In today’s world, you cannot buy the necessities of life without wealth. Each one of us either dreams or works to have money. But even if you somehow earn it, it does not guarantee that you will use it wisely. This is why one needs to be financially literate. So that you know how to manage the money you earn by working day and night. Let’s understand financial literacy.
Financial literacy is the understanding of various financial concepts related to the management of personal finance, money, borrowing, and investing. It provides the knowledge to make financially correct decisions thus, impacts our daily lives. It includes the issues an average family faces when they try to set a budget, buy a home, decide pension schemes and fund their child’s education. Thus, financial literacy allows a consumer to manage his wealth efficiently.
Need for financial literacy
In the past, payments were done using cash. But nowadays, you hardly see a teenager with cash in his hand. The mode of payment is getting digital day by day. But the percentage of people with financial literacy is not increasing.
FINRA, an organization that regulates the finance and banking, issues a test as a part of its National Financial Capability Study. It is a five-question test that measures consumers’ knowledge about interest, compounding, inflation, diversification and bond prices. Surprisingly, only 37% of those who gave the test got all answers correct. This suggests that the public is deprived of the basic economic and financial principles that they come across in their daily lives. Hence, it’s no wonder that so many people accumulate debts.
These days, financial institutions are coming up with new schemes and credit opportunities. Without proper knowledge of checks and balances, people tend to get into financial trouble. Furthermore, people owning credit cards have little knowledge as to how it works. Hence, the lack of financial literacy is the root cause of the saving and investment problems people face.
If you think that low financial literacy is due to the low literacy level in developing countries, then you’re wrong. Consumers in developed countries also fail to demonstrate their capabilities to make the right financial decisions. On a global level, countries face populations hardly aware of the concept of financial literacy.
What makes this declination in financial literacy even worse is that people are hesitant to learn. The Organization for Economic Co-operation and Development (OECD) conducted a survey. As per the result, people find choosing the right investment for a retirement plan more stressful than a visit to the dentist.
Hence, the importance of financial literacy needs to be recognized. People now manage their own retirement plans, take student loans, medical loans, credit cards, and mortgage debts. Thus, without the right financial education, people make decisions that risk their hard-earned money.
Day by day, financial literacy is becoming more significant in our lives. Let’s understand its importance below.
1. Complex options
Financial institutions, be it government or private introduce new plans and schemes every day. Consumers are asked to choose among these investment and savings products. Now, these products offer different options varying in interest rates and maturities. But the consumers do not have the knowledge to make the right choice.
Decisions were not taken by the consumers in the past, pension funds were managed by the professionals. It puts the financial burden on the companies sponsoring them. Consumers were not involved with the decision-making. They did not even contribute to the processing of funds.
Furthermore, they were rarely aware of their funding status and pension investments. But today, employees have the opportunity to participate in the pension plans. They decide how much to invest and in which scheme. So the public needs to be aware of the financial concepts.
2. Lack of government initiative
You can hardly see any campaign initiated by the government on the importance of financial literacy. While they are busy creating a place in the parliament houses, the common people are suffering.
3. Growth in the finance market
The finance sector has become dynamic. Now it is a global marketplace that is influenced by many participants and factors. Technological advances such as electronic trading are bringing a rapid change in the finance environment. Thus, financial markets are becoming more volatile and swift.
4. Conclusions from studies
A financial services company TIAA-CREF did some study. They found that those with financial literacy plan for retirement and have more wealth than those with no retirement plan. Thus, people with low financial literacy have less wealth and tend to borrow more. So they end up buying on credit. When they are unable to pay their balance each month, they spend more on interest. This group of people does not invest, take debts; all due to poor understanding of finance.
Financial literacy helps consumers to save and invest in the right plans. Thus, it avoids debt, bankruptcy and getting broke. The financial crisis of 2008 shows us the financial impact on an entire economy that arose from a lack of understanding of mortgage schemes.
Hence, it is becoming more imperative that consumers understand the basics of finances. So that they can decipher complex financial products and options. Although understanding finance is not easy, once done, it can ease life’s burdens tremendously. Thus, financial literacy needs to be emphasized by the government and companies for a better economy.