In any research you do about finances, debt, or money management, you might come across the term financial literacy. While the phrase might sound complicated, it just means how you make your financial decisions based on what you know about money.
If you have made it a goal to improve your finances, then financial literacy should be a part of your vocabulary. Take a look below at five important ways you can improve your financial literacy and gain this important life skill.
Why should you work on your financial literacy?
Financial literacy is the process of acquiring skills and education around financial concepts and equipping yourself to make informed, healthy financial decisions. It can take a long time to fully master, and it’s important to stay on top of the changes in how money, investments, banking, and the economy function. Like nearly everything else, financial literacy is about life-long learning.
Many of us know that we should spend time understanding our finances and when we put it off, it can cause unnecessary anxiety and stress. According to a 2018 study by the FINRA Investor Education Foundation, more than half of Americans agree that thinking about their finances makes them anxious.
Financial literacy can help eliminate that anxiety by giving you skills that set you up for more money wins and fewer woes. If you are financially literate, you can make financial decisions more easily because you understand both basic and complex concepts that control your money.
What does it mean to be financially literate?
What are the concepts that you should learn in order to be financially literate? These skills can range from understanding how a checking account is different than a savings account, to knowing how a credit score works. Financial literacy can be broken down into five major categories:
- Banking – Understanding debit cards, savings, checking and money market accounts, and bank fees.
- Budgeting – Reviewing monthly income and expenses, and planning for future goals.
- Saving – Building an emergency fund, saving for long-term and short-term goals, understanding how interest rates affect your savings.
- Debt – Learning about debt to income ratio, repayment terms, debt solutions and forbearance.
- Investing – Contributing to retirement, brokerage accounts, and taxes implication of different investments.
Financially literate individuals work on learning about each of these categories and the concepts that fall within each one – and they aren’t afraid to ask for help. Whether that help comes from someone they know, such as a teacher or parent, or finding guidance from professional experts, they take the time to ask questions, listen to the answers, and take action.
5 ways to improve your financial literacy
1. Read financial books
An easy way to improve your financial literacy is to expand your personal library with a few financial books. Look for books that teach you about budgeting, debt, investing, and saving. You can even expand into niche personal finance books about topics such as real estate investing or financial independence.
It’s true that the more you read and apply that knowledge, the more successful you become– there’s a reason why Warren Buffett spends so much time reading. If you aren’t much of a bookworm, look for audiobooks that you can listen to during your commute. The important thing is to find a topic within finance that interests you and start learning about it.
2. Use credit responsibly
One of the most important skills you can learn about finances is how to use credit responsibly. Credit is a major issue for many Americans who don’t or can’t pay their debt on time. This usually happens when you spend more than you make and since 2009, roughly 19% of Americans spend more than they make.
If you want to use credit responsibly and ensure you don’t habitually spend more than your income, pay off your credit card in full each month. If the end of the month leaves you with a larger balance than anticipated, try making payments throughout the month instead.
Here is one way to manage how you use your credit: When you want to purchase something using your credit card, look at your checking account balance first. Do you have enough in your checking account to cover the balance? If yes, you can use your credit card responsibly. If no, wait until you have the money readily available so you don’t have to worry about accruing credit card debt.
3. Start budgeting regularly
A financially literate individual knows the value of budgeting. A budget is a roadmap for your money. Think of it not as a limit, but rather a tool that gives you a guide for how and when spend. A budget also shows you exactly what you spend the most money on, helping you make changes needed.
If you have never budgeted before, you should know that it’s a great way to improve your financial literacy. Start by doing an audit of your income and expenses from last month. This can be as simple as creating a two-column sheet with one column for income, and one column for expenses. Look through your bank statement and credit card account and write down everything you spent and all the money you earned.
Next, categorize your expenses into buckets. You can use a simple strategy called the 4 F’s method. The 4 F’s method breaks down your expenses into four major categories: fixed, fun, fudge, and future.
- Fixed – Necessary and consistent expenses or bills that you pay each month like rent or mortgage, utilities, debt payments, groceries, internet and cell bills, insurance and taxes.
- Fun – Expenses that are not necessary such as spending at restaurants, shopping, clothing, gifts, or subscriptions.
- Fudge – Any miscellaneous expenses not accounted for.
- Future – Money set aside for savings goals like vacations, car, a house, or retirement.
After you categorize your expenses, you can quickly identify which category you spend the most amount of money on. Then you can use the audit to help you budget for the following month more realistically.
4. Understand your 401(k)
Many working Americans have a 401(k) retirement plan. These employer-sponsored retirement plans are popular because they allow you to set aside pre-tax money from each paycheck to put into your retirement account. However, a whopping 63% of Americans don’t understand exactly how a 401(k) works.
Not understanding how this investment vehicle works could have negative consequences, especially if you borrow from your 401(k) or don’t take advantage of a company match. Here are a few questions about 401(k)s you should know the answers to:
- Does my company offer 401(k) matching? If so, how much?
- What type of funds am I contributing to? Are they conservative or aggressive?
- What type of expenses are associated with my 401(k)?
- How much do I need to set aside from each paycheck in order to reach my retirement goal?
Contact your human resources department or the vendor who handles your 401(k) to get the specifics about your plan. Then do your research or consult with a financial advisor or other financial expert who can give you pointers on how to maximize your retirement savings.
5. Understand how credit scores work
Many Americans know that a credit score is a tool that helps them gain access to different types of loans and credit. However, credit scores can be tricky to understand and control if you don’t know what goes into making up your score. Understanding how credit scores work is one part of a core financial literacy foundation. Here are four steps you can take to learn about your credit score.
- Look up how a credit score is set. Typically, scores are based on debt payment history, total amount of debt owed, length of history, type of debt, and new debt.
- Obtain a copy of your credit report. You can get a free report from Annual Credit Report which is a verified site by the Consumer Financial Protection Bureau. Your credit report will include information from Equifax, TransUnion, and Experian. A credit report is different than a credit score.
- Make sure your information is correct and current. If any changes need to be made, contact your creditors.
- Review your credit scores. You can obtain your credit score for free using CreditKarma.
Financial literacy starts with action
If you aren’t sure where to start improving your financial literacy because you’re struggling with existing debt, we could help. Download our free How to Manage Debt Guide to learn about your debt options now. This free information is a great way to start taking ownership of your money, grow your financial literacy, and move toward the financial future you want.
- Teach Your Kids How to Use a Credit Card Before College (Freedom Debt Relief)
- Learn a New Language During Quarantine: The Language of Money (Freedom Debt Relief)
- Here’s Why You Need to Up Your Financial Literacy: It’s Costing You Money (CNBC)
- The 2020 TIAA Institute-GFLEC Personal Finance Index (TIAA Institute)