What is Financial Literacy and Why Is It Important?

Table of contents
financial literacy
Organize, Pay, and Build Your Credit Profile
Consolidate bills and BNPL payments, effortlessly manage your budget, and avoid overdraft fees. Join Cushion now and build your credit history with the payments you're already making!
Sign up for Free

About 43% of Americans don’t have a basic understanding of financial concepts. If you are a part of this statistic, you are not alone. More importantly, now is the time to change that. While you might not have learned proper money management techniques at home or in high school, the reality is that most things today seem to revolve around money so you shouldn’t put off learning basic financial skills any longer.

Financial literacy is at the center of how you handle your money, whether you are paying off student loans, juggling multiple credit cards, or putting money away in a retirement savings account. In fact, it filters into many other aspects of life as well, including your relationships and career.

So what is financial literacy, why is it so important, and how can you gauge how financially literate you actually are? Read on to find out.

What is Financial Literacy?

Financial literacy is the term used to describe your understanding of various financial skills and your ability to maintain a good relationship with money. Financial skills include budgeting, saving, investing, and other personal finance–related knowledge.

Credit reporting agency Experian reports that the total debt per American averaged $92,727 in 2020, the highest it’s been since 2010. Unfortunately, nearly 69% of Americans also live paycheck to paycheck, according to a 2020 survey by the American Payroll Association.

Living paycheck to paycheck does not necessarily mean that you are financially illiterate; it just means that you might have to work a little harder at money management than someone who has a larger financial cushion. A number of factors contribute to someone’s level of debt and income security, but these shockingly high numbers can be attributed to inadequate financial education to some degree. Lack of financial literacy can be detrimental to an individual’s personal and financial well-being, resulting in poor spending habits, low credit, and bankruptcy, among other negative consequences.

Turn Daily Expenses into Credit Profile Wins
Consolidate bills and BNPL payments, effortlessly manage your budget, and avoid overdraft fees. Join Cushion now and build your credit history with the payments you’re already making.
Get started

5 Key Components of Financial Literacy

Financial literacy is a spectrum made up of many components—you may excel in some areas and need some serious financial education in others. No one is perfectly financially literate, but practice and consistency are important in achieving your full financial potential. Here are some areas you might want to pay particular attention to.

1. Budgeting

One way to measure your financial literacy is to evaluate if you have a budget in place, stick to it, and routinely update it to reflect changes in income and expenses. Budgeting holds you accountable and makes you aware of where your money is going and when. It can also help you avoid overdraft fees and reach your short-term and long-term financial goals.

There are a handful of budgeting techniques to choose from; you should evaluate your income, expenses, current spending habits, and financial goals in order to determine which one would be best for you.

2. Debt management

Most people living in the U.S. are in some form of debt, whether it is from student loans, medical bills, a car loan, credit cards, a mortgage, or something else. It’s easy to see how millions of Americans get stuck in the cycle of high interest rates and find themselves swimming in financial issues they never saw coming.

Because debt and financial insecurity are so closely related, many Americans resort to making minimum payments, or no payment at all, and never scratch the surface of what they owe. With proper debt management, you can pay down your balances and boost other aspects of your financial life, such as your credit score and net worth.

3. Savings

Your savings (or lack thereof) is another indicator of your financial literacy. A savings account works as a buffer against life’s mishaps and emergencies—often it’s not a matter of if something will happen but when. If you are prepared with savings when things go south, you avoid the headache of incurring debt.

It is essential to separate your spending money from your saving money using checking accounts and savings accounts. It may even be beneficial to use different accounts for different goals, such as one account for emergency savings and another for short-term or long-term personal savings. In other words, you should refrain from dipping into your emergency savings for a kitchen remodel or week-long vacation; those funds should be withdrawn from an entirely different account.

4. Investing

Investing is the method through which your money makes money for you. Even if you are focused on paying off debt or building your savings, it is wise to have a plan for building your investment portfolio. Most people think they have to allocate thousands of dollars a month to investing; this is not true. What is true, though: The earlier you start, the better it will be for you in the long run.

You should also realize the risk involved in investing; before setting out to grow your money, do your research and understand the potential consequences. Investing can have major financial impacts—positive or negative.

Investment options include:

  • Stocks
  • Bonds
  • Mutual funds
  • Retirement accounts
  • Real estate
  • Cryptocurrency
  • Businesses
  • Commodities

5. Creditworthiness

This involves reviewing your credit report and checking your credit score on a semi-regular basis. Everyone makes mistakes, and that includes credit bureaus and credit reporting agencies. Occasionally, there can be a mistake on your report that could potentially damage your credit score or ability to apply for a loan or credit card. The sooner that you can dispute these inaccuracies, the more likely you are to avoid conflict.

While you’re at it, study up on what factors into a credit score. There are five elements: payment history, credit utilization, credit history length, credit mix, and new credit. Simply understanding these five elements will help you realize the importance of making on-time payments, using your available credit wisely, and knowing when to open or close accounts.

Wealth Gaps and Access to Financial Information

Due to the accessible nature of information, it’s easier to learn about financial literacy if you have a phone or computer, WiFi, and general interest. YouTube, Facebook, Instagram, and even TikTok are full of influencers and experts who give free tips and strategies.

However, the United States still sees significant wealth gaps among race, gender, and socio-economic classes, as long-standing systemic barriers to entry significantly affect access to wealth building. These barriers have disproportionately affected financial literacy for generations of women, minority groups, and lower income individuals.

If financial education is new to you, the idea of implementing these strategies may feel out of reach. It’s important to remain consistent and seek out credible resources that will assist you on your journey to financial wellness.

In Conclusion

If you struggle with one or more financial literacy components, it is never too late to double down on your education and relationship with money. Taking the time to understand the basics is step one, and that process will require discipline. Just remember that putting in the work now will help you institute daily practices that will make a big difference in the short term and help you create a future of financial security.

Last Updated on March 03, 2024
Found this helpful?
Dig deeper into your finances by starting a Free Trial with Cushion.
Get started
Cushion is your go-to app for organizing, paying, and building your credit profile with your existing bills, subscriptions, and Buy Now Pay Later.
Disclaimer: The information provided in this website is for educational purposes only and should not be considered as financial advice. Consult with a financial professional for personalized guidance regarding your specific situation.
Organize, Pay, and Build Your Credit Profile
Consolidate bills and BNPL payments, effortlessly manage your budget, and avoid overdraft fees. Join Cushion now and build your credit history with the payments you're already making!
Sign up for Free

Get the credit you deserve for payments you're already making.

Your credit profile will thank you.
Get started