If you’ve spent any time reading personal finance information and news, you’ve come across the term “financial literacy.” People who are financially literate understand basic concepts that help them manage their money. They understand the basic financial concepts that can help people get out of debt, save money, and prepare for retirement.
Let’s look more closely at what does it mean to be financially literate, why it’s important and how to improve your own financial literacy.
What is financial literacy?
Financial literacy is an understanding of personal finance concepts like budgeting, investing and managing finances. This includes planning what to do with your money, paying off debt, understanding the time/money trade-off, tracking spending, retirement planning and more.
Earning money won’t get you far if you don’t learn how to manage it. People who are financially illiterate can make poor financial decisions that result in losing money or becoming victims of scams.
Without understanding the importance of balancing a checkbook, paying off debt, understanding compound interest and planning for retirement, you can end up living paycheck-to-paycheck and struggling financially.
Why is financial literacy important?
The more you know about personal finance and how to handle your money, the better decisions you can make with every paycheck.
We all face personal finance decisions that can affect our future. This can include getting insurance, paying for college expenses, getting a mortgage, buying a car, and planning for retirement.
Besides basic financial concepts, financial literacy includes understanding your rights as a consumer, calculating the time value of a purchase and whether something is an asset or a liability.
Financial literacy is a skill that you sharpen over time as you apply it to daily life. It teaches you how your decisions affect you down the road. It helps you develop a financial plan as you look at what you make, what you spend and your debt obligations.
Still, financial illiteracy is a problem at all ages and income levels. Personal finance is not traditionally taught in school. Most people start to learn about money when they get a job and have to pay bills.
Predatory lenders prey on the financially illiterate with high-interest rates, subprime mortgages, and even fraud. Lack of financial knowledge can lead someone to high debt, bad credit, and even bankruptcy.
How to improve your financial literacy
Improving financial literacy is an important step toward becoming better at managing your money. Here are some basic concepts that will help you build wealth and put yourself in a good financial position.
Learn to budget
Budgeting is one of the most important financial skills to master. A budget puts the power in your hands and allows you to decide how to spend every dollar you make.
The idea behind a budget is to balance the money coming into your account with the money coming out. Start off by adding up all sources of income for the year, for both yourself and any other person who contributes to your household income.
The next step is to look at your expenses, both regular and irregular. Review your bank and credit card statements for the last three months and group the expenses in categories such as groceries, utilities, car-related expenses, and so on. Don’t forget to include less frequent expenses like your property taxes or auto insurance.
When you build your budget, allow enough room for saving and investing for the future. This includes setting money aside for emergencies and saving for retirement.
All of your expenses, debt repayment and savings should add up to your total income. If you spend more than you make, you need to make some hard decisions about what expenses to reduce or cut out entirely.
The goal is to have financial breathing room so you can pay your bills and feel secure in your financial future.
Plan for emergencies
Planning for the future means expecting emergencies. This is where an emergency fund comes in. No one wants an emergency to happen but when they do, they are costly and stressful.
Having an emergency fund in place will reduce your stress when something unexpected happens. Even if you can only set aside $25 each week, the savings can add up.
Start by setting up an automatic transfer to a separate account such as Wealthsimple Save. Try to increase your deposits over time and throw any unexpected money, such as a refund or bonus check, into the fund.
Once you have $1,000, aim to save three to six months of expenses. This can help carry you through a job loss or an unexpected illness. If you have to dip into your account to pay for an emergency, just work on building the funds back up as soon as you can.
Manage your debt
One key to financial literacy is learning how to manage your debt. This includes credit cards, auto loans, mortgages, and personal loans. Every debt you owe is money you’ve already spent from your paycheck.
It’s important to not take on more debt than you can handle comfortably. Allow enough breathing room in your budget so you can pay your debt and have money left over to save and invest at the end of the month.
Make a plan to pay off your debt and reduce your monthly costs. This will free up room in your budget for investing, saving for retirement, and building an emergency fund. It will also help you sleep better at night.
Here are more ideas on how to manage your money better and pay down your debt.
Start investing
Once you have your debt under control and a plan for your emergency fund, consider investing. Investing is a good way to grow your money and a hedge against inflation. Wealthsimple.com has a wealth of articles explaining the basics of investing.
Before you put any of your money in the stock market, it’s important to educate yourself about stocks and bonds. While they can be a good way to grow your money, they come with inherent risks.
People who like a set-it-and-forget-it approach to finances may benefit from Wealthsimple Invest. This intelligent portfolio helps you diversify your investments and meet your financial goals. You can pick your risk level tolerance and build a custom portfolio of low-fee funds.
Save for retirement
Retirement is closer than you think. Every dollar you save today is a dollar that helps you live better once you’re no longer able to generate income.
If you have a retirement account option through work, this should be your first stop. Many companies offer an employer match to help you stash away money for your golden years. Find out how much your company match is and contribute enough to get the full amount.
Retirement accounts such as 401(k)s also offer tax advantages. This will help you save money on your tax bill at the end of the year and also let your money grow tax-free until retirement.
The more you can save today, the better off you will be in retirement.
Know the terminology
Being financially literate means knowing what different finance terms mean and how they can affect you and your money. Spend some time to learn the basics of personal finance, such as compound interest, APR, financial planning, the time value of money and so on.
The more time you spend educating yourself about personal finance, the better equipped you will be to manage your money. When you lack financial literacy, you can make poor financial decisions that can have negative effects on your finances.
Financial literacy in Canada
Financial literacy is such an important topic that the Canadian government created the Task Force on Financial Literacy in 2009 to recommend the best way to promote it. The idea is to help Canadians learn how to make good financial decisions and improve their financial well-being.
The government has put together resources to help people learn how to save for their education, buy a house, manage their credit, build a budget, and plan for retirement. Some free tools offered include a budget planner, financial goal calculator, a mortgage calculator, mortgage qualifier tool, and a credit card comparison tool.
The Canadian financial literacy program offers a learning program on the basics of money management and workshop on understanding your credit report. Other resources include a financial literacy blog that offers practical tips on money management.
