Financial Literacy

Financial literacy is having the knowledge and skills to manage financial resources effectively for financial well-being. The knowledge ranges from an understanding of the way the American economy works to an understanding of the items on financial statements. The skills include the ability to reconcile a bank statement and follow a stock’s performance.

Financial literacy includes familiarity with sources of financial information such as of government reports, company reports, stock listings, and business news. Most of all, those who are financially literate are familiar with the types of information available, the sources and uses of that information, and the ways in which the pieces fit together to give an accurate picture of a person’s financial position and the risk of losing their investments.

Without this knowledge and skill set, it is virtually impossible to plan for a secure financial future.

Background

Financial literacy requires both knowledge and skills. These two components complement one another, resulting in a framework for the evaluation and management of financial resources. The goal is to secure the greatest returns possible on an investment by making the best use of the investor’s financial resources with the information available at the time. An understanding of the risk involved is also important, since only securities insured by the federal government are considered risk-free.

Financial knowledge is made up of an understanding of economics, financial statements, financial markets, and risk management. Economics deals with the ways in which the stock market, government fiscal policy, unemployment rates, interest rates, and business cycles interrelate. This knowledge can be gained by taking a class in economics, watching financial television programs, or reading business publications. Understanding the risk-return tradeoff is also essential. When the markets are acting efficiently, an investment with greater risk will have a greater return than an investment with less risk. The difference in the return is the "compensation" the investor is awarded for taking on a greater level of risk. It takes financial literacy to make an informed decision about an acceptable level of risk.

An understanding of the workings of the financial markets is another aspect of financial literacy. There is no perfect model of the markets that will allow an investor to avoid unintended losses, but the more an investor understands, the better able that investor will be to make intelligent investment decisions. Government monetary policy influences interest rates, which in turn add to the cost of borrowing. Knowledgeable investors are aware of the way these variables influence one another.

Financial skills include the ability to reconcile a checking or credit card account. This skill is important for those keeping track of the flow of money into and out of their accounts. Being able to read a financial statement or annual report and compute the return on an investment—as well as being able to calculate meaningful ratios from those figures—is also key to evaluating investment alternatives. Even more basic is the ability to make a budget—and stick to it. This includes an awareness of the timing of cash in and out of your accounts, and what it means for your ability to pay bills on time. That in turn affects your credit rating.

Impact

Having a financially literate populace is vital to the health of the American economy. If people understand what low interest rates mean to housing prices, they will be in a better position to negotiate an offer for a home they wish to purchase. If they understand the variables that go into assessing credit worthiness, they will know which financial demands require their attention. Likewise, an informed population will be better able to determine the amount to set aside for retirement, future medical needs, and education expenses.

The US government recognizes the importance of financial literacy and has put programs in place to educate people on the subject via various agencies and organizations. The congressionally chartered Federal Financial Literacy and Education Commission, for example, is made up of more than twenty federal entities. It maintains a personal financial education website, MyMoney.gov, with information that includes the five key topics for managing and growing your money. The five topics are earning, borrowing, saving and investing, spending, and protecting your money.

The President’s Advisory Council on Financial Literacy (2008–13) was another government organization. Formed under President George W. Bush, the council's 2008 Annual Report to the President included twelve achievements and fifteen recommendations. The achievements included work with the United States Small Business Administration to establish the SBA Office of Entrepreneurial Education for those involved in starting and managing their own business. The recommendations were broken into five sections ranging from expanding and improving financial education in our schools and universities to promoting greater awareness of personal financial literacy for the general population. Included in this were incentives to create programs that would help people assess their own financial state and what they could do to improve upon their current situations. Between 2013 and 2015, President Barack Obama's President's Advisory Council on Financial Capability for Young Americans promoted financial literacy in schools, families, communities, workplaces, and through technology.

Financial literacy enables people and families to manage their money effectively because they have the necessary knowledge and skills. When deciding between jobs offering different health or retirement plans, a person with financial knowledge can evaluate the financial impact of each offer. When deciding between savings accounts or investment opportunities, a person with financial knowledge will seek out hidden costs and compare the opportunities to others to find the best. An entrepreneur with financial knowledge is able to budget and plan for a start-up business, as well as to assess the competitive environment for the product or service to be offered. When deciding upon the mix of investments that best suits their personal needs, financially literate people can assess the risk of the individual investment, evaluate the overall risk of their financial position, and decide if the additional risk is acceptable and warranted. With an understanding of financial concepts, people can evaluate credit card offers before selecting the offer that is best for their financial situation.

Bibliography

Cygan, Donna S. The Joy of Financial Security: The Art and Science of Becoming Happier, Managing Your Money Wisely, and Creating a Secure Financial Future. Sage Future, 2013.

Davidoff, Howard, and Debby Fowles. The Everything Personal Finance in Your 20s and 30s Book. Adams, 2008.

Don’t Break the Bank: A Student’s Guide to Managing Money. Peterson’s, 2012.

"Financial Literacy and Education Commission." U.S. Department of the Treasury, home.treasury.gov/policy-issues/consumer-policy/financial-literacy-and-education-commission. Accessed 25 Sept. 2024.

Frey, Alex H. A Beginner’s Guide to Investing: How to Grow Your Money the Smart and Easy Way. Ivy Bytes, 2013.

Scott, Carol Lawhorne, and Don Philpott. Military Finances: Personal Money Management for Service Members, Veterans and Their Families. Rowman, 2013.

"MyMoney Five & Tools." MyMoney.gov. Financial Literacy and Education Commission, www.mymoney.gov/mymoney-five-tools. Accessed 25 Sept. 2024.

Stouffer, Tere. The Everything Budgeting Book: Practical Advice for Saving and Managing Your Money—from Daily Budgets to Long-Term Goals. Adams, 2013.

Tucci, Paul A. The Handy Personal Finance Answer Book. Visible Ink, 2012.

U.S. President's Advisory Council on Financial Capability for Young Americans. United States, 2014. Library of Congress, www.loc.gov/item/lcwaN0016852/. Accessed 25 Sept. 2024.