The Meaning of Financial Literacy
Written By Douglas Matus
For some people, literacy comes easily. A love of stories combines with easy comprehension of reading basics, and another bookworm is born. For others, reading comes with some difficulty, but an emphasis in elementary education ensures basic facility.
For financial literacy, the reality could not be more different. A few people have natural gifts with money while others get the benefit of tutelage from parents. For the rest, a lack of instruction reinforces the view that financial concepts are obscure and difficult.
These people often muddle through the basics and leave everything else to experts. However, anyone can become financially literate. The trick is to understand the hallmarks of financial literacy, and then encourage them through daily practice.
Cash Flow and Investments
The two concepts that form the basis of financial literacy are cash flow and investments. To understand these two ideas provides a foundation for the development of better financial habits.
“A person is financially literate if they understand cash flow and budgets,” says Benjamin S. Offit of Clear Path Advisory, “and know how saving and investing can help them in the future.”
A well-organized budget can help you keep tabs on your cash flow, i.e. how much money comes in and goes out on a regular basis. A financially literate person would strive for a positive cash flow, in which expenditures never exceed income.
Cash flow also bears relevance on investments, or money committed in the hope of a profit. Smart investors place money in items that generate cash flow, such as rental properties, instead of static investments. If you’ve purchased something merely in the hope that it will “someday” increase in value, it remains an overall liability.
The Meaning of Debt
The second hallmark of financial literacy is an understanding of the different kinds of debt. Bad debt represents money owed on depreciating assets; in other words, practically all of consumer credit card debt. The statistics on bad debt present a sobering picture of the general state of financial literacy.
“One in four Americans has more money in credit card debt than they do in savings,” says Andrea Woroch, a consumer and money-saving expert. “Being financially literate means understanding how your everyday spending and saving affects your overall financial health.”
Good debt, such as student loans or a mortgage, represents money owed with the expectation of a return. A financially literate person understands how bad debt restricts his or her finances, and avoids it in order to build personal savings.
Making Financial Decisions
A final trait of financial literacy is the ability to make your own decisions. Those who lack confidence about money will let professionals make choices for them. This comes into play not only with financial advisors but also at banks, where a lack of financial literacy can lead to inferior rates.
In order to make the most of your money, you should know how to look out for your own best interests. Financially literate individuals know how to shop around, and they also know how to weigh the viability of an investment. Finally, while financial experts will always have their uses, a financially literate person knows how to consider advice — and not merely accept it wholesale.
Tips for Improved Financial Literacy
Once you’re familiar with the basic concepts behind financial literacy, you can pursue better strategies in your daily life. One way to increase cash flow is to seek discounts and comparison shop. Whether clipping coupons or negotiating a sale price, intelligent spending gives you more money to invest or save.
Another good rule is to contribute at least 10 percent of your income to retirement. If you have an employer match for your IRA, make sure to contribute the maximum; after all, the match represents free money.
Also, improved financial literacy can be as simple as reading the fine print. Pay attention to your bank statements to catch inconsistencies, and take every opportunity to educate yourself.
“People can develop greater financial literacy habits simply by doing research,” says Leslie H. Tayne, financial attorney with Tayne Law Group. “If you educate yourself a little each day, you will not only learn the importance of saving — you will make better financial decisions.”