Why is Financial Literacy Important?

Throughout the entire month of April, financial institutions and other organizations around the country hold Financial Literacy Month. They offer financial education programs, mainly for America’s youth, to improve the financial well-being of all consumers. 

Whether we like it or not, financial literacy plays a significant role in our lives. Our ability to manage money has a direct impact on us today and in the future.

Over the past few decades, the way we handle personal finance has changed. Cash is not used nearly as much today as it was in the past. We rely heavily on credit cards, making it easy to overspend. Our lack of financial literacy is detrimental to our overall financial well-being.

No one likes talking about personal finance, but sometimes it is absolutely necessary. Many people today lack basic financial principles and have nothing to fall back on when the unexpected happens.

Between budgeting, debt, emergency funds, and retirement, just thinking about our personal finance can be overwhelming. That’s where financial literacy comes in. 

What Exactly Is Financial Literacy?

Financial literacy is having the knowledge to make smart financial decisions so you can enjoy a more stress-free life. The overall goal of being financially literate is to develop a strong understanding of basic financial concepts so that you can better manage your money.

To take a definition from Investopedia.com: “Financial literacy is the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing. The lack of these skills is called financial illiteracy.” 

Financially illiterate is something you probably don’t want to be. It means you don’t have the financial security for an unexpected emergency. It means sending your kids to college may be difficult. It means you don’t have enough money put back to appreciate your well-deserved retirement.  

Many Americans lack the financial knowledge they need in order to thrive. Worrying about money can be scary, however, you can’t allow yourself not to when considering a few statistics about America:

  • Between 50% and 78% of Americans are living paycheck-to-paycheck. The study also found that it wasn’t just lower-income families. Close to 25% of households earning $150,000 or more are living paycheck-to-paycheck (Washington Post).
  • 80% of Americans have some form of debt, noting that the average consumer debt is $38,000, excluding mortgages (ShiftProcessing).
  • 28% of U.S. adults have no emergency savings at all and only 41% of Americans could cover a $1,000 emergency with their savings. (BankRate).
  • 20% of Americans don’t save any money at all (BankRate).

One goal of being financially literate is having the ability to overcome the cycle of living paycheck to paycheck. When you’re financially literate, you can work towards your financial goals such as increasing your short and long-term savings, paying off debt, and having a solid emergency fund.

Ultimately, having financial literacy affords you the freedom to have a life where your money isn’t a problem.

A girl holding money.
Having good financial literacy can help you lead a stress-free financial life.

The Fall Of Financial Literacy

Financial literacy has been in rapid decline in recent years. More and more Americans are lacking knowledge in the area it matters most. Why is this?

The Great Recession was an 18-month period in which there was a general decline in global economies. 

The national unemployment rate in December 2007 was 5%; it was 10% in October 2009. The GDP saw a 4.3% decline. The S&P 500 declined by 57.8%. The Dow Jones Industrial Average declined by 50% in 2007 and plummeted even more after that.

After The Great Recession, however, the economy bounced back. You could assume that because of this Americans bounced back as well, but that would be wrong.

Although many Americans did fully recover, there was a significant gap between those who did and didn’t. The majority of Americans who didn’t were the ones between the ages 18 and 34. The gap between the prosperous and the struggling continues to widen.

The Financial Industry Regulatory Authority (FINRA) conducts a nationwide survey every three years to measure the financial capability of Americans. Their survey of more than 27,000 people is one of the largest and most comprehensive studies in the country. Their findings reveal just how much financial literacy has declined in the United States. 

Their reports are consistent: many Americans struggle financially. Americans are not saving. A solid majority have not planned for retirement. 

The survey from Finra.org reports that 53% of Americans feel anxious just thinking about their finances. 54% aren’t sure what they need to save for retirement and 42% of Americans don’t have a retirement account at all.

The study, The State of U.S. Financial Capability, wasn’t finished there. 19% of Americans reported that their household spent more than their income; 46% lack an emergency fund; 66% are unable to answer more than three of five basic financial literacy questions. 

Financial Struggles During COVID-19

It doesn’t take something as notorious as The Great Recession to cause havoc in the homes of many Americans. We are currently in the midst of our biggest financial crisis since 2009: the coronavirus.

The coronavirus pandemic has not only caused millions to become sick and ill, it has also caused a significant number of job losses.

NPR.org reports that 46% of households in America face some financial turmoil during the pandemic. Of those, 54% of households with an income of less than $100,000 reported facing serious financial trouble.

The pandemic has caused many to deplete their savings. Many are struggling to pay off loans, car payments, rent and some are having difficulty paying for food.

This is just another example of how the stock market can strengthen but the people can still struggle. The lack of financial security compounds to other problems in people’s lives.

Why This Downfall?

Many experts agree that this lack of financial capability is due to the lack of financial education. This is why the impact is so great on the younger generation. Many college students and high school students have no financial education at all. They may even struggle to calculate how much a cash advance or loan would cost them.

The Financial Literacy Quiz, conducted by FINRA, is a five-question quiz on topics such as mortgages and interest rates. Only 34% of respondents could answer at least four questions, compared to 42% in 2009. This drop is most noticeable in younger Americans.

Student loans also play a vital role in this study. 48% of respondents report that they are worried they won’t be able to pay them off. 47% said they wish they had chosen a less expensive college.

FINRA also reveals that 49% of Americans who have received just 10 hours of financial education report spending less than they earn. The verdict is that a good economy doesn’t necessarily improve people’s financial lives.

The importance of financial literacy may be more relevant now than ever. It shouldn’t take a financial recession or an ongoing pandemic to realize money matters.

Why Is Being Financially Literate Important?

Financial literacy is important because your knowledge of personal finance encompasses every aspect of your life. To some extent, everyone wants to be in a position where they don’t have to worry about money at all. Being financially literate can help you get there.

There are many reasons why having financial literacy is vital to our everyday lives. In this article, we’re going to discuss a few key reasons why, and they are listed below:

  • Budgeting
  • Getting out of debt
  • Being prepared for an emergency
  • Saving for the retirement you want
A person putting a coin in a budget jar.
Knowing how to budget will help you save money in the future.

The Importance Of Budgeting

When you create a budget, you’re really just creating a spending plan for your money. This gives you the chance to take note of where every single dollar you earn is going.

Budgeting is just something you should do. The benefits of budgeting are endless. Having a sound spending plan has a few perks of its own:

  • Control your spending
  • Track your expenses
  • Get out of debt
  • Prepare for emergencies
  • Save more money

There is an infinite number of age-old principles out there that can provide your foundation of money management. These range from “always live below your means,” “save 10% of what you make” and “tell every dollar what to do.” You still have to do it though.

Budgeting sounds simple, and it is simple, in theory. However, the difficult part lies in having the discipline to stick to your budget. 

Creating a budget should be the first step in your personal finance journey. It gives you the ability to control your money rather than having your money control you, and that’s the first benefit of budgeting.

Controlling Your Money

When you create a budget, you’re able to physically see where your money is going. This enables you to get closer to your goals and avoid overspending.

Track Your Expenses

This goes hand-in-hand with controlling your money. By tracking your expenses, you see where the majority of your money is really going.

Creating a budget may help you notice the Netflix subscription you haven’t used in a year but are still paying for. It will bring to focus on the things you may need to cut back on in order to save more money.

Get Out Of Debt

Being in debt has become a norm for many people today, but it hasn’t always been that way. 

Living below your means has become an extremely difficult thing to do since the invention of the credit card. A recent survey from CreditCards.com reveals that 47% of Americans currently have credit card debt. CNBC.com reports that 55% of people who have a credit card also have credit card debt.

This data recently saw a spike due to the coronavirus pandemic. 23% of Americans with credit card debt have added to it during the pandemic. Millennials were hit the hardest (34%).

The credit card perfectly illustrates just how good we are at spending money we don’t have. If you use your credit card responsibly and pay the balance off each month, you have nothing to worry about. However, that doesn’t always happen. 

When you fail to pay off your entire balance, you end up paying compound interest. That’s one thing you don’t want. According to WalletHub.com, the average interest rate for a new credit card is 17.98%.

This is where budgeting comes in: you can assign how much money you’re going to put into getting out of debt. If you stick to your plan, your debt should be much easier to tackle.

Prepare For Emergencies

It’s definitely less than ideal, but preparing for emergencies is just something we have to do.

Unexpected inconveniences come up all the time. Whether your car breaks down, you get laid off or there’s a death in the family, being low on cash makes difficult times worse. That’s where your emergency fund comes in.

Having an emergency fund can save you from drowning in debt after taking a financial blow. They are especially useful if you only have one source of income or are working toward a financial goal. 

Generally, you want your emergency fund to be able to cover at least three to six months’ worth of living expenses. With this financial security, you won’t be thousands of dollars in debt after your unexpected crisis.

Implement your emergency fund into your budget. You can start small, building towards your goal each week, until you have a solid stash packed away.

Save More Money

The final reason why you should create a budget may sound the most appealing: you’ll be able to save more money.

Studies have shown that more and more Americans are failing to save money. A GObankingrates.com survey concluded that 69% of Americans have less than $1,000 in savings in 2019, compared to 58% in 2018.

This is the main reason why most people budget in the first place. Saving more money allows you to reach your financial goals much quicker. 

Having the opportunity to save more money, however, only comes when you combine all of the previous steps. 

Save For The Retirement You Want

Having a budget, tracking expenses, and getting out of debt are all smart financial decisions for the present, but what about the future?

Saving for retirement looks much different today than it did for, say, our parents or grandparents. The social norms such as working for a single employer for your entire career and retiring with a cozy pension are mostly gone.

In the modern world, saving for retirement is largely up to the individual, rather than the employer. 

An Ipsos.com survey conducted in the past few years revealed that 55% of Americans are worried that their social security benefits won’t be there when they retire. Naturally, this differs from the generation of Baby Boomers (41%), Millennials (55%), and Generation X (67%).

Another survey by Ipsos.com concluded that 53% of Americans don’t believe they’ll be able to retire by age 65. When asked why 40% reported it was due to their inability to save.

While you should start saving for retirement as early as possible, fortunately, it’s never too late. There are many outlets you can use to save for retirement, and it’s a good idea to implement them into your budget. 

Many employers who offer a traditional 401(k) will also offer a match on your contributions. Investing up to the match is a great way to take full advantage of free money.

Another route you could take is opening an IRA. An IRA is a retirement savings account that invests your money in mutual funds. They come in two forms: Traditional and Roth.

A Roth IRA allows you to pay taxes upfront. This means that when you withdraw your money when you’re 59 and a half years old, it’s tax-free.

Conclusion:

There has never been a better time to gain an upper hand in your finances. The importance of financial literacy is substantial even during a pandemic. Grasping a basic, fundamental understanding of your finances can be greatly beneficial to you and your entire family.

Understanding the essential need for a budget, the importance of getting out of debt, being prepared for an emergency, and planning for retirement are just a few things to strive for on your journey to financial freedom.

Although becoming financially literate will take some time, the benefits will be well worth it in the end. When you succeed you will be more than able to live the life you’ve always wanted.

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Riley Draper