What Is Financial Literacy and Why Is It Important?

View all blog posts under Articles | View all blog posts under Master of Accountancy

A young woman using a calculator sits at a desk in front of a computer.

Many young people aspire to careers that will enable them to earn sizable salaries, or at least to generate enough income to live a comfortable and secure life. However, earning money is only part of the equation; it’s also important to manage that money effectively using basic financial literacy skills.

Financial literacy includes everything money related, from budgeting to basic cash management. Moreover, financial literacy is crucial for establishing personal wealth or family financial security; a lack of money management skills can lead to financial roadblocks.

People who lack basic financial literacy may be unlikely to develop savings. They may fall into extensive credit card debt or rack up financial losses due to gambling or poor investments. Financial setbacks can be avoided by improving core financial skills.

What Is Financial Literacy?

Financial literacy refers to an individual’s ability to learn and use a wide range of financial skills, with the goal of wise stewardship of the resources. Strong financial literacy can support many key life goals, whether that means owning a home, starting a business, or leaving an inheritance for children and grandchildren.

Financial Literacy: Key Skills

To achieve financial literacy requires honing core financial literacy skills, including the following:

  • Budgeting. To make smart financial decisions, planning ahead is important, tracking income and expenses weekly or monthly.
  • Managing finances. Financial management means saving and investing monetary resources in a way that keeps them safe, and perhaps even allows them to grow.
  • Investing. The financially literate person may seek shrewd investments in stocks and bonds; in retirement accounts, such as individual retirement accounts (IRAs); in real estate; or possibly even in business ventures.
  • Using credit. While opening a credit line isn’t necessarily a bad move and may even be wise, financial literacy requires prudence. Excessive debt can be dangerous.

Essential Terminology

An important aspect of financial literacy is understanding key financial terms and concepts, such as the following:

  • Credit score. A credit score is a numerical rating that reflects an individual’s creditworthiness; it has a significant impact on the kind of loans available, and the level of interest paid. Credit scores may also determine eligibility for a credit card and may even come up when applying for a job or an apartment lease.
  • Creditworthiness. Lenders, including mortgage and credit card companies, seek to assess whether a borrower is financially sound enough to justify a loan. They may use the borrower’s credit score to determine creditworthiness.
  • Compound interest rates. When a person invests money, they can often earn interest on interest, making the overall investment more valuable over time. In other words, the investment grows based not only on the principal (the initial investment) but also on the interest that the principal generates. If a $100 investment accumulates $5 in interest during its first year, then further interest will be based on the total sum of $105, not just the initial $100.
  • Investment accounts. An investment account is an investment portfolio that may include stocks, bonds or other investments. Common investment accounts include IRAs and 401(k) accounts, which are retirement accounts for individuals to set aside money to withdraw once they leave the workforce.
  • Buying power. Buying power refers to the amount of goods or services a person can purchase with a particular currency, accounting for inflation.
  • Collateral. When seeking a loan, the lender may require a physical asset that it may seize if the borrower is unable to repay the loan. With home mortgages, the collateral is usually the house itself.

Knowing the right basic vocabulary is useful when assessing savings or investment opportunities or considering means for protecting or growing your money.

Why Is Financial Literacy Important?

Why is financial literacy important in day-to-day life? Why is it key to reaching short- and long-term financial goals? Consider a few reasons why developing financial literacy can be a smart idea.

Financial Literacy Aids Smart Decision-Making

First, financial literacy supports prudent decision-making, helping individuals achieve their life goals without falling into financial pitfalls, such as heavy debt.

Short-Term Goals

Financial literacy can support short-term goals. Imagine a family that wants to take a vacation at the end of the year. By creating and sticking to a weekly budget and depositing a small part of each paycheck into a savings account, the parents may build a vacation fund without missing any bills, overdrafting a credit card or racking up credit card expenses.

Long-Term Goals

Financial literacy also helps with long-term goals. For example, imagine a couple that has welcomed their first child into the world. If they have a basic knowledge of the financial tools and resources available, they might open a 529 plan: a savings plan that allows parents to set aside money for educational expenses in a way that protects their money and exempts it from taxation.

Financial Literacy Prepares People for the Unexpected

In addition, financial literacy offers a meaningful safeguard against unexpected life events.

Unexpected or tragic things can happen, from a minor car repair to major surgery, leaving families with unplanned-for expenses. The financially literate family can approach unplanned expenses with an emergency fund for just such occasions, without outstanding debts putting a strain on their finances.

Additionally, financially literate people typically know about loan options, payment plans or other resources that can help them weather unexpected changes without taking on too much additional debt.

Financial Literacy and COVID-19

Financial literacy is especially valuable in the face of the ongoing COVID-19 pandemic. Many individuals and families are contending with higher-than-usual levels of economic uncertainty. They may lack job security or have unplanned medical costs.

Now more than ever, having a clear financial plan, including emergency savings, is crucial. Whatever their financial situation, people need the sense of direction that financial literacy can provide in this shaky, unpredictable era.

Why Financial Literacy Is Important for Students

Clearly, financial literacy benefits individuals and families. Why is financial literacy important for students in particular?

Plenty of evidence suggests younger people tend to be less financially literate; for example, a recent study by the TIAA Institute indicates that only 16% of millennials can pass a basic financial literacy quiz.

Why Students Need to Develop Financial Literacy

Financial literacy is important for the young, and especially those who are either college age or just out of college, for several reasons.

Financial Literacy Brings an Understanding of Debt

One of the biggest problems that young people face is burdensome student loan debt. Financial literacy can provide a clear-eyed perspective on debt and its long-term life implications.

Investing Starts Early

Graduates just entering the job market may have many opportunities to open investment accounts or retirement savings accounts, These include employer-sponsored 401(k) plans or IRAs they open with a financial planner’s help. These resources can be very effective when started early, making financial literacy key.

Emergencies Happen to Anyone

For young people who live paycheck to paycheck, major disruptive expenses can prove devastating. Not only that, but sudden medical needs can happen to anyone, even those who are young and otherwise healthy.

Financial Literacy Minimizes Common Pitfalls

Financial literacy offers clear boundaries and guidelines on credit card use. Financial literacy helps young people avoid making costly mistakes early in their adult lives.

How Parents Can Teach Financial Literacy

Parents have a number of tools and strategies available to them for instilling their children with basic financial literacy.

Provide Hands-on Opportunities

One of the best ways for parents to instill good financial habits in their kids is to actually provide them with hands-on money management opportunities.

When kids are old enough to do some household chores or help in the yard, parents can start rewarding their efforts with modest allowances. Over time, parents may also help their children open savings accounts to start depositing their money, and even walk them through bank statements and basic budgets, explaining important financial concepts and terms.

Have Candid Discussions

Parents can help their kids develop mature habits about their money by treating them like adults, even before they turn 18. Specifically, parents might regularly sit down with their children, explaining monetary concepts, preparing them for the kinds of decisions they’ll make when they start earning regular income, and also discussing future financial goals they can plan for themselves.

Lead by Example

Parents can provide concrete examples of sound financial habits. For example, they can have their children participate in making a household budget. They might call their little ones over, show them their process, and explain some of their decision-making in age-appropriate terms.

What Are the Benefits of Financial Literacy?

Financial literacy can yield practical, tangible benefits in a person’s life; these direct economic benefits may also extend to family members, including spouses, children and grandchildren. What are the benefits of financial literacy? Consider these examples.

Increased Likelihood of Homeownership

Homeownership has always been closely associated with the American dream, and indeed, it can be a clear sign of financial security.

Buying a home can be a challenge: It requires saving for a down payment, maintaining a positive credit score, and developing a smart budget for monthly utilities and expenses. Developing basic financial literacy tools can make homeownership achievable.

Social and Family Benefits

While money may not equate to peace or happiness, financial insecurity can lead to tension and strain. In families struggling financially or in marriages in which the partners have incompatible financial goals, discord can reign.

Improved Quality of Life

For those who are interested in a more luxurious quality of life or simply a higher level of economic stability, financial literacy is essential. For example, in a household burdened by debt, including student loan repayments and high credit card balances, a big chunk of each paycheck might go to paying off those debts. That’s money that can’t be put toward vacations, new cars or household improvements.

Avoiding Scams and Schemes

Another significant benefit of financial literacy is that it arms people against financial scams. Fraudsters and con artists tend to prey on those who don’t have sound financial understanding, enticing them into questionable investment opportunities or selling them on credit cards with high interest rates. Financial literacy can arm people against such schemes.

Planning for the Future

Financial literacy helps people plan for bright futures. Most working professionals want to know that their retirement is secure and they’ll be all right even if their twilight years bring some unexpected health costs. Financial literacy allows people to discover a host of retirement planning options.

Similarly, couples may want to ensure that they leave a generous financial inheritance for their offspring, something they can accomplish through legacy and estate planning.

How to Become a Personal Financial Adviser

For those interested in developing financial literacy, as well as guiding others toward greater financial stability, becoming a personal financial adviser is a good career move.

What Is a Personal Financial Adviser?

A personal financial adviser is a professional who meets with individuals and families to discuss their financial goals, both short- and long-term. The adviser then presents customized solutions to help clients meet those goals, including investments, savings accounts, tax strategies or even household budget recommendations.

Essential Skills for a Personal Financial Adviser

A personal financial adviser needs numerous essential skills, starting with technical competencies. A financial adviser must be prepared to help clients meet specific goals, which may mean drawing from a wide range of tools.

In addition, a personal financial adviser offers the right resources to address a client’s specific financial situation. For instance, a good adviser will know the pros and cons of Roth IRAs versus traditional IRAs and be prepared to help a client choose the best option.

Financial advisers also need interpersonal skills. They must listen to a client’s needs and goals, and then clearly communicate suggestions for the best ways to achieve them.

Becoming a Personal Financial Adviser

People pursuing a career in this field will need to follow these basic steps:

  1. Get the right education. Personal financial advisers typically need a bachelor’s degree in finance, accounting, economics or a related field.
  2. Gain work experience. Aspiring financial advisers may hone their skills by working under the supervision of licensed advisers.
  3. Gain the necessary certification. To use the fullest range of investment tools, advisers must sit for Financial Industry Regulatory Authority (FINRA) exams.
  4. Become a certified financial planner. Becoming a certified financial planner (CFP) calls for passing a one-day exam focused on legal issues surrounding financial advisory services.
  5. Consider an advanced education. An advanced degree, such as a Master of Accountancy, can provide additional expertise with key financial planning skills and methodologies.

Financial Literacy Resources

Finally, for people interested in developing an understanding of basic money management, several financial literacy resources can help.

Webinars

Organizations like the Consumer Financial Protection Bureau offer regular webinars (as well as an archive of past events), providing tips and instruction on maintaining sound financial habits. These include webinars aimed at students, parents and teachers, providing different paradigms for learning and teaching financial literacy. Additional webinar topics include handling student loan debt and using basic money management tools.

Worksheets

Worksheets can boost financial literacy. For example, basic budgeting worksheets can provide specific guidelines for living frugally. There are also personal finance worksheets available to help individuals weigh their income versus expenses, review their monthly financial habits and make informed long-term goals.

Apps

Personal finance apps are handy for supporting wise financial decisions. For example, apps can help track expenses, establish personal budgets and extrapolate trends from a personal banking or checking account. These apps may be useful for boosting personal financial awareness or promoting smarter spending and saving habits.

Promoting Financial Literacy

Financial literacy is an excellent way to learn about avoiding major money traps while putting important financial goals within reach. A Master of Accountancy program can deliver the necessary foundation for individuals who want to pursue money management and financial advisory services as a career and assist clients in developing sound financial literacy.

Rider University’s online Master of Accountancy program provides the technical skills, analytic competencies and communication proficiencies needed for success in this role. Find out more about the opportunity to become an effective personal financial planner.

Recommended Readings

What Is Fraudulent Financial Reporting? A Look at a Vital Accounting Issue

7 Careers in International Financial Management

5 Types of Auditing for Accounting Professionals to Consider

Sources

The Balance, “Top 10 Financial Tips”

The Balance Everyday, “Where Can I Find Worksheets to Help Live Frugally?”

Certified Financial Planner Board of Standards, About CFP Board

Consumer Financial Protection Bureau, Financial Terms Glossary

Entrepreneur, “Financial Literacy: The Key to the Growth of the Economy”

Federal Trade Commission, “FTC’s Top Tips for Financial Literacy Month”

Financial Advisor, COVID-19 Crisis Underscores Importance of Financial Literacy

Financial Advisor, The Societal Benefits of Financial Literacy

Forbes, “Money 101 for Millennials: Seven Tips for Improving Your Financial Literacy”

Forbes, “The Time Is Now to Immediately Start Your Child On the Road to Financial Literacy With these Five Hands-on Tips”

Forbes, “Why Financial Literacy in Schools Matters Today For the Workforce of Tomorrow”

Investment News, “Financial Literacy: An Epic Fail in America”

Investopedia, “The 5 Best Budgeting Apps”

Investopedia, “8 Financial Tips for Young Adults”

Investopedia, “Financial Literacy”

Investopedia, “What Do Financial Advisors Do?”

Investopedia, “Why Financial Literacy Is So Important”

National Credit Union Administration, Financial Literacy & Education Resource Center

National Credit Union Administration, Personal Finance Worksheets

North American Securities Administrators Association, About

TIAA Institute, “Millennials and Money: The State of Their Financial Management and How Workplaces can Help Them”

U.S. Bureau of Labor Statistics, Personal Finance Advisors

U.S. Financial Literacy and Education Commission, Best Practices for Financial Literacy and Education at Institutions of Higher Education

Yahoo! Finance, The Devastating Effects of Financial Illiteracy