What is Financial Literacy?
Financial literacy refers to the information, skills and abilities of a person that gives them the insight to make informed decisions about their funds and finances in a wise, effective and resourceful manner.
These financial decisions include plans to make realistic budgets and settle debts. Financial literacy also leads to better comprehension of the differences between various financial products. In conclusion, families that are attempting to balance their budget, purchase a home, pay for their children’s education, or secure an income in retirement are significantly impacted by financial literacy.
Why is Financial Literacy important?
People who are financially literate are more likely to be independent and self-sufficient. In order to make wise and informed decisions about managing your money, a fundamental understanding of financial markets, capital budgeting, and investment possibilities is necessary. Also, knowing how to handle your money reduces the likelihood of encountering fraud-like circumstances.
An individual who is financially literate has a considerable advantage and control over his funds and financial future than one who is not financially literate.
What are the five key components of Financial Literacy?
There are some key components to financial literacy and they can aid you in meeting your goals for a safe and secure financial future. These key components are as follows:
- Track your income
The basic rule of finance is to know your income and expense. If you know where your money is coming from, you can plan where it has to go. So, the primary thing you need to do is to understand your sources of income and carefully track it. Once you know how much funds you are going to receive periodically and where it is coming from, you can make plans on how to put the funds to the best possible use.
Without a clear understanding of your income, you will not have a good idea of how much money you have at your disposal or how to use it wisely for maximum benefit.
- Create a personal budget
The next key component of financial literacy is to have a plan on how to wisely spend your money. This plan is referred to as the budget. In the words of Benjamin Franklin: “If you fail to plan, you are planning to fail”. So, set up a budget to apportion your income for the most important expenses and events that you need to meet on a monthly basis.
The benefit of having a budget is that you can identify the areas where you are losing money unnecessarily. This makes it easier to plug these leaks. Here it is important to note that while setting up a budget and sticking to it might not be easy initially, we can always revisit the budget at the next cycle and make changes as and where necessary. However, always have a budget ready before you spend money so that you can decide where your money must and must not go.
- Set up Financial goals
Setting up achievable financial goals is the next component of financial literacy. Having a viable financial goal will help us to streamline our activities towards achieving it. Also, it will lend us a sense of purpose and accountability.
On the other hand, achieving financial goals can serve as the foundation of financial security and wellness. The route to financial freedom and a life free of debt can both be found with the help of meaningful goals. The advantages of creating financial objectives all contribute to improving financial well-being. We will feel more secure in our financial decisions and experience a marked reduction in worry over money.
- How to handle borrowings
There are various tools of lending available in the market and these are often easily available to the average individual. However, disciplined borrowings and dedicated repayments are a must to ensure proper management of finances.
The various tools of credit like Credit Cards and Loans can prove to be very useful and effective during times of crises or emergencies, however, if they are not dealt with properly, they can prove to the bane of one’s existence. Repayments on loans must be scheduled at affordable limits and must be adhered to strictly. Credit cards are often accompanied by a minefield of hidden charges. A proper study must be done before we select an appropriate Credit Card or banking tool. Also, special emphasis must be placed on paying off credit card balances in a timely manner as late payment fee can set us back in the road to financial recovery.
- Protection and Prevention
Security is an important factor for every individual. One of the main goals of financial literacy is to ensure financial wellness. And financial wellness is only possible if people feel safe, secure and protected during emergencies. Setting up an emergency fund and periodically replenishing the fund is an important step towards ensuring financial security.
Another important aspect is to ensure that contingencies or emergencies are covered by way of insurance. There are multiple insurance options available today that can provide adequate coverage for individuals, families, businesses or properties. By paying a small premium amount, we can ensure that our loved ones and precious possessions are not deterred by financial loss. However, this step requires adequate forethought and planning and this is where financial literacy makes a difference.
If you have knowledge of these 5 components, you will be financial literate and will be able to control your finances and chart a course for success.
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