What Is Financial Literacy?
Financial Literacy Explained in Less Than 3 Minutes
Financial literacy is the ability to understand the products and concepts you need to manage your money. There’s a wide range of knowledge that will allow you to see the potential costs of your decisions, and taking the time to understand banking, saving, investing, and more may help you achieve economic and financial stability.
Financial Literacy Definition and Examples
Financial literacy refers to myriad skills that you might call on when making a choice about what to do with your money. Some of them are basic—like how to add and subtract the money you earn, spend, and save—while others involve a complex combination of calculations and risk assessment.
For example, a financially literate person knows that if they take home $2,000 a month in pay, they cannot spend more than $2,000 each month without going into debt. Someone with a higher level of financial literacy may know that they should save some of that $2,000 for the future. Someone with even more financial literacy might be familiar with the 80/20 budgeting rule (spend 80%, save 20% of your income) and aim to set aside $400 of the $2,000 they have coming in each month.
One person might choose to put all $400 in a high-yield savings account, and another might choose to use that $400 to buy stock. Both are financially literate choices, depending on each person’s goals, understanding of those products, and risk tolerance.
How Financial Literacy Works
Because financial literacy begins with your first interactions with money, it is a lifelong journey—one that inevitably has good and bad moments. While you can develop financial literacy by consuming educational content about personal finance, you will also gain it through real experiences.
Financial literacy is the ability to understand the pros and cons of a money decision, weigh the costs, and confidently decide what to do. But being financially literate doesn’t mean you know everything about money; rather, it equips you to seek out the answers you need in order to make a good financial decision.
Here are some questions financially literate people often ask themselves when faced with a money decision:
- How much will this cost?
- How do the short-term and long-term costs of this choice compare?
- What are the rules that apply to this choice? For example, if I miss a payment, will I have to pay a fee?
- If I use my money for this, what will I have to give up? What will I gain?
- If this is a risky decision, can I afford to lose this money?
A financially literate person also understands how common personal finance products work, like checking accounts and credit cards, as well as how costs like interest and fees are calculated. Some of the core concepts of personal finance include understanding how credit works, how to budget, and how to invest.
In the U.S., April is Financial Literacy Month or National Financial Capability Month. The dedicated month gained traction in the early 2000s when the National Endowment for Financial Education (NEFE) began promoting April as Financial Literacy for Youth Month. Over the years, federal and state governments have reinforced April as Financial Literacy Month through a series of declarations and proclamations.
- Financial literacy means you have the ability to weigh the pros and cons of a money decision and confidently choose what to do.
- Being financially literate doesn’t mean you know everything about money, but you do know what questions to ask in order to make an informed decision.
- In the U.S., April is Financial Literacy Month, during which a number of governments, schools, and other organizations develop and promote programming designed to help people learn more about how to manage their money.