What Is Financial Literacy?
Financial literacy is the ability to understand the use of money as it applies to
your personal finances, according to the National Financial Educators Council.
Financial Literacy Skills
Financial literacy skills include an ability to find, understand and use resources
and information to help you make informed decisions about your personal finances,
according to the American Institutes for Research.
Having these skills can provide the confidence, knowledge and ability to make solid
financial decisions. Financial literacy skills promote financial self-sufficiency,
stability and well-being.
Why Is Financial Literacy Important?
It allows you to make better decisions through problem-solving, critical thinking
and having a grasp of essential facts and concepts related to basic personal
finance.
Building your financial literacy helps you create a secure future, avoid financial
pitfalls and achieve your financial goals.
The 5 Principles of Financial Literacy
There are five principles of financial literacy:
Earning
Saving and investing
Borrowing and managing your debt
Spending and planning
Protecting your assets
These principles of financial literacy serve as a road map for good money
management and are the establishment of a solid financial foundation. Learning
about them — and putting them into practice — can improve your financial situation
now and in the future.
Earn
Your income is the foundation of your personal finances. It is the basis for your
lifestyle and your financial future.
Implementing the Principle
Learn to live within your means and pay for your lifestyle without excessive debt.
Manage your income and workplace benefits.
Take advantage of employer matches for your 401(k) or similar retirement plans.
Find ways to put aside portions of your income for the future.
Set up automatic retirement plan contributions so you won’t be tempted to skip a
contribution toward your retirement.
Saving and Investing
Creating a budget will help you put aside money for savings and investments. This
allows you to grow your wealth and can empower you to make major financial plans
such as buying a house or paying for retirement.
Implementing the Principle
Monitor where your money is going each month.
Cut out optional expenses for things you can live without and put the money into
savings or investments such as an IRA, investment fund or annuity for retirement.
Create separate categories or “buckets” in which you can set money aside for
specific goals from holiday presents to vacations to home purchase to retirement.
Borrowing and Debt Management
Borrowing wisely will allow you to make major purchases while building your credit.
This can help you pay for a home, car or a college education. But avoid excessive
debt that can eat into your ability to save and invest in the future.
Implementing the Principle
Carefully weigh major loans to determine if you can afford them — make sure you
live within your means.
Review and compare interest rates before applying for a loan.
Keep debt to a minimum and easily manageable within your budget.
Pay your bills on time and make more than the minimum payment.
Monitor your credit score.
Spending and Planning
When you get your paycheck, consider following the 50-30-20 budget or the 80-20
strategy.
Following the 50-30-20 budget means putting 50% of it toward needs, 30% toward
wants and the remaining 20% toward savings and investments. This is one of several
personal finance strategies that can help you keep your spending on track.
With the 80-20 budget, you “pay yourself first” by setting aside 20% for savings,
then using the remaining 80% for both fixed and variable expenses.
Implementing the Principle
Shop for the best value when making purchases.
When making a large purchase, consider whether it is a need or a want and consider
whether buying it is within your means.
Consider “paying yourself first” by making it a habit to set money for savings
aside before anything else to shape and drive your budget.
Protecting
You will need to protect your financial assets: savings, investments and your
budget. This can take the form of an emergency fund and insurance.
Implementing the Principle
Create an emergency fund — enough money to pay for three to six months of expenses.
Determine with your spouse or partner what constitutes an emergency and only dip
into the fund for those situations.
Purchase insurance to cover risk to yourself and your belongings. Consider
homeowners or renters insurance, health insurance, car insurance, disability
insurance and life insurance.
How To Set Financial Goals
Determine how much money you need to achieve each goal. You’ll need to consider
factors like inflation and time horizons — the amount of time left before your
goal. You can break down the goals into smaller milestones and create a timeline
for accomplishment.
You can use tools like spreadsheets for budgeting apps to track your progress. And
you should regularly reassess and adjust your goals as circumstances change.
Celebrating milestones along the way will help you stay motivated.
How To Create a Budget
A budget is a plan for spending your money each month. Creating a budget will help
make sure you don’t run out of money before the month is up. You can also use it to
save money to pay for long-term goals.
Begin creating your budget by making a list of your monthly expenses.
Expenses can include:
Rent and other bills that are the same each month
Utilities and other bills that are different each month
Car insurance and other bills you may only pay once or twice a year
Clothes
Credit card bills
Entertainment
Food
Gas and transportation
School supplies
Unplanned expenses such as home or car repairs and medical expenses
Now, figure out your income. Write down how much money you make every month.
Include all forms of money, like paychecks, tips, side jobs or child support.
Finally, subtract your expenses from your total income. If the number is less than
zero, you are spending more than you make. You’ll need to look for places to cut
back your expenses or find a way to make more money.
If you get a number greater than zero, this is money you can budget each month
toward savings or some other financial goal
Using Your Budget
You can use your budget to make a plan at the beginning of each month on how you
will spend the money you earn.
Keep track of your spending by writing down everything you spent each day — or keep
track using an app. At the end of the month, you can see where your money went.
This can help you adjust your spending. You may discover expenses that you can cut
back on — or eliminate.
Use this knowledge to adjust your next month’s budget. If you do this every month,
you’ll eventually fine tune your spending and saving to make it more manageable and
efficient. And it can help you start saving more.
How To Save Money
Next, make regular deposits into this account, whether it’s weekly, monthly or
based on your paycheck. Consistency is key.
Automating your savings deposits can keep your deposits consistent. Direct deposits
from your job mean you won’t notice a portion of your income going into savings.
Automated deposits can keep you from skipping one. You also won’t forget to make a
deposit.
How To Invest Money
When you invest your money, it’s essential to have a clear financial goal in mind.
Most people invest for retirement, but others invest for specific purposes like
buying a home or paying for their children’s education.
Different investment options, such as stocks, bonds and mutual funds, come with
different benefits and risks. It’s essential to know the level of risk you’re
comfortable with and balance that against your financial goals. This balance varies
from person to person, so understanding your risk tolerance is crucial.
Finally, the amount you should invest depends on your unique financial situation
and goals. It’s never too late to start investing, but the earlier you begin, the
more time your investment portfolio has to grow.
How To Protect Your Assets
Insurance is important to protect your assets because it provides financial
security in case of unexpected events, such as accidents, natural disasters or
lawsuits, minimizing the financial impact and helping safeguard your hard-earned
assets.
Types of Insurance for Protecting Your Assets
Life insurance
Disability insurance
Health insurance
Homeowners or renters insurance
Life Insurance
The most important reason for purchasing life insurance is to provide financial
protection to named beneficiaries in the event of the policyholder’s death.
You can also develop life insurance strategies to help achieve various financial
goals, such as saving for education, retirement, optimizing estate plans and
supporting business succession plans.
Disability Insurance
Disability insurance is important because it protects your income in case you
become disabled and can no longer work.
It covers common but disabling injuries and illnesses that can prevent you from
working for extended periods of time, such as cancer or severe bodily injury. It
can also provide an income source while you are unable to work.
It is especially beneficial for sole providers or parents who need to support their
families. People with recurring injuries or those in physically demanding jobs
should also consider disability insurance.
Health Insurance
Health insurance protects you against financial risks from high medical costs. It
covers the most essential medical benefits necessary to keep you healthy. And it
helps you pay for treatment of injuries and illnesses.
It also covers preventive care, which can detect a serious condition early. This
can lead to early and less complicated treatment. Health insurance is often
provided by employers in the United States. But you can also purchase health
insurance on your own.
Homeowners or Renters Insurance
Homeowners and renters insurance protect your belongings if they are lost, damaged
or destroyed through theft, accident or acts of nature. Both can also protect you
financially if someone is injured in your home or apartment.
In the case of homeowners insurance, your whole home may be insured against loss or
damage.
Common Financial Mistakes
Financial literacy can help you guard against some of the most common financial
mistakes people make. These include problems with credit card and student loan debt
and predatory lending.
Credit Card Debt
The most common financial mistakes with credit card debt include overspending,
making only minimum payments and carrying high-interest balances.
To avoid the credit card debt trap, stay on budget and only charge what you can pay
off each month to avoid interest and build your credit score. It’s also wise to set
up automated payments so you don’t miss any, adding unnecessary interest and
penalties to your bill.
Making more than minimum payments each month can help to pay off your debt faster.
Student Loan Debt
With student loan debt, common mistakes include borrowing more than necessary and
not understanding repayment options.
Tips for Avoiding Student Loan Debt
Apply for financial aid, grants and scholarships to reduce your reliance on loans.
Consider federal, state or nonprofit loans over private loans.
Only borrow what you need.
Pay interest while still in school to reduce the amount of debt.
Refinance your loans if interest rates go down.
Predatory Lending
Predatory lending mistakes involve falling for high-interest loans and deceptive
lending practices.
To avoid becoming a victim, do your research and compare loans from several
lenders. It’s best to avoid high-interest loans, particularly those at interest
rates that grow faster than you can repay them. Don’t sign any loan agreements
without understanding everything required for repayment.
Be cautious of phone calls, door-to-door or mail solicitation offering loans. These
are often a sign of predatory lending.
Financial Literacy Among Specific Demographics
Financial Literacy for Women
Women also face obstacles due to the wage gap, housing market disparities, divorce-
related financial consequences and inadequate retirement planning. But resources
like the Women’s Institute for Financial Education, WISER and FLOW provide
assistance and guidance for financial empowerment.
Financial Literacy for the Black Community
African Americans struggle the most with insurance and risk comprehension, while
debt management is their strongest area.
Financial Literacy for Latinx Households
Financial literacy in the Latinx community lags well behind white Americans. But it
is crucial for the U.S. Latinx community, whose members face economic disadvantages
and a significant wealth gap compared to white Americans.
Financial literacy rates for the Latinx community were 38% on the 2022 TIAA
Personal Finance Index, compared to 50% for all adults on average and 55% for white
Americans.
Limited access to education, low wages and fewer benefits contribute to the wealth
disparity. Better understanding financial literacy and utilizing available
resources can help improve individuals’ financial situations.
Financial Literacy for LGBTQ+ Individuals
There are free financial literacy resources tailored to LGBTQ+ individuals such as
Healthy Rich and The Debt Free Guys, with a companion podcast called Queer Money.
Financial Literacy for People with Disabilities
The study found that people with disabilities:
Scored lower when tested on basic financial concepts — 44% correct answers vs. a
53% national average.
Had a lower perception of their financial knowledge — 70% saw themselves positively
vs. an 81% national average.
Have similar access to financial education — 20% were offered and participated in
programs vs. a 22% national average.
Financial Literacy for Older Adults
Financial literacy among older Americans is a mixed picture.
Financial Literacy for Veterans and Service Members
Transitioning out of the military leaves many veterans scrambling to adjust to
civilian life, civilian health coverage and creating a post-military budget.
Financial Literacy for First-Generation Americans
“Although low-income immigrants are a minority of all immigrants, they are of
particular interest to policymakers and service providers seeking to support
individuals and families who may need tailored assistance to get on a path to
upward economic mobility,” the study authors wrote.
Support is available through financial advisors specializing in immigrant needs and
organizations like Immigrant Finance and the International Rescue Committee.
Community groups such as CASA and Immigrants Rising also offer assistance.
Resources for Financial Literacy
The best resources for learning about financial literacy include financial experts.
Look for reputable websites, online courses and books by financial experts.
Financial institutions, public media and community organizations also offer
educational videos and workshops.
These sources provide information and resources to build financial knowledge and
decision-making skills.
Financial Literacy Resources
Key Terms
Key Financial Literacy Terms
Financial Literacy
Financial literacy means having the knowledge and skills needed to make financial
decisions, which will promote your financial stability and well-being.
Budgeting
Budgeting is the process of prioritizing your needs and obligations and assigning
portions of your income toward those costs.
Credit Score
Your credit score is a number that financial institutions or credit bureaus assign
to you based on your credit history to help them measure the risk of extending
credit to you.
Emergency Fund
Emergency funds are cash reserves you set aside for financial emergencies or other
unplanned expenses. They are typically equal to three to six months of your income
or expenses.
Expenses
The amount of money you have to spend including for bills, rent, mortgage, food,
transportation and other costs associated with your lifestyle.
Income
Income is all money you earn including wages, salaries, tips and other pay.
Inflation
Inflation occurs when the prices of commonly used goods and services increase in
cost over time, impacting the personal finances of consumers.
Interest
Investment
Risk
Risk is your exposure to danger, harm or loss through any financial transaction,
especially those you make intending to profit from, such as an investment.
Source: U.S. Consumer Financial Protection Bureau
Frequently Asked Questions About Financial Literacy
What are the key components of financial literacy?
The five principles of financial literacy are knowing how to budget, save and
invest your money, manage your debt, plan for your financial future and protect
your assets through risk management. You can achieve these by building your
financial knowledge, skills and behavior — and by setting realistic financial
goals.
How can you improve your financial literacy?
To improve your financial literacy, find ways to educate yourself about personal
finance. Read about money matters in magazines, newspapers and personal finance
books. Learn to use financial management tools through your online banking account
or phone apps and talk with financial advisors, teachers, professors or others
about what to study and where to turn for help.
How can setting financial goals help you in the long run?
Setting financial goals gives you a clear roadmap for your financial journey. It
allows you to prioritize aspects of your personal finances while making informed
decisions. Goals give purpose and enable you to build wealth, reduce debt and build
a secure future.
What does it mean to live within your means?
If you are living within your means, you are covering all your expenses with just
your income — and not going into debt. To live within your means, maintain a
balanced budget, avoid excessive debt and put your needs over your wants. By living
within your means, you can avoid financial stress, build savings and achieve long-
term financial security.
Why is having an emergency fund essential?
Having an emergency fund provides a financial cushion during unexpected situations.
It creates a safety net to cover unforeseen medical bills, car repairs or job loss.
An emergency fund reduces stress and prevents the need for high-interest loans or
going into debt.
