By Frank Kamuntu
Developing financial literacy to improve your personal finances involves learning and practicing a variety of skills related to budgeting, managing, and paying off debts, and understanding credit and investment products. The good news is that, no matter where you are in life and financially, it’s never too late to start practicing good financial habits.
Here are several practical strategies to consider.
Create a Budget
Track how much money you receive each month against how much you spend on an Excel sheet, on paper, or with a budgeting app. Your budget should include income (paychecks, investments, alimony), fixed expenses (rent/mortgage payments, utilities, loan payments), discretionary spending (nonessentials such as eating out, shopping, and travel), and savings.
Pay Yourself First
To build savings, this reverse budgeting strategy involves choosing a savings goal, such as paying for higher education, deciding how much you want to contribute toward it each month, and setting that amount aside before you divvy up the rest of your expenses.
Pay Bills Promptly
Stay on top of monthly bills, making sure that payments consistently arrive on time. Consider taking advantage of automatic debits from a checking account or bill-pay apps and sign up for payment reminders (by email, phone, or text).
Get Your Credit Report
Once a year, consumers can request a free credit report from the three major credit bureaus—Equifax, Experian, and TransUnion—through the federally created website AnnualCreditReport.com.7
Review these reports and dispute any errors by informing the credit bureau of inaccuracies. Because you can get three of them, consider spacing out your requests throughout the year to monitor yourself regularly.
In a 2022 survey by the Federal Reserve, 27% of adults in the United States reported not being OK financially and not living comfortably financially.
Check Your Credit Score
Having a good credit score helps you obtain the best interest rates on loans and credit cards, among other benefits. Monitor your score via a free credit monitoring service (or, if you can afford to and want to add an extra layer of protection for your information, use one of the best credit monitoring services). In addition, be aware of the financial decisions that can raise or lower your scores, such as credit inquiries and credit utilization ratios.
Manage Debt
Use your budget to stay on top of debt by reducing spending and increasing repayment. Develop a debt reduction plan, such as paying down the loan with the highest interest rate first. If your debt is excessive, contact lenders to renegotiate repayment, consolidate loans, or find a debt counselling program.
Invest in Your Future
If your employer offers a 401(k) retirement savings account, be sure to sign up and contribute the maximum to receive the employer match. Consider opening an individual retirement account (IRA) and creating a diversified investment portfolio of stocks, fixed income, and commodities. If necessary, seek financial advice from professional advisors to help you determine how much money you will need to retire comfortably and develop strategies to reach your goal.
Example of Financial Literacy
Emma is a high school teacher who tries to inform her students about financial literacy through her curriculum. She educates them on the basics of a variety of financial topics, such as personal budgeting, debt management, education and retirement saving, insurance, investing, and even tax planning. Emma’s students can and will use these concepts later in life for things like renting an apartment, getting a first job, or even just paying for fun activities such as going to the movies.
Understanding concepts such as interest rates, opportunity costs, debt management, compound interest, and budgeting, for example, could help her students manage the student loans that they might rely on to fund their college education and keep them from amassing dangerous levels of debt and endangering their credit scores. Similarly, she expects that certain topics, such as income taxes and retirement planning, will eventually prove useful to all students, no matter what they end up doing after high school.
Why Is Financial Literacy Important?
Being financially literate from a young age gives an individual the tools and resources they need to be financially secure later in life. The lack of financial literacy can lead to many pitfalls, such as accumulating unsustainable debt burdens, either through poor spending decisions or a lack of long-term preparation. This, in turn, can lead to poor credit, bankruptcy, housing foreclosure, or other negative consequences.
How Do I Become Financially Literate?
Becoming financially literate involves learning and practicing a variety of skills related to budgeting, managing and paying off debts, and understanding credit and investment products. Basic steps to improve your personal finances include creating a budget, keeping track of expenses, being diligent about timely payments, being prudent about saving money, periodically checking your credit report, and investing for your future.
What Are Some Popular Personal Budget Rules?
Two commonly used personal budgeting methods are the 50/20/30 and 70/20/10 rules, and their simplicity is what makes them popular. The former entails dividing your after-tax, take-home income pay into three areas: needs (50%), savings (20%), and wants (30%). The 70/20/10 rule also follows a similar blueprint, recommending that your after-tax, take-home income be divided into segments that cater to expenses (70%), savings or reducing debt (20%), and investments and charitable donations (10%).
What Are the Principles of Financial Literacy?
There are five broad principles of financial literacy. Though other models may list different key components, the overarching goal of financial literacy is to educate individuals on how to earn, spend, save, borrow, and protect their money.
What Are Some Examples of Financial Literacy?
As a high school student transitions to college, they may be faced with the task of deciding which school to attend and how to finance their education. This may include how much money they should be saving from their after-school job, how the terms of their loan will work, and what opportunity costs exist throughout their decision-making process.
In this example, the student will make more financially responsible decisions if they are more financially literate. Financial literacy in this example extends to savings, employment, budgeting, loans, and financial planning. By being financially literate and making smart decisions, the student can set themselves up for long-term success.
The Bottom Line
Financial literacy is the knowledge of how to make smart decisions with money. This includes preparing a budget, knowing how much to save, deciding favorable loan terms, understanding the impacts on credit, and distinguishing different vehicles used for retirement. These skills help individuals make smarter decisions and act more responsibly with their personal finances.
