Financial literacy refers to one’s ability to understand and apply sound financial management skills. Those who are financially literate are able to achieve a lifestyle that is financially sustainable, balanced, and responsible. The best way to manage your finances is by increasing your financial literacy – prioritizing budgeting and saving, as well as understanding credit and debt.
What is Financial Literacy?
To be financially literate, one must possess the knowledge and ability to make good financial decisions. According to the Federal Financial Literacy and Education Commission, being financially literate means understanding these five key principles:
- Knowing how much you earn and being knowledgeable about mandatory deductions and tax withholdings. This will allow you to forecast the money that will be available to you (your net income).
- Understanding the effect that interest rates have on borrowed money and building a strong credit score by making repayments on time.
- Saving and Investing. Planning for long and short-term savings goals, and setting money aside for emergencies. It is also important to understand how you can grow your savings through investment strategies that fit your goals.
- Understanding the importance of spending within your budget and being a smart shopper. This includes the process of setting and sticking to a monthly budget, as well as being a responsible consumer.
- As identity theft and fraud attempts are increasingly common, it is crucial to understand how to safeguard your financial information.
Financial Literacy vs. Poor Financial Literacy
Debt levels in Canada are increasing rapidly, with average household debt now at 177% of disposable income. What that means, is that there is $1.77 in credit for each dollar of household disposable income. The average amount of household debt excluding mortgages is $20,759. According to the 2019 Canadian Financial Capability Survey, roughly one in six Canadians (17%) have monthly expenditures that exceed their monthly income and one in four (27%) need to borrow to pay for essential expenses.
Developing and maintaining a budget is an important part of becoming financially literate. Studies have shown that Canadians who budget their monthly expenses are half as likely to fall behind on their financial commitments than those who don’t keep a budget. A sign of financial literacy is planning for savings, and Canadians who do so are much more confident that they know how much they need to save for retirement; 56% vs 28% for those who haven’t planned for savings. Budgeting is a sign of even greater financial literacy, and 61% of Canadians who keep a budget indicated that they would be able to come up with $2,000 to cover an unexpected expense compared with only 46% for those who feel too time-crunched or overwhelmed to create a budget.
How Financial Literacy Can Help Your Bottom Line
Financial literacy should be considered a necessity rather than a luxury, as understanding how to manage your finances properly will allow you to make better decisions that will improve your long-term financial standing. Let’s take a closer look at some of the main focuses of financial literacy:
- While it may seem like a daunting task to commit to a savings plan, you should aim to start saving as soon as possible – even if it’s only a small amount at first. Start by making long-term (e.g. saving for retirement) and short-term (e.g. saving for an emergency fund) savings goals and hold yourself accountable to them. You may be surprised by how quickly your savings can add up.
- Learning to manage debt responsibly is a major component of financial literacy. Make sure that you understand the true cost of taking on new debt and be aware of bad habits that may hurt your credit score. One way of taking more control of your finances is to pay down your debt as soon as possible and avoid falling into credit-debt cycles.
- Budgeting will help you manage your finances and you should avoid overspending on non-essential items. Try to set a budget that is realistic and one that you can hold yourself accountable to.
- Learning how to grow your savings is an important process in becoming financially literate. Evaluate what your targets are and select investment strategies that suit your goals and risk profile.
The bottom line is that being financially literate will equip you with the knowledge required to manage your money more effectively – every decision you make relating to your personal finances will be done so upon sound principles.
How to Improve Your Financial Literacy
You can achieve financial literacy by learning financial concepts and applying them to your everyday life. There are many avenues from which you can learn from, such as consulting your friends and family, doing your own research, and using technology to assist you.
- Speak to friends and family. Although each situation is unique, consulting your friends and family members who are financially responsible can help you determine a course of action to achieve financial literacy for yourself. It is never too early to start – by seeking advice when you are young, you are building a great foundation for yourself to become more financially literate.
- It is important to do your own due diligence when it comes to your finances. By understanding the different factors that affect your investments, the growth of your savings, and your borrowing costs you’ll be able to make better decisions to improve your financial health. Resources such as podcasts, books, and expert advice on social media can help you improve your financial literacy.
- There is a wide range of personal finance apps and software that can help you make better decisions while providing you with the tools to learn. According to Statistics Canada, Canadians who use digital tools for budgeting are among the most likely to stay on top of their bill payments and monthly cash flow.
Becoming financially literate can be a hard process, but it is something that everyone can and should master. Understanding basic finances will allow you to make good financial decisions for your future and improve your long-term financial health.