Why is Financial Literacy Important?

Posted by Shaun Morgan in MindsetMay 1, 2022(Last Updated July 28, 2022)4 min read
Key Takeaways
  • Understanding basic money skills is called financial literacy.
  • We have built a world that operates almost entirely on the accumulation and proper use of money. And yet, the basic skills of how money works are a mystery to most.
  • Sure, people can buy and sell, open accounts, get loans, invest a little in retirement, and even write a check, but they don’t know the basic principles for accumulating wealth.
Are you ready to make some real money moves?

We have built a world that operates almost entirely on the accumulation and proper use of money. And yet, the basic skills of how money works are a mystery to most.

 

Sure, people can buy and sell, open accounts, get loans, invest a little in retirement, and even write a check, but they don’t know the basic principles for accumulating wealth. Understanding basic money skills is called financial literacy.

 

What Does It Mean To Be Financially Literate?

 

A financially literate person understands how to accumulate wealth because they know how the money game works. 

 

So what goes into financial literacy? This is incredibly hard to pin down, but generally, you can include building financial vocabulary, understanding personal accounting, understanding the power of investing, and applying this knowledge in real-world situations. 

 

Building Financial Vocabulary

 

Building your financial vocabulary is pretty straightforward, but many people don’t understand that before you can be “good with money,” you need to know what you’re talking about. For example, you would never claim to be “good with engines” if you couldn’t explain what an alternator is. But people claim to be “good with money” all the time who can’t explain an APR (Annual Percentage Rate). 

 

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To be financially literate, you need to start building basic money vocabulary. Of course, it would be impossible to list all of the vocabulary words here, but you’ll get a feel for how much or how little you already know once you get started.

 

Start reading financial blogs like CapWay to get a feel for where you are and where you would like to be.

 

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Understanding Personal Accounting

 

After you’ve built a foundation of financial vocabulary, you need to understand personal accounting. Financial literacy is the most important part because you can’t survive financially without good personal accounting.

 

Lack of good personal accounting is why people who win the lottery or become super-rich and famous overnight often end up broke.

 

So, what is personal accounting? Well, imagine that your life is a business. You would want your business to make money, right? If not, you wouldn’t stay in business because it wouldn’t be profitable. Personal accounting is the art of keeping your life in business.

 

 

Someone who understands personal accounting understands that everyone needs to track their spending, build a budget around that spending, maintain and build good credit, stay out of bad debt, prepare for emergencies, and put aside money for retirement—to name a few.

 

Maintaining this balancing act keeps you out of the negative side of finances. You’ll have good credit, no debt, and the ability to withstand the bumps in the road now and in the future with good personal accounting. 

 

You have a position of strength from which to move into growing your wealth with investments. 

 

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Understanding the Power of Investing 

 

The next part of financial literacy is understanding that investments grow your wealth. Unfortunately, most people think of investing in the same way they think of gambling—a way to get rich quickly with a high chance of losing all your money. This is completely wrong. 

 

Investing, when done correctly, is all about slowly growing your wealth by accumulating assets that put money in your pocket.

 

Because there are so many good ways to invest, an investor will usually focus on just one investing method to begin with. The most common beginner investment options are stocks and bonds in mutual funds, real estate, or building a business.

 

By balancing risk and reward--other financial vocabulary words that you may want to know--you can start to build your net worth with investments. This is where you move from being financially stable (your expenses don’t exceed your income) to financially independent (your income from investments exceeds your expenses). Investing wisely is the key to building wealth that savings on income alone cannot do. 

 

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Applying Financial Knowledge

 

The last level of financial literacy is applying these principles. True financial literacy using your financial knowledge to improve your life. 

 

So if you know what an APR is, you can compare credit card rates. If you understand how budgeting is supposed to work, you can use it to decrease spending on things that don’t matter to you. Finally, if you understand that investing is a long-term game, you can hold investments through the ups and the downs to build wealth over time.

 

The power in gaining financial knowledge is applying it to your everyday life. So whether you are going grocery shopping, paying bills, or investing in your retirement account, financial literacy is helpful at any stage in your life.

 

 

Becoming Financially Literate 

 

Financial literacy is no different than becoming “literate” in any topic. How do you become “literate” in a sport? Consume hundreds of hours of content about the sport and then put that into action to learn through trial and error. Remember, practice makes perfect.

 

The only way to become literate is to learn it and then do it. Trial and error will teach you better than any lesson can. However, your mistakes don’t have to be the only way you learn. By understanding financial literacy basics, you can stop the error before it happens.

 

The Importance of Financial Literacy

 

Financial literacy may be the most important skill someone can acquire. Your ability to handle money impacts everything that you do. Becoming financially literate helps you overcome money stress, focus more on work that matters to you, and focus more on your family and other important aspects of your life.

 

While there is no guaranteed success by being financially literate, failure is guaranteed by being financially illiterate. Financial illiteracy can lead to living paycheck to paycheck, being rooted in debt, and other financial deficits that stop you from building wealth. 

 

Being financially literate leads to smart money decisions, which build wealth—most of the time.

If you want to survive and thrive in the world we’ve created, which revolves around money, you must become financially literate.

 

How have you applied your financial knowledge to your life over the past six months? Please share with us your thoughts in the comment section below.

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