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Financial literacy is simply the ability to understand and apply good financial management skills. You’re financially literate when you understand basic personal finance principles and terms and are able to manage your day-to-day finances successfully. This includes things like being able to make a budget, track spending, calculate interest on savings and loans, manage credit cards, and plan for retirement.
A lack of financial literacy is potentially damaging and far too common. Around two-thirds of Americans can’t pass a basic financial literacy test. That’s a test that asks simple, but really important questions, like asking people to calculate exactly how much interest they’d have to pay annually on a loan given a specific interest rate on a specific amount. Many people don’t understand even the most basic financial terms. The kind you’ll find on a credit card statement or loan agreement. And that means they’re sometimes forced to make financial decisions without fully understanding what the decision is or appreciating the terms and conditions attached to it.
This can be compounded by the fact that not knowing much about something doesn’t necessarily stop us from doing it. When it comes to finances, often we just don’t know how much we don’t know. We simply do what others do, including taking out student loans, buying cars on credit, and running up credit card bills. This means that the world is full of people happily making big decisions about finances without really knowing what they’re doing or what the other options are. The good news is that there are a few things you can do to improve financial literacy.
Financial education is still lacking in the average high school or college curriculum, so if you don’t have financially savvy parents or other mentors willing to pass on their wisdom, you will have to self-educate. Luckily this is easy to do with plenty of personal finance blogs, podcasts, and even online courses that you can study. You might want to search for a glossary of terms for each area of personal finance relevant to you. If you’re applying for a credit card, you’ll want to fully understand terms like APR, grace period, and annual fee. If you’re investing in the forex markets, you’ll need to know about pips, margin, and slippage.
There are also a few really good books you can read to improve financial literacy. One of my favorites is a century old, but the principles it covers are still 100% relevant to modern-day life. Others I recommend for basic financial literacy are The Millionaire Next Door and The Automatic Millionaire.
Once you’ve established some basic financial literacy, you will slowly improve your small daily financial decisions. This is a great first step because lots of small daily decisions have to be made quickly, on the fly, without thinking too long about them. There are plenty of other decisions, however, where you’ll have time to research your options, and you most definitely should. Many people never consider alternatives when it comes to big financial decisions. They take the auto loan the dealer sells them, or the credit card offer that lands in their inbox with a promise of ‘pre-approval’, or they start paying into the default retirement plan that their employer offers.
Part of becoming financially literate is admitting that you can’t know everything about every aspect of personal finance. But you can find out what you need to know as you need to know it. When it comes to borrowing or investing money, in particular, do your research. There are comparison sites you can use to get a quick overview of competing credit cards, online brokers, or bank accounts. Then dig deeper into the ones that interest you, looking for any extra terms and conditions that might be relevant to you. Learn to employ ‘just in time’ research, looking very closely at a specific decision just before you have to take it. Things change fast in the personal finance arena, so doing this ensures you have up-to-date information and comparison data.
You don’t have to be a mathematician to be great with finances, but if, like the people who failed the financial literacy test, you couldn’t work out how much interest you’d pay per year on a $1,000 loan with a 20% interest rate, it’s worth going back to the basics. To be financially literate, you do need to understand percentages and how interest works, including compound interest. You need to be able to compare interest rates, whether you’re choosing a loan or a savings plan. Even more basic math is used in budgeting. It’s amazing how many people don’t budget when it really is mainly about adding up (essential and non-essential expenses) and dividing (income into different categories).
Ultimately, developing basic financial literacy will help you feel more in control, better informed, and less stressed about money. So it’s definitely worth spending a little time on.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.