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If you’ve spent any time reading up on education or financial news lately, you’ve probably come across the term financial literacy. The goal behind teaching financial literacy is to help people develop a stronger understanding of basic financial concepts—that way, they can handle their money better.
That’s a worthy goal, especially when you consider a few stats about how the typical American handles money:(1)
- Nearly four out of every five U.S. workers live paycheck to paycheck.
- Over a quarter never save any money from month to month.
- Almost 75% are in some form of debt, and most assume they always will be.
Ouch! With those numbers, it’s no surprise that leaders in business, education and government want to help spread the benefits of greater financial literacy to as many people as possible.
In fact, it mattered so much to lawmakers, in 2004 the Senate passed a resolution officially recognizing April as Financial Literacy Month to “raise public awareness about the importance of financial education in the United States and the serious consequences that may be associated with a lack of understanding about personal finances.”(2)
As more people become aware of the importance of financial literacy, we should be asking: What skills, traits and best practices do people show who are “financially literate?” and How does this skill set really affect personal finance?
What Is Financial Literacy?
It might sound intimidating, but it’s simple: Financial literacy is made up of the skills and decisions that allow people to win with money. And don’t be misled by the word literacy. Although understanding stats and facts about money is great, no one has truly grasped financial literacy until they can regularly do the right things with money that lead to the right financial outcomes.
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When you have this skill set, you’re able understand the major financial issues most people face: emergencies, debts, investments and beyond. Financially literate people know their way around a budget, know how to use sinking funds, and can tell you the difference between a 401(k) and 529. Here are the concepts financially literate consumers have mastered:
It’s one thing to learn how to add and subtract in elementary school—it’s something else entirely to actually apply those principles to your own finances! Most Americans live paycheck to paycheck, and it’s largely because of a gap between what the math says they can afford and what they actually spend. Financial literacy can make people habitual budgeters who are willing to save for their goals and delay gratification in order to have peace of mind, both today and in the future.
Sixty-nine percent of Americans would be unable to cover a $1,000 emergency if one happened to them today.(3) But the wise minority realize the paycheck-to-paycheck lifestyle is no way to live. In fact, 15% of Americans have over $10,000 set aside for such an occasion.(4)
In addition to mortgages, which amount to nearly $9 trillion in debt nationwide, Americans are weighed down with auto loans, credit cards and student loans. The Federal Reserve Bank of New York reported in 2017 that the total consumer debt in America had reached $3.76 trillion.(5) To see how that debt load impacts daily living, consider that Northwestern Mutual reported in 2017 that 40% of Americans now send up to half of their monthly income out in debt payments.(6) A big part of financial literacy focuses on understanding how the time and money people spend on paying off debt hurts their ability to invest in their future.
Teaching financial literacy skills in schools is becoming more popular all the time. After all, what better place to communicate these life lessons around money than in the classroom? And you can probably guess that we believe financial literacy is as fundamental to learn as reading and writing!
How Many People Are Financially Literate?
Based on the stats that we’ve already considered, it’s fair to guess that the majority of people don’t know how to handle their money. And while there’s no one sure way to measure how many people have financial literacy, the lack of certain skills would confirm that guess.
For example, if you used the number of people who don’t live paycheck to paycheck as an estimate of financial literacy, only about 20% of people would qualify!
Budgeting could be another skill for measuring financial literacy. And how do Americans stack up in that department? Sadly, less than a third of workers (32%) stick to a defined budget.(7)
Let’s look at the findings of the National Financial Capability Test given to over 17,000 people from all 50 states. The National Financial Educators Council (NFEC) reports that less than half (48%) of participants were able to pass the 30-question test that covered things like budgeting, paying bills, setting financial goals, and other personal-finance related topics.(8)
Fewer than half are passing a basic exam on financial literacy—and the average test taker only answered 63% of the questions correctly!
On the bright side, there’s a trend in the other direction—many young people are boosting their financial literacy through personal finance courses in high school. And research shows it’s having a positive impact! In 2016, Ramsey Solutions Research surveyed over 76,000 American students who had taken a personal finance class, and many of the results are in stark contrast to the NFEC report. We found that students who had taken a course in personal finance highly understood key financial topics such as:(9)
- The difference between credit cards and debit cards (86%)
- How to pay income taxes (87%)
- How home, auto and life insurance work (90%)
- How student loans work (94%)
- What a 401(k) is and how it works (79%)
Are You Financially Literate?
To help you decide whether you should include yourself among the financially literate, think through the following questions and give yourself some honest answers.
- Do you know how to create a monthly budget that includes all of your basic expenses, your bills, any debts, and your sinking funds for future purchases?
- Are you currently debt-free? Or are you taking active steps to reduce your debts?
- Do you know about how much money you spend to cover living expenses over a period of three to six months?
- Do you have an emergency fund in place that would allow you to get through a sudden large life event like a layoff or a totaled vehicle without having to borrow money?
- Do you have an understanding of how compound interest allows invested money to grow over time?
- Do you know the various kinds of insurance that are needed to protect your finances and investments?
- Do you understand the difference between an investment and insurance?
What Action Steps Can You Take?
Hopefully you were able to answer yes to all—or at least some!—of the assessment questions. If so, congratulations! You’re probably among the fortunate few who have achieved real financial literacy!
But in case you found yourself answering no to some of the questions, don’t be discouraged! There are steps you can take to get a better understanding of how money works. In fact, the same Ramsey Solutions research we cited above shows that many who take personal finance courses experience awesome results with their money when following these steps:
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1. Start a baby emergency fund.
Begin by saving up $1,000. This is to keep you from being thrown off track when those inevitable tough financial events hit you. (You’ll be making this emergency fund even bigger later on.)
2. If you’re still in debt, get out of it!
You’ve seen for yourself how much debt slows down financial progress. To rid yourself of pesky debts, just list them from smallest to largest. Then use the debt snowball method to pay them off. As you pay off the smallest debt, roll what you used to pay toward it onto the next largest debt. Repeat this process until all your debts are cleared!
3. Finish your emergency fund.
This is another area where taking a class on good money habits helps—those who do so save an average of $3,000 per year in personal earnings.(10) To complete this step, move all the momentum you gained while paying off debt toward saving up three to six months’ worth of living expenses.
4. Invest 15% of your income in retirement.
It’s never too late (or early) to plan for retirement, as our research shows. Eighty-seven percent who take a finance class agree they feel confident about investing.(11) You can face the future with hope when you have a plan that includes smart retirement investment. Use good growth stock mutual funds in a tax-advantaged retirement savings plan like a 401(k) or Roth IRA. Investing 15% can help ensure you beat inflation over the long haul—while still having enough income to put toward paying off your home.
5. Save for college.
Over half (51%) of students who learn about finance in high school plan to pay for college themselves.(12) The best methods are Education Savings Accounts and 529s.
6. Pay off your mortgage early.
This monthly housing payment is one of the biggest expenses for most people. Imagine never sending out this payment again—and owning your home free and clear!
7. Keep building wealth and giving generously.
The purpose of financial literacy isn’t just head knowledge. The real goal is to be able to use your money to do the things you truly want to do, like retire with dignity, spend free time with family, and give to other people and worthy causes.
Financial Literacy is Changing Communities for the Better
By now, you’ve got a pretty good sense of where you stand in terms of your own financial literacy. Maybe you have a lot to learn, but it’s encouraging to know that increasing financial literacy could transform whole families, communities and even the nation!
Many educators are already working hard to bring this kind of understanding to millions of students nationwide. Every year, thousands of graduates go through our middle school and high school personal finance curriculum, Foundations in Personal Finance, and gain financial literacy skills that empower them for a lifetime of money success. We love that so many young people are picking up these essential skills and habits!
At Ramsey Solutions, we’re incredibly grateful for teachers—and not just personal finance teachers, but all teachers! That’s why we’re thrilled to announce our Teacher Appreciation Giveaway! With the help of our sponsor, Amridge University, we’re celebrating National Financial Literacy Month this April by giving away some awesome prizes!
Teachers can register for a chance to win:
- A $5,000 vacation
- $3,000 towards technology for the classroom
- One of three $1,000 gift cards
- One of three cases of The Graduate Survival Guide
Are you a teacher? Be sure to enter today! If you’re not a teacher, share this with the teachers in your life.