What is Financial Literacy? Meaning, Importance, and Why It Matters

Financial literacy is the ability to manage one’s money. The goal of financial literacy is to help in understanding financial concepts that will help them to manage their money better. It is a life skill that one must grasp for good financial wellbeing. Financial literacy includes budgeting, investing, insurance, and loans and interest. In this article, we have covered the importance of financial literacy and how can one improve their financial literacy skills.

What is finance in simple words?

Finance is the management of money. It includes activities like savings, investing, borrowing, lending, budgeting, and forecasting. Finance has three main categories, namely personal finance, corporate finance, and public finance.

Personal finance is specific to an individual and includes banking, purchase of financial products like credit cards, loans, insurance etc. Corporate finance includes activities related to running a business. Like the issue of stocks and bonds and also includes activities related to financing a project. Public finance includes budgeting, taxing, spending by the government for the welfare of the public. The fiscal policies that the government drafts also comes under public finance.

What is financial literacy?

Financial literacy is the ability to understand and effectively use financial skills. These financial skills are as simple as budgeting, investing, credit management, and financial management. In other words, financial literacy is the ability to manage money. A strong foundation of these financial skills will help in achieving various life goals like retirement, education, and even going on a vacation.

Financial literacy includes many skills. However, the most popular ones are budgeting, managing expenses, paying off debt and understanding the risk return trade off in investment products. Acquiring these skills would require one to understand the basic financial concepts like time value of money, compound interest, annualized return and opportunity cost.

With an abundance of credit products available in the market like credit card debt, overdraft facility on debit cards, and EMI, financial literacy becomes important. Understanding debt and having basic financial knowledge will help individuals to use these products responsibly.

Financial literacy often teaches individuals how to make major financial decisions. Moreover, it increases financial discipline and financial capability. This will lead to major lifestyle changes like saving and investing regularly, managing debts effectively and fulfilling life goals efficiently. Additionally, financial literacy will ensure one’s financial wellbeing and also protect individuals from financial frauds.

Lacking the knowledge of these skills leads to financial illiteracy. Financial illiteracy leads to budget mismatch, higher expenses than income, accumulation of debts, poor credit score, being victims to financial frauds, and other negative consequences.

Why is financial literacy important for you?

Financial literacy is important because it equips one with the knowledge and skill to manage money effectively. Without financial literacy, the actions and decisions one make or do not make with respect to savings and investments would lack a strong foundation. Financial literacy helps in understanding financial concepts better and enables one to manage their finances efficiently. Furthermore, it helps in effective money management, making financial decisions, and achieving financial stability. Moreover, financial literacy provides in depth knowledge of financial education and various strategies that are indispensable for financial growth and success. Also, it enables one to be debt free by adopting the best debt strategies.

One can understand the importance of financial literacy by understanding the four components of financial literacy better. They are:

Budgeting

Budgeting is an essential life skill that helps in acquiring financial knowledge for planning and managing money. It is one of the most important components of financial literacy. It is necessary to keep a tab on one’s spending habits. Optimal money management will help in creating an actionable financial plan. The actionable plan will help in tracking the expenses, segregating the unnecessary ones and help in spending money wisely.  This way, one can save more. The thumb rule for budgeting is that income has to be greater than the expenses. The difference between the two (income and expenses) is what helps in stashing up as savings.

Budgeting helps in planning for short, medium and long term expenses. It enables individuals to save accordingly. Hence, one doesn’t require to compromise on any of their goals. Therefore, budgeting is vital for financial security and independence.

Debt

Debt is nothing but one’s borrowing. One is spending money that isn’t theirs. For example, if an individual borrows money from the bank or uses a credit card or takes a short term loan. All these become part of the debt.

Mostly, debt is perceived in a negative aspect. Which makes understanding debt very important. However, not everyone can buy a house or car or pay tuition fees with cash. In such scenarios borrowing or taking a loan is the only way out. But the most important thing is to differentiate between good debt and bad debt. Also, one should always aim to avoid bad debt as much as possible. This is the basics of debt management. 

Good debt is borrowing money for things that are necessary for making a living. For example, buying a home or paying education expenses. On the other hand, bad debt is borrowing money for unnecessary expenses. For example, using a credit card to buy expensive clothes or electronic gadgets, etc.

Therefore, being able to differentiate between necessary and unnecessary expenses will help an individual from not drowning in heavy debts.

Saving

Saving ensures financial wellness, a secure present and an uncompromised future. One can build wealth in the long term through proper financial planning.  Keeping a tab on one’s spending habits will help in saving money. Therefore, through savings, one can easily achieve the following:

Achieve important financial goals. For example, full payment of a home loan, kid’s education, and retirement savings.

Create an emergency fund. An emergency fund acts as a cushion during unexpected life events. The fund should have at least six months worth one’s income.

Inculcate financial discipline. Through saving money regularly, one can achieve financial discipline and excel in their life.

Investing

Instead of holding the money idle in a bank account, one can divert it to financial instruments. Investing is all about generating and growing wealth to enjoy a secure and happy future. It is all about putting money in an avenue that will help in generating significant returns over time. Investments will help in generating additional monthly income and significant returns. One can also achieve their financial goals at the same time allocate funds towards retirement saving. Some of the widely used investment options are equities, debt instruments, mutual funds, real estate, and gold.

Therefore, becoming financially literate will help in:

• Building wealth
• Protecting oneself in case of emergencies
• Achieving goals
• Securing one’s family future
• Retirement planning
• Lead a stress free life

How to improve your financial literacy skills?

Developing financial literacy skills is essential. It helps in improving personal finance management. Personal finance is a process which involves learning, practising and applying a variety of financial skills. It ranges from budgeting, managing, paying off debt, understanding credit and various investment products. The following will help in improving financial literacy skills:

Create a budget: One should start tracking their income and expenses on a monthly basis. This will help in segregating necessary and unnecessary expenses. 

The budgeting process should include:

• Income (payslips, investments etc.)
• Fixed expenses (bills, rent, loan payments, etc.)
• Other expenses (shopping, travel, etc.)
• Savings

Manage bills: One has to ensure they are paying bills promptly. Choose auto debit options for recurring bills from the bank account. Set up payment reminders to stay on top of monthly bill payments. Paying bills should not be postponed or neglected. Hence one needs to make it as a priority in their budgeting.

Maintain a good credit score: Having a good credit score will help in getting the best interest rates on credit cards and loans. Therefore, aim to maintain a good score that will help in the case of borrowings.

Manage debt: Manage debt by reducing spending and increasing repayments. Have a debt reduction plan that will help in reducing the liability. For example, paying off loans with high interest rates first. 

Start saving and investing: Savings is not difficult when it is done systematically. After proper budgeting, all the one has to do is identify financial goals and put their financial resources to optimal use. One can divert their financial resources (savings) towards investing. Investing in a goal will help individuals achieve them easily. Small and regular savings will help in realizing life goals without much stress. Systematic investment plans will enable individuals to save a fixed amount regularly every month. Also, the key to generating significant returns is to have a long term investment horizon. Therefore, one should have a good strategy for identifying financial goals, segregating them as short, medium and long term goals and investing. Also, it is important to be patient with investments and not get panicked with market volatility. Furthermore, one can consult a financial advisor for planning their investments.

Conclusion

Financial literacy is a major life skill one needs to have as it increases your financial capability. Planning finances, managing budgets and savings should be taught right from the school days. However, it’s never too late to learn about it. One can improve financial literacy by understanding the components of it. One can always begin their investment journey even after they turn 50. But starting early has its own benefits.

Let Scripbox help you in managing your money optimally. Scripbox is a financial solution provider who will customize a plan for you to convert your savings into investment. All one has to do is to set their goals and plan their finances. Make a budget and save money. We will help to convert the savings into investments and guide in achieving life goals. Scripbox’s readymade plans are available where one can choose any life goal. Alternatively, we customize plans based on individuals’ goals and finances.

So why wait, when you can start your investment journey today. Happy Investing!

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