How To Be Financially Literate: 5 Fundamental Concepts

Person counting money

How to be financially literate by counting money

According to a recent survey, nearly two-thirds of Americans can’t pass basic financial literacy tests. The Financial Industry Regulatory Authority (FINRA) findings reveal a troubling lack of financial knowledge among Americans. Only 34 percent of survey respondents could correctly answer all five questions on a basic financial literacy test. 

The numbers are even lower when it comes to more specific concepts, such as credit history and savings goals. These findings underscore the need for financial education in this country to improve overall financial literacy. 

For many people, the term “financial literacy” conjures up images of balancing a checkbook or investing in the stock market. While these are important aspects of personal finances, they only scratch the surface of what it means to achieve financial literacy. 

Learn how to be financially literate and the 5 main concepts that will help you understand how to manage your money. By learning these core personal finance concepts, you can make more informed decisions about credit, debt, and saving for the future.

What is Financial Literacy?

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Financial literacy is having the knowledge you need to make sound financial decisions. Being financially literate means you understand important financial concepts such as banking, credit, and debt, and you have money management skills such as budgeting and investing. 

The road to financial literacy starts with a single step, which is understanding the importance of money. Money is rooted in many decisions, so it’s important to have a good grasp of its role in your life. To improve your financial literacy, you must learn how to manage money, how to save and how to invest, and how to make your money work for you. 

Benefits of Financial Literacy

Picture this: You’re about to make a significant purchase, let’s say, a car. You know that you need to finance it, so you start shopping around for the best deal. But instead of just looking at the monthly payment, you also consider the interest rate and the length of the loan. You compare different offers and ultimately decide on the one that will save you the most money in the long run.

By understanding debt, credit, and money management, you are able to reap these benefits of financial literacy:

Making informed decisions

people doing research using computers and taking notes

One of the benefits of financial literacy is that it allows you to make informed decisions about your money. When you understand how money works, you’re better equipped to choose saving and spending. You’re also more likely to spot financial scams and avoid making costly mistakes.

Planning for the future

Those who gain financial knowledge are better equipped to make sound decisions about their present and future finances. They are also more likely to save money and be less reliant on debt. With a strong financial foundation, you can plan for retirement, buy a home, and achieve other financial goals.

Debt management

Couple reviewing their finances and using calculator

Overwhelmed with debt? Job loss, medical expenses, or other unanticipated events can lead to what feels like insurmountable debt. If you find yourself struggling to pay down multiple credit card balances, student loans, or other debts—and keep up with everyday living expenses—it’s time to create a debt management plan.

5 Essential Personal Finance Concepts

Personal financial management refers to making informed decisions about how you spend and save your money. The best way to define financial literacy is knowing when to save and spend. It’s being able to create a budget and stick to it. It’s being able to assess financial opportunities and make sound investment decisions. In short, it’s about taking control of your financial future.

But it’s not just about big decisions you make, either. Everyday financial decisions can have an impact on your long-term financial goals. That’s why it’s important to be informed about the basic financial concepts. Here are five essential personal finance concepts that everyone should know.

1. Why You Need a Bank Account

Close up of Credit Cards

A bank account is one of the financial management tools available to you. It’s a safe place for saving money, paying bills, accessing your funds, and receiving payments. When you deposit money into a bank account, you can avoid the temptation of spending it all at once. You can also earn interest on your savings, which can add up over time. A bank account can also provide a safety net in an emergency.

Additionally, a bank account can help you keep track of your spending habits, set up automatic loan payments, and stay organized. For these reasons, it’s important to have at least one bank account – and preferably more than one. By having multiple accounts, you can take advantage of different features and interest rates and make sure that your money is always accessible when you need it. So if you’re not already using a bank account, now is the time to open one.

Types of Accounts You Can Open

There are many different types of bank accounts available, and the best one for you will depend on your financial goals.

Checking account: A checking account is a bank account that allows you to deposit money and write checks against that balance. Checking accounts are convenient because they provide easy access to your funds. You can usually use a debit card to make purchases, and you can also set up direct deposit so that your paycheck is automatically deposited into your account.

Savings account: A savings account is a type of bank account that allows you to earn interest on your deposits. The interest percentage will differ depending on the type of savings account you choose or have available through your specific bank. Savings accounts are a good place to keep money that you don’t need immediate access to, such as emergency savings or retirement savings. Many savings accounts have withdrawal limits, so you will need to plan ahead if you want to access your funds.

Online Banking vs. Using Physical Banks

Nowadays, people can do almost everything online – from shopping to booking tickets to ordering food. So it’s no surprise that even banking has also gone digital. Online banking offers a number of advantages over traditional brick-and-mortar banks, such as convenience, lower fees, and higher interest rates.

Here are some things to consider when deciding whether to use online banking or a traditional bank:

Online banks:

  • No physical locations
  • Can be done anywhere at any time
  • Higher interest rates
  • Easy access to your account information
  • Accessible 24/7

Traditional banks:

  • Brick-and-mortar locations
  • In-person customer service
  • Can deposit cash 
  • May offer different types of accounts

2. Making a Budget

Budgeting using a pen, paper and calculator

One of the personal-finance basics is learning how to create and stick to a budget. A budget is a tool that can help you track your income and expenses to make informed financial decisions. It can also help you identify spending patterns and areas where you may be able to save money.

What is a Budget?

A budget is a plan that shows you how you will spend your money over a period of time. A budget can help you make informed decisions about your spending, track your progress towards financial goals, and stick to a plan.

How to Create a Budget

Creating a budget is relatively simple. First, calculate your monthly income. This can include your salary, side hustle earnings, and other forms of income. Then, list out all of your expenses for the month. Include both fixed expenses (rent or car payments) and variable expenses (such as groceries or entertainment). Once you have your income and expenses listed, compare the two to see where you can cut back on spending.

There are many different ways to create a budget. You can use a budgeting app, create a spreadsheet, or write down your expenses in a budget binder. 

Online Budgeting Tools

There are a number of financial management tools, managing money budgeting tools, and tracking spending apps available to help you stay on track with your finances. Take charge of your finances with one of these online budgeting tools:

3. Understanding Credit

Person counting cash

Strong financial literacy skills include understanding credit and how to use it responsibly. Credit is a type of loan that allows you to borrow money from a lender and then pay that money back over time. 

There are two main types of credit: revolving credit and installment credit. Revolving credit, such as credit cards, allows you to borrow up to a specific limit and then pay back the money. Installment credit, such as auto loans, involves borrowing a fixed amount of money and then making payments on that loan until it is paid off.

Credit scores

Your credit score is a numerical representation of your creditworthiness, and lenders use it to determine whether or not to extend your credit. Although your education level, bank account balance, stock portfolio, employment status, and salary are all not factored into your credit score, it is essential to become financially literate to understand how your credit score is determined. According to Mint, 18% of adults ages 18 to 24 say they never check their credit scores, so if you’re in that age range, start paying attention to your credit score.

Your credit score is calculated based on five key factors

  1. Payment history (35%): This includes whether you have made your payments on time and in full.
  2. The ratio of debt to credit limit (30%): This is also known as your “credit utilization ratio.” It is the amount of debt you have compared to your credit limit. A lower ratio is better.
  3. Credit history length (15%): This is the length of time you have had credit accounts. The longer your history, the better.
  4. Credit history (15%): This is the length of time you have been using credit. The longer your history, the better.
  5. Type of credit used (10%): This includes the mix of credit you have, such as credit cards, auto loans, and mortgages.
  6. Recent searches for credit (10%): This refers to the number of inquiries made on your credit report in the past 12 months. It is important to keep this number low, as multiple inquiries can lower your credit score.

To know your current standing, you can order a free credit report from the three major credit agencies:

You may also visit AnnualCreditReport.com to get started.

Credit cards

Woman sitting on couch with laptop open and credit card in hand

There are a number of different types of credit cards, each with its own set of benefits and drawbacks. Credit card companies compete for customers by offering different incentives, so it’s important to compare options before choosing a card. Some things to consider include the interest rate, annual fee, and rewards program.

Here are the different types of credit cards:

  1. Secured credit cards: A secured credit card is a good option for people with bad credit or no credit history. To get a secured card, you must put down a deposit equal to your credit limit. This deposit acts as collateral in case you default on your payments.
  2. Unsecured credit cards: An unsecured credit card does not require a deposit. 
  3. Balance transfer credit cards: A balance transfer credit card allows you to transfer the balance of one credit card to another. This can be an excellent way to save on interest if you can find a card with a lower interest rate.
  4. Rewards credit cards: Rewards credit cards offer points, cashback, or other perks for using the card. 
  5. Student credit cards: Student credit cards are designed for people attending college. They usually have lower interest rates and no annual fee.
  6. Business credit cards: Business credit cards are designed for business owners and offer a variety of perks, such as cashback on business expenses.

4. Debt management

Person looking through spread sheets to manage debt

Taking control of debt can feel stressful and overwhelming, but the better you get at understanding the financial basics of debt, the easier it will be to eliminate it altogether.

Credit card debt

Credit card debt is a widespread problem in today’s society. In fact, recent research found that the median debt per family is $2,700, while the average debt stands at $6,270. These figures represent a significant increase from previous years and indicate that many families are struggling to keep up with their payments. If you are struggling to pay off your credit card debt, a few options are available to you, including balance transfers and debt consolidation.

Debt payoff strategies

You can also try some of the following methods for paying off debts:

Snowball method: With the snowball method, you focus on paying off your smallest debts first with the snowball method. Once you’ve paid off a debt, you move on to the next one. This method is effective because it gives you a sense of accomplishment and motivation.

Avalanche method: With the avalanche method, you first focus on paying off your debt with the highest interest rate. This method saves you money in the long run because you will pay less in interest.

Debt Management Programs

If you’re struggling to pay off your debt, you may want to consider a debt management program. A debt management program is a way to consolidate your debt and make one monthly payment. The program will also work with your creditors to lower your interest rates and waive late fees.

Several organizations offer debt management programs, such as:

  1. National Foundation for Credit Counseling
  2. Money Management International
  3. American Consumer Credit Counseling

To find the right program for you, you can contact one of these organizations or search online.

5. Investing Your Money

Tablet with stock trends displayed

Investing is putting money into an asset with the expectation of earning a return on that investment. Common investments include investing in a stock market, bonds, and mutual funds. Many people choose to invest because it offers the potential to earn more money than what could be earned through traditional savings methods.

What to consider before investing

Learning about financial literacy can be a daunting undertaking but with the right tools, and proper resources, it can be manageable. Here are a number of factors to consider when deciding whether or not to invest, such as:

  • Your investment goals

  • Your risk tolerance

  • Your time horizon

  • Your financial situation

In addition to these, there are several different types of accounts that you can use to invest your money, depending on your goals. The most common types of investment accounts are:

Individual retirement accounts (IRAs): An Individual Retirement Account, or IRA, can be an excellent tool for investing your money and growing your wealth over time. IRAs offer many different investment options, from traditional stocks and bonds to more specialized investments such as real estate, precious metals, or mutual funds. Additionally, IRAs typically have lower fees and more favorable tax benefits than other types of investment accounts. 

401(k)s: With a traditional 401(k), you can make contributions from your pre-tax salary, which allows your investments to grow tax-free until you withdraw them in retirement. Additionally, some employers may be willing to match a portion of your contributions, helping to maximize the growth of your savings over time. 

Standard brokerage accounts: An investment account that allows you to buy and sell stocks, bonds, mutual funds, and other securities. Brokerage accounts are offered by financial institutions, such as banks, and are regulated by the Securities and Exchange Commission (SEC).

Education savings accounts:  An ESA is a type of savings account that allows you to set aside money for future educational expenses, such as tuition or books. Often, ESAs allow you to make tax-deferred contributions and enjoy investment tax benefits. Additionally, ESAs may also offer greater flexibility in how your funds can be used, allowing you to withdraw your money for qualifying educational expenditures at any time without penalty. 

Health savings accounts: A health savings account (HSA) is a tax-advantaged account used to save for medical expenses. Contributions to an HSA are tax-deductible, and funds in the account grow tax-free. Withdrawals from an HSA are also tax-free, as long as they are used to pay for qualified medical expenses. 

There are a number of different ways to invest your money and it’s important to consider what your goals are before you start. If you’re looking for more immediate returns, you may want to focus on short-term investments.

With a short-term investment, you’re looking to make a quick profit by buying and selling securities within a relatively short period of time, typically one year or less. In contrast, a long-term investment is one that you hold onto for several years, usually with the goal of earning compound interest and providing yourself with a longer timeframe to ride out any market downturns.

For these reasons, investment diversification is often recommended as a key part of a well-rounded financial plan. When done correctly, investing can be a powerful tool to help reach long-term financial goals.

8 Financial Education Resources for How to Be Financially Literate

Two men using computer for education

Use finance management tools

Dip your toes into financial literacy by starting to track where your money goes. This can be as easy as signing up for an online financial management tool such as  Mint or You Need a Budget and connecting your bank accounts and credit cards. 

Take a course

If you want to learn more about personal finance, enroll in a financial literacy course available online or in person. A financial literacy class can offer a comprehensive overview of personal finance management and provide practical tools to help you achieve financial stability. Check out your local library or community events website to find free financial literacy workshops near you.

Subscribe to financial publications

Several financial publications offer valuable insights into personal finance. Reading these publications can help you stay up-to-date on the latest financial news and trends. Sign up for free to receive the Morning Brew in your inbox daily, or budget a few dollars a month for the Wall Street Journal

Listen to finance-focused podcasts

Podcasts can be a great way to learn about personal finance. Some popular podcasts include Find Your Freedom, Planet Money, Afford Anything, and ChooseFI.

Find a mentor

A mentor can offer guidance and support as you work to gain financial literacy. If you know someone who is “good with money,” ask them some questions over coffee.

If you don’t know anyone who can serve as a mentor, join a financially focused facebook group such as Women’s Personal Finance (for female-identifying individuals) or ChooseFI. These serve as a platform where individuals can come together and share their experiences and advice.

Create your budget

One of the best ways to learn about personal finance is to create your budget. This will give you a firsthand look at your spending habits, teaching you to become better at managing debt, learn about saving money, and invest for the future.

Start investing

Millenials are often encouraged to start investing early. The most successful have been created in their 20s. Why? The sooner you start, the longer your money has to grow. That’s the power of compounding interest.

Read finance blogs

Many finance bloggers out there offer valuable insights into personal finance. Some popular finance blogs include TwentyFree, The Savvy Couple, The Simple Dollar, and a lot more.

Summary

If you’re ready to make a change to achieve a stronger financial future, now is the time to learn how to be financially literate. Start by utilizing some of the resources listed above.

You can also talk to a financial advisor, who can help point you in the right direction. And finally, discipline yourself to stay the course even when you don’t feel like it. Financial literacy is a journey, not a destination, and it takes time to build your knowledge base, but taking the time to truly educate yourself on finances and how you can build wealth, is always worth it.

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