What is financial literacy and why should you care?

At a glance

• Financial literacy refers to the knowledge and skills you can develop to make smart decisions about money. 
• Financial literacy encompasses day-to-day spending, credit and debt, savings and investments, your retirement plan and your estate plan.
• Financial literacy can help you create financial stability for you and your family.
• University of Phoenix is committed to helping students make smart financial decisions. Learn more about how you can save time and money on your degree!

What is financial literacy?

Financial literacy is an umbrella term used to describe the knowledge that enables people to manage their personal finances.

In short, financial literacy means you have the knowledge (or know how to find the necessary information) to make smart decisions about money.

These skills will prove useful throughout your life, whether you’re seeking a loan for a new car, funding your college education, deciding where to invest your long-term savings, paying off debt or planning your retirement.

Here, we’ll dive into what financial literacy looks like and how you can cultivate it in your own life.

Financial literacy for beginners

Financial literacy encompasses a broad range of personal finance areas:

• Day-to-day spending
• Management of credit usage and outstanding debt
• Savings and investments
• Retirement plans
• Estate plans

Financially literate individuals have a good grasp of where they stand. They may even have a written plan that will help them get where they want to be in one year, five years, 10 years or beyond.

For many years, financial literacy was not taught in high school, although a growing number of states now require personal finance courses as a graduation requirement. As a result, unless you majored in accounting or finance in college, you probably never received formal instruction on how to manage your personal finances. 

That said, financial literacy is not only important for everyday savings. It is also critical for those considering going back to school. There are a variety of ways to fund your education, and your choice can affect your future. University of Phoenix is dedicated to helping you understand the ways you can save on a college degree.

Let’s take a closer look at the five most important aspects of financial literacy.

1.   Spending and budgeting

Before you can plan for the future, you need to take stock of where you are now. Do you know what your total monthly income is and where that money goes? If not, it can be very helpful to track your income and expenses for a month or two to gain a better understanding of your spending habits.

Commit to recording every expenditure you make. Begin by collecting and saving receipts for things you pay for, then document your spending on a spreadsheet, creating appropriate categories like insurance, phone bills, internet access, electricity, clothing, dining out, out-of-pocket medical expenses, groceries, gifts and so on. Don’t forget to include online purchases or recurring bills where you’ve set up auto pay. If you prefer, you can use a free app like Mint or one offered by your bank.

Once you’ve documented everything, you can begin your analysis.

• What are your biggest bills each month?
• Are these essential expenses or discretionary spending?
• How much are you saving each month?
• Does your spending in any one category surprise you?

Once you know how much is coming in and where it’s going, you can develop a monthly budget that ensures you are covering all necessary expenses while still hitting your savings goal.

This means you’ll need to be aware of which expenses you can potentially reduce (e.g., electricity, clothing and dining out) compared to other expenses that are largely fixed (e.g., a mortgage and most taxes). 

One oft-repeated formula, the 50/30/20 rule, recommends you set aside 50% of your take-home pay on needs, 30% on wants and 20% on savings.

2.   Credit and debt

Often, our biggest spending years coincide with major life milestones such as college, marriage and raising a family. That’s a lot of pressure to overspend, but if you keep your eye on the big picture, you’re more likely to practice self-restraint and pay as you go.

Part of this self-discipline means having a healthy respect for credit cards and paying them off in full and on time every month. Judiciously using credit cards can help you build a solid credit score and will reflect positively on your credit report.

This, in turn, will help you qualify for more favorable interest rates and other terms the next time you may need a private student loan, car or home.

However, if you don’t truly need to use a credit card, don’t! It’s easy to miss a credit card payment or fall short for a billing cycle or two, which sets you up for late payment penalties and inflated bills due to accumulated interest charges that can exceed 20%. 

Debit cards, on the other hand, won’t expose you to possible interest and penalty charges because the money used to pay for a debit card purchase is deducted directly from your bank account. However, if the money isn’t there when you use your debit card, you may incur an overdraft charge at your bank.

Also, debit cards won’t help you build a good credit score. Since you’re paying for things as you go with a debit card, you’re not technically using credit (even though the cards look similar) and those debit payments are not reported to the three credit-reporting bureaus (Equifax, Experian and TransUnion).

3.   Savings and investments

When it comes to savings and investments, there is a lot for the financially literate person to learn.

First, you’ll want to ensure some financial stability by creating an emergency fund for unexpected large expenses, like a car repair, illness or job loss. Most advisors suggest saving the equivalent of at least three to six months’ worth of expenses to be safe. In this way, you can weather unanticipated bills and smooth the impact they have on your finances.  

You can do this automatically too. Many banks and financial institutions can transfer a regular amount into a long-term savings or investment account every payday or every month.

Beyond your emergency fund and checking account for day-to-day expenses, you may want to pursue longer-term investments, which could be an online bank savings account, a certificate of deposit, mutual funds, exchange-traded funds, or individual stock and bond purchases.

This is not an area to jump into without doing research. You will need to educate yourself as there are key differences between the many financial products available and the interest they offer, along with associated fees, commissions and risks.

When thinking about long-term investments, it’s important to think about how long you can afford to “park” your money so it remains untouched and can grow. There is always a trade-off between higher-earning investments like stocks or stock mutual funds and the potential risk of losing money during market fluctuations.

On the other hand, safer investments that include U.S. bonds, bills or notes tend to pay lower interest rates, and if you are too conservatively invested in bonds, inflation could erode your balances over time.

4.   Your retirement plan

No matter how far away it seems, retirement is a key part of financial literacy for beginners.

Keep in mind that Social Security benefits will likely be insufficient to cover all your expenses in retirement, and most people will need to rely on their personal savings for a significant part of their income. What’s more, people are living longer than ever in retirement. It’s important to plan for a retirement that’s comfortable, especially since most won’t likely have the ability to work for income after a certain point in life.

Even with all this in mind, many people spend more time planning their summer vacation than they do their retirement. Considering that your retirement could span 30 years or more, that needs to change, even if you’re currently enrolled in college. Even a very small amount, regularly contributed, can grow over time.

Would it surprise you to learn that, if two people set aside $100 a month for their golden years, but the more ambitious one started saving at age 25 while the other didn’t get started until 10 years later, at age 35, the early saver will have almost twice as much saved for retirement at 65? According to BusinessInsider.com, this theoretical example results in the difference between $89,000 and $162,000.

The moral of the story is to make time work to your advantage! Start saving early with regular contributions. If money is tight due to tuition or other bills, you can start small, with $25, $50 or $100 a month being funneled into a 401(k) plan if your employer offers one, or a traditional or Roth IRA.