What Are the Key Components of Financial Literacy?

By becoming financially literate, you’ll handle your finances a lot better. You will be more efficient at achieving your goals and even improve your quality of life. As you can see, the phrase financial literacy gets tossed around a lot. However, not many people understand the term.

What is financial literacy?

You don’t have to be financially literate to understand what components make up financial literacy. On the other hand, you can’t become financially literate without understanding what goes into financial literacy. This is why; if you want to improve people’s lives in the long run, you must learn how to start a financial literacy program.

With that in mind and without further ado, here are some of the critical components of financial literacy that you need to learn about.

Budgeting

The term budgeting means making a plan to spend money. Some expenses are recurring:

Utility bills

Mortgage payments

Travel expenses

Food

Subscriptions

So, you're already budgeting by setting aside the money for these expenses as soon as you get your monthly income.

Now, what we’ve mentioned is the most rudimentary form of budgeting. You should also start a savings account, make an emergency fund, and use budgeting tools. This way, you’re more in control over your finances, and fewer expenses can surprise you.

This matters because it ensures you always have the money to fulfill your plans and meet your obligations. This is especially important if you’re running a business.

Credit

Credit is your ability to use the money that you don’t own (yet). This is an advance that you get and have to pay back. Now, the amount of credit that you can access is determined by your creditworthiness.

This is often expressed in credit score, a scale on which your financial trustworthiness is put into numerals. The most commonly used scale is FICO, expressed from 300 to 850. The higher the number, the higher the creditworthiness.

Your credit score is especially important regarding your ability to get an unsecured loan (a loan without collateral). An alternative to this is a secured loan, where you use your asset to guarantee your creditworthiness.

Debt management

Debt is a critical component of your finances; however, many people don’t know how to use it properly. They cannot calculate how much debt they can actually afford, which pushes them even deeper into the debt spiral.

A debt spiral is a scenario in which you must take new loans to pay for the old ones. This vicious cycle provides a short-term solution by increasing your monthly credit payments. The problem is that because your income is clearly insufficient, there’s no prospect that things will improve on their own.

Most importantly, loans you can get with a low credit rating are quite unfavorable. This means that you’ll end up paying a fortune in interest. Payday loans are even worse. The majority of these loans have an APR of 300-400%.

So, aside from just learning how to get approved for a loan, you need to learn how to clear your debt. Knowing a thing or two about debt consolidation and early repayment methods is probably the best idea.

Identity theft protection

The worst thing about identity theft is that you can be financially responsible and have someone else steal your money and ruin your credit. This is why identity theft protection needs to be a part of your overall financial literacy.

Because we live in a digital world and most electronic payments are connected to our virtual profiles, this is also a matter of cybersecurity. You need to learn how to set up a strong password.

You must also know what to do when your identity is compromised. You can freeze your credit, change your passwords, and notify institutions like banks that your identity is compromised. However, you would first have to learn how to recognize this.

Taxation

Taxes are one of the most intimidating parts of financial literacy. What are taxes, and when do you need to file them? This is the most rudimentary question, but it is, sadly, a question that many people don’t have an answer to.

At the very least, you must familiarize yourself with the income tax and IRS forms that apply to your case. By getting informed, you’ll be less intimidated by taxes and lower the chance of making mistakes.

Remember that these forms are relatively simple so anyone can file them. The problem is that they require basic financial literacy. Now, once you learn more about this, you’ll be able to get the most value out of your tax refund, tax returns, and tax deductions. This, however, is still far away.

Investing

Investing is a financial activity that allows your money to make money. So, you take an investment fund, use it to buy stocks or options, and if their value increases, you reap the benefits. You can sell these stocks for profit or collect dividends (if it pays dividends).

The problem with investing is that it’s not as simple as it seems. First, you need to find an investment app (a replacement for a traditional broker) and find the stocks to trade. Then, you need to understand the risk-to-reward ratio (RRR) and decide based on this.

Next, you need to learn how to make stop orders. This allows you to stay financially safe even when you’re not actively monitoring the market movement. In other words, there’s a lot of research and finesse for you here.

Some investors spend hours studying charts and developing trading strategies. Either way, it’s a method that helps you make your investment opportunities more consistent. The last thing you want is to engage in gambling-like behavior.

Wrap Up

While this is far from everything you need to learn, it’s the bare minimum you should be familiar with to consider yourself financially literate. Keeping track of these aspects of your finances will ensure your household or business a much healthier financial life.

Since this is so important, you should enlist in a course or find some learning materials. Lastly, this topic deserves to be taught from a very young age. Only in this way can you help children grow into fiscally responsible adults.