financial literacy

Why Is Financial Literacy Important?

Financial literacy refers to the basics of money, debt, investing, and more. It’s important because it can have a large impact on your financial success.

Last updated:

May 11, 2022

EarlyBird helps parents, family, and friends collectively invest in a child’s financial future. Learn more.

What You'll Learn

Money touches nearly every part of our lives. But unfortunately, many of us don’t have the financial education to help us reach our full potential when it comes to money — or to effectively teach our children strong financial skills.

Financial literacy has been declining in the United States. Fewer Americans get the education they need to manage their money and make important financial decisions for their future. 

Financial literacy has so many benefits. It can empower you and help you save thousands of dollars. Imagine if you could find ways to save an extra $100 a month without feeling like you’re sacrificing anything. Over a ten-year period, that’s $12,000 saved!

Financial literacy can not only help you cut unnecessary costs, but it also teaches you how to put that extra money to work for you. So now you’re banking hundreds of thousands of dollars toward retirement or building generational wealth — all by just starting early and investing a little at a time.

You can play a role in teaching the children in your life financial literacy and help make a meaningful impact on their future. And thanks to the abundance of free resources available online today, accessing the information you need is easier than ever. 

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What is Financial Literacy? 

Financial literacy is a general term that refers to understanding basic financial concepts. This can include banking, budgeting, saving, investing, tax basics, and more. 

You don’t have to be a financial whiz or an accountant to be financially literate — just like you don’t have to be an English professor to be literate in general. 

Financial literacy refers to the basics. Someone who is financially literate understands the money concepts that are relevant to their lives — but they won’t necessarily be an expert in economics, cryptocurrency investing, or any other financial topic that isn’t directly related to their personal financial situation. 

Principals of financial literacy
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According to MyMoney.gov, there are five basic principles of financial literacy:

  • Earn: Understand your pay and benefits to make the most of what you earn.
  • Save & invest: Plan, save for, and invest for future goals like retirement or buying a house.
  • Protect: Accumulate emergency savings, have the right insurance, and take the necessary precautions to protect your finances.
  • Spend: Spend responsibly, and shop around to make sure you’re getting the best value for your hard-earned money. 
  • Borrow: Understand debt and borrowing, as well as the costs of doing so. Understand credit scores and how your actions contribute to your credit rating.

If you understand these five areas, you will be financially literate. There’s certainly more to learn beyond this — but if you know the basics, you’ll be on the right track toward financial success. 

Why is Financial Literacy Important? 

Financial literacy gives us the skills and knowledge we need to manage money and achieve financial success.

It helps us make more informed financial decisions, like knowing when it’s best to rent vs. when it’s best to buy. 

It helps us avoid costly mistakes, like taking on excessive credit card debt or making poor investment decisions. 

And it helps us feel more confident, more secure, and more in control of our lives. 

Financial literacy is important for many reasons. Here are some of the most significant. 

1. Many Americans struggle with their finances due to limited financial knowledge 

Many Americans are in less-than-ideal financial situations. While many factors are at play here (stagnating wages, rising costs, etc.), a lack of financial education certainly contributes. 

This is evidenced by the fact that only 34% of adults in the U.S. can answer four or five basic financial literacy questions correctly. 

That means that roughly 2/3 of Americans are not considered financially literate, while just over ⅓ are. 

There are many more worrying statistics:

  • Almost half of Americans don’t expect to have enough money to retire comfortably
  • 65% of college students graduate with student loan debt
  • 40% of adults can’t cover a $400 financial emergency
  • 19% of American households spend more than they make
  • 46% of households don’t have a rainy day fund

Taken together, these statistics show a clear trend: Americans are underprepared when it comes to financial knowledge. The best remedy for this? Financial literacy education. 

2. Financial literacy gaps can contribute to inequality

Up to 2/3 of Americans could be considered financially illiterate — but the figure is even higher for certain demographics. This worrying trend could be contributing to inequality — racial inequality, income inequality, wealth inequality, and more. 

There is data to support this. Black and Hispanic families have considerably lower incomes, net worths, and wealth. Black and Hispanic individuals also scored lower on the FINRA financial literacy quiz. 

Net worth graph
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And it’s not just a factor of racial inequality: The lack of financial education in schools contributes to wealth inequality that can span multiple generations. 

Financial literacy is often taught at home rather than in schools. Because of this, children from financially literate families have a leg-up when it comes to money knowledge. Meanwhile, children from families with low financial knowledge are much more likely to follow in their parents’ footsteps. 

In fact, research has found that kids emulate their parents’ financial habits and that many money habits are set as early as age 7.

This gap in financial knowledge can contribute to greater inequality throughout society. 

3. People are responsible for more of their financial health than ever before

These days, most of us are completely responsible for our own financial futures. This is particularly true in retirement when we must rely on savings that we have accumulated. 

Sure, there is Social Security. But the average Social Security benefit is $1,658 per month, while the average household spends about $5,854 per month. There is also concern that Social Security funds are becoming depleted.

While it was once common for companies to offer pension plans, most companies have turned to defined contribution plans, which leaves more of the responsibility on individuals. Many companies offer no retirement plan at all, forcing individuals to come up with their own retirement investment strategies. 

And it’s not just retirement planning. Increasingly, young people are forced to make major financial decisions early in life. 

The rising costs of college (now over $35,000 per year, on average) force most students to rely on student loans. As a result, 17 and 18-year-olds are making life-changing decisions that often lead to them accumulating tens of thousands or even hundreds of thousands of dollars in debt. 

College is still beneficial for most students — the point here is that teenagers are being asked to commit to decades of student loan debt. Many may not fully understand the consequences of this debt due to limited financial literacy. 

4. Financial literacy can save you money

Understanding finance basics can help you save a lot of money over time. 

For example, you can save money on bank fees by understanding how to avoid them and by keeping adequate funds in your account to avoid overdraft fees. 

Having good credit can also help you save money. The better your credit score is, the lower interest rates you will typically pay on loans and credit cards. 

Credit scores chart
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This can add up to big savings on credit card bills, auto loans, and, most significantly, mortgages. In fact, having a good credit score could potentially save you tens of thousands or more over the life of a mortgage. 

5. Financial literacy can give you financial security and peace of mind

Feeling secure and confident in your financial situation can help provide significant peace of mind. 

Recent studies show that more than half of Americans live paycheck to paycheck. And millennials are significantly more likely to live paycheck to paycheck than older generations.

This lifestyle of always relying on that next paycheck can create a lot of financial stress. What happens if you lose your job or an unexpected expense pops up?

Financial literacy can help reduce these worries. With the right knowledge, you can start saving money, build an emergency fund, and invest for the future. 

6. Financial literacy gives you more options 

The more financial knowledge you have, the more empowered you are. Financial knowledge and confidence reduce your dependence on employers, partners, family, etc.

Think of the different stages of financial independence:

  • As a child and teen, you are financially dependent on your parents.
  • As a young adult, you are financially dependent on your employer.
  • When you reach retirement, you are independent. You don’t need a job, support from your parents, etc. 

And you don’t have to wait for retirement to feel financially secure. Simply having money in the bank and investments earning you money while you sleep can help pave the way. 

Plus, you’ll feel more confident in every financial decision you make. 

Your Next Steps in Financial Literacy

Financial literacy is a broad topic. Where should you even begin?

1. Start with the basics

In most cases, this means getting a handle on your spending, learning about budgeting, and starting to save some money. It’s also important to understand the basics of how debt works so that you can reduce your debt-related expenses (like credit card interest).

Elements of a successful budget
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Once you’re confident with those topics, you can move on to more advanced areas like investing. 

2. Utilize your resources

Next, understand that there are a wide variety of beneficial resources out there to help individuals learn personal finance skills. 

  • Many nonprofit organizations offer free financial education/coaching.
  • Many community colleges offer financial education courses available to community members.
  • Many online resources exist, both free and paid.
  • Even YouTube and other social platforms can provide valuable information (just be wary of people trying to sell you on specific products, investments, or ideas).

You could even enroll in an online personal finance course, like this one from Udemy. 

And for many more free resources on personal finance and investing, check out the EarlyBird blog

3. Start tracking

It’s beneficial to gather some information about your financial life. Here are some key ideas to consider:

  • Sign up for a free credit monitoring service, like Credit Karma or Credit Sesame 
  • Start tracking your spending using pen-and-paper or an app like Mint
  • Make a list of all your assets (valuables) and all your liabilities (debts)

By putting things down on paper (or using an app), you can start to monitor your progress and identify insights to help you improve your financial situation.

4. Teach the children in your life

If you have children in your life, it’s important to do your best to pass on financial wisdom to them. 

Teaching children financial literacy

This applies to parents teaching their children, aunts and uncles teaching nieces and nephews, and family friends teaching young kids in their lives. The specifics of the relationship don’t matter — it’s more about what knowledge is passed down.

This is increasingly important because financial skills aren’t generally taught in most schools. It’s up to adults to teach kids key financial concepts, like how the stock market works, how to build a nest egg, and how to pay for college.

One great way to start teaching kids valuable money skills is to set up an EarlyBird account for them. EarlyBird is an investment platform that makes it simple to start a custodial investment account for children

Loved ones can then invest in the future success of the child — using a combination of stocks, bonds, ETFs, and even cryptocurrency. That way, the kids can observe and learn valuable skills about saving, investing, passive income, and more. 

The Bottom Line

Financial literacy gives us the skills and knowledge we need to reach our full potential and achieve financial success. Having a deep understanding of money management can help people take control of their own lives and feel confident in their decisions.

Unfortunately, most people don’t have the financial literacy they need, and the problem is even more pronounced for young people.

The good news is that it’s not too late. There are more resources available than ever to help people learn basic financial literacy principles that can help them not just survive, but thrive.

Download EarlyBird in the app store today to start investing in your children’s future. 

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This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.

Author

EarlyBird Team

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INVEST EARLY, GROW TOGETHER
Download EarlyBird today and start investing in your child’s tomorrow.
INVEST EARLY, GROW TOGETHER
Download EarlyBird today and start investing in your child’s tomorrow.
INVEST EARLY, GROW TOGETHER
Download EarlyBird today and start investing in your child’s tomorrow.