. Join a financial literacy group.
Finance groups are great for connecting people from all walks of life with different experiences so that you learn and grow much faster than if you were on this road alone or with one or two other people. The Fin Lit Club is just that and you can become a member for FREE! Learn more about the benefits of joining our club right here.
5. Keep building wealth and giving generously.
The purpose of financial literacy isn’t just head knowledge. The real goal is to be able to use your money to do the things you truly want to do, like retire with dignity, spend free time with family, and give to other people and worthy causes.
Once you’ve acquired knowledge, skills and wealth, it’s important to give back. One way you can do that is by teaching in one of our webinars or conferences from your experience (you don’t have to be a teacher) or participating in our community through discussion and interaction.
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