What Is Financial Literacy and Why Is It Important?

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Read time 6 minutes

Joy Clady

Published on Oct 14, 2024

If someone asked you to define "financial literacy," how would you do it? A quick internet search would likely return plenty of definitions that make it seem like being financially literate is a fancy way to say having financial knowledge or an understanding of finances. Perhaps an inquiry to friends would provide examples about topics that one would need to know about, such as budgeting, saving or investing.

While these are a reasonable start, it is sort of like saying that being fluent in a language is simply having knowledge of how to spell some words or conjugate a verb on paper. You can probably see what is clearly missing — wouldn’t one need to be able to actually use the language and speak the language to be considered fluent? Being able to recite grammar rules is a start, but it is different from being able to use those rules in conversation.

Financial literacy requires not just being aware of the concept that it is not sustainable to spend more than you earn, but also taking action, such as by setting up a spending plan that you actively use to allocate money to future goals, track your spending, and make adjustments to keep things in balance.

Why Is Financial Literacy Important?

Alan Greenspan, a renowned economist and former chairman of the Federal Reserve, believed that the top problem in today’s generation and the economy is the lack of financial literacy.¹ This highlights the importance of financial literacy and also prompts the question of what could be done to improve one’s financial literacy.

You could start by reading personal finance books, magazines or newsletters. Or, listen to a financial podcast or take a class. Always consider the source to ensure you're getting accurate, updated and unbiased information. Practice what you learn by creating a budget, setting savings goals and making informed and purposeful financial decisions.

Financial literacy is not only having knowledge about financial terminology or how to manage money but also using and implementing that knowledge. For example, it’s not only important to know that having an emergency fund is beneficial, but also to use that knowledge to take action by establishing a monthly contribution to a savings account.

While it is one thing to understand that impulse spending can stand in the way of achieving financial goals, it is another thing to actually behave in a way that avoids that unnecessary impulse buy.

Financial Literacy for Students: What Does It Look Like?

If the first lessons of language learning include basics like vocabulary and simple grammar, what are the initial building blocks of financial literacy? It might be knowing the difference between a checking and a savings account, or knowledge about how interest rates affect your overall cost when taking out a loan or understanding the terms of a credit card agreement. As you progress, you might delve into more complex topics like investment choices for retirement plans, deciding between renting or buying a house, or determining what insurance coverage you need to protect your assets.

Key Components of Financial Literacy

When questioning, What is financial literacy? and pondering the various bits of knowledge that would be helpful for financial literacy, several categories come to mind:

Earn: Before you can save, invest, give or make purchasing decisions, you need to have an inflow of funds. Typically, this inflow comes from income from your career. Understanding your income sources and how to maximize them is an important component of financial stability.
Spend: Make informed spending decisions that align with your financial goals. This means creating and sticking to a spending plan, avoiding unnecessary debt and being mindful of your purchases.
Save and invest: While it is important to earn money for financial stability, the saying goes that it is not what you earn, but what you keep. An understanding of the importance of saving a portion of your income for short-term goals or as a financial cushion for emergencies, and investing a portion for long-term goals is a start. Next, understanding risk, knowing how interest and investment returns can work for you in the long run, and being aware of your own emotions is key.
Protect: It is easy to think about how to multiply your money, but it is also important to protect yourself from potential losses. Ensuring your financial health includes protecting your assets. This involves having the right insurance coverage, preventing identity theft and knowing how to avoid fraud.
Borrow: Understand when and how to borrow responsibly. This includes using your understanding of loan terms to make good decisions about when, how much and for how long to borrow. This category also includes avoiding high-interest debt traps and establishing a good credit history.
Give: Financial literacy isn't just about saving, investing, or debt management and risk; it's also about giving. By managing your finances wisely, you can be a better steward of your money, help others and be a cheerful giver. Being generous with your resources fosters a sense of community and gratitude. While cutting your tax bill is not the main motivation in giving, becoming informed on gifting rules and tax breaks may allow you to give more than you imagined.
Estate planning: In addition to considering how your assets will be distributed after your death, estate planning also covers issues while you are alive. How do you want your medical care to be handled if you are incapacitated? Who do you want to make medical decisions for you if you are unable to do so? Do you want someone to be able to make legal and financial decisions for you? Documents such as a living will, medical power of attorney and durable power of attorney are part of this estate planning category.
Taxes: Taxation is a topic that can be a part of all the other categories of personal finance. While decisions about employee benefits, investing, borrowing and giving are made on your goals and values, considering the tax consequences of various options can help you achieve a more optimal outcome.
Emotions: Some may not realize the importance of emotions in financial literacy, but it turns out that it is a key topic that permeates every other personal finance category. An awareness of your emotions, biases and fears around money is vital to achieving financial peace and financial success.

Consider the continuum of language learning — you start with the basics, then move on to conversational proficiency and eventually reach fluency, where you can engage in meaningful conversations. Similarly, financial literacy is a journey. We all may be at different points on this continuum, and the goal is to advance by continuously learning and applying that knowledge to practical situations.

This journey involves practice. Just like with language, where mistakes are made along the way, such as misusing a term or using incorrect grammar, missteps will also happen as you practice your personal finance skills. By learning from those mistakes, you will be able to make better decisions in the future.

Study More About Finances Here at GCU

Part of exploring the questions, What is financial literacy? and Why is financial literacy important? could be to also consider what financial literacy is not. It is not about becoming obsessed with money or becoming materialistic. It is also not about being miserly or avoiding spending money at all costs.

Instead, it is more about making good use of your resources to live a balanced life, enjoying the things you value both now and in the future. Just like becoming more proficient at a language requires continuous learning and active practice, with continued learning and active practice, your financial literacy can be enriched.

At GCU, you can improve your own financial literacy by enrolling in the personal finance course FIN-210, which explores various categories of personal finance topics. If you would like to pursue a career in which you help others with their financial planning, you may want to consider the BS in Finance with an Emphasis in Financial Planning.

This CFP Board Registered Program meets the education requirement needed to be able to register for the CFP^® exam — an important step in the CFP^® certification process,² while introducing you to topics such as investments, insurance, estate planning, taxation and retirement. Or, you can improve your overall business and investing finance knowledge by enrolling in a BS in Finance degree.

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Written By

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Joy Clady

Chair,

Finance, Colangelo College of Business