This article has been written by Usha SP pursuing an Executive Certificate Course in Corporate Governance for Directors and CXOs from Skill Arbitrage.

This article has been edited and published by Shashwat Kaushik.

Introduction

Financial literacy refers to the ability to manage money effectively. Money is what is earned in return for the efforts and time you contribute to selling goods or providing services to others. Managing money refers to making the best use of money and controlling it to optimise wealth creation.

It is not always necessary that people with a consistent income and a stable and steady job be financially successful. Likewise, it is not always true that people who earn less are not financially successful. A successful financial journey depends on a person’s attitude towards money and the efficiency with which it is managed.

Financial attitude refers to the way one perceives or evaluates money and their preferences for its usage. Depending on their “financial attitude,” people may choose to decide the amount of wealth they would like to create. People with a financial attitude who want to create more wealth, will need to apply the right financial skills and techniques to achieve their financial goals.

Financial literacy is the process of having the right financial attitude and applying the right financial skills to increase personal wealth and achieve financial goals.  It is an evolving journey in which different aspects of finance management are to be applied based on the financial situation. 

This article seeks to highlight the significance of financial literacy in today’s fast-paced and dynamic world. Wealth creation provides a path to financial freedom. It is also a symbol of one’s personal and societal stability and success.  

Importance of financial literacy

We invest substantial time and effort in earning money.  Managing it efficiently is as important as earning money itself.  Money that is not well “managed”  is wasted time and effort.  Being financially literate helps improve our personal finances and accelerate our efforts to achieve our financial goals. It helps us avoid financial pitfalls and “setbacks”,  by enabling us to  make well-informed financial decisions. Financial literacy helps us navigate the complexities of numerous financial products and services.  It prepares us for financial emergencies and helps us achieve financial milestones. It gives us the ability to improve our spending habits and pay off our debts. Financial literacy grants us the freedom to contribute meaningfully to our family and society.  It protects us from falling prey to financial fraud and safeguards our financial resources. Therefore, it  is imperative to be financially literate. It provides us with the flexibility to lead the life of our choice within our means and desires. 

• Increased financial security: Financially literate individuals are better equipped to make sound financial decisions, which can lead to increased financial security. They are more likely to have a budget, track their spending, and have an emergency fund. This can help them weather unexpected financial storms, such as a job loss or medical emergency.
• Greater financial independence: Financial literacy can help you achieve greater financial independence. When you understand how to manage your money wisely, you can set and achieve your financial goals, such as saving for retirement, buying a home, or paying for your children’s education. This can give you a sense of control over your financial future and allow you to live life on your terms.
• Reduced risk of financial problems: Financially literate individuals are less likely to experience financial problems, such as bankruptcy or foreclosure. They are more likely to understand the terms of their loans, avoid predatory lending practices, and make informed investment decisions. This can help them protect their credit, avoid debt, and build a solid financial foundation.
• Improved decision-making: Financial literacy can help you make better financial decisions in all areas of your life. From choosing a credit card to investing in a retirement account, having a strong understanding of personal finance can empower you to make choices that are in your best interests.
• Increased confidence: Financial literacy can boost your confidence in your ability to manage your money and achieve your financial goals. When you know how to handle your finances effectively, you can feel more in control of your life and less stressed about money.
• Stronger relationships: Financial literacy can also strengthen your relationships with others. When you are financially literate, you can communicate more effectively about money with your spouse, family, and friends. This can help prevent financial disagreements and create a more harmonious household.
• Greater peace of mind: Financial literacy can provide you with greater peace of mind. When you know that you are managing your money wisely and working towards your financial goals, you can relax and enjoy your life without worrying about money.

There are many ways to become financially literate. Some of the most effective ways include:

• Taking a financial literacy course: Many colleges and universities offer financial literacy courses. These courses can teach you the basics of personal finance, including budgeting, saving, investing, and borrowing money.
• Reading books and articles about personal finance: There are many excellent books and articles about personal finance available. These resources can provide you with valuable information and insights that can help you improve your financial literacy.
• Talking to a financial advisor: A financial advisor can help you create a personalised financial plan and provide you with ongoing guidance and support.

Who needs to be financially literate

Any person who wants to be financially successful and gain financial freedom should aim to be financially literate. Parameters such as age, gender, income, and educational or social background do not play a role in determining the need to be financially literate. A person who is not financially literate could find it challenging to achieve financial goals. He may also land in a distress situation in cases of financial emergencies. It is, therefore,  imperative that one start learning the usage of financial products and services and the techniques needed to manage their finances at an early age in life. An early starter can fast-track wealth creation by starting to save early to leverage the power of compounding money and avoid making financial blunders. 

Financial literacy can be achieved by various mechanisms, such as reading up on research information available on the internet, subscribing to financial content, listening to podcasts, reading books, observing others  behaviour in different financial situations and learning from their experiences, reaching out to financial experts or attending workshops and conferences.

Steps to financial literacy

The first step to financial literacy is having the right financial attitude and setting the right financial goals.

Financial attitudes differ by individual and situation. However, financial goals, though individualistic, can be planned and set in advance. Goals can be short, medium or long term.

Short term goals could be just about achieving certain immediate or short-term financial objectives. They could be as simple as managing your expenses within a limited part of your income, deciding on the value of  your rental accommodation, subscribing to OTTs, planning short vacations or making entertainment choices.

Medium-term goals are slightly more long term such as a five-year goal. It may include joining a college, planning an international vacation, buying expensive electronic gadgets or buying jewellery.

Long-term goals are life goals such as higher education, investment in property, buying a medical plan or creating a retirement corpus. Long-term goals generally take a longer time to achieve and are more strategic in nature.

Setting short-term, medium-term and long-term goals helps allocate money to each of these goals to achieve them on a timely basis. There is no age limit to set or execute any of these goals. For example, a college student may not find it interesting or impressive enough to allocate money for a retirement or emergency corpus. However, early investment in these long-term goals reduces the contribution size and thereby makes it easier to achieve the goal. The power of compounding also works to the advantage of an early starter. The money that is saved for long term goals compounds over time and creates a larger corpus, as compared to those who start late. A person who starts late must make larger contributions, making it more difficult to achieve the goals.

Principles of financial literacy

Proper understanding and application of financial principles help individuals attain personal financial goals faster. There are five simple yet key principles of financial literacy that can be applied to short-term, medium-term or long-term financial goals:

Earning income

This is an essential and most important element of the financial journey. An individual should create a steady and stable source of income to start his financial journey. The higher the income, the faster an individual can achieve his financial goals. But even where income is not high, it is important that it be steady. A consistent income helps plan the financial outcome better.

Income can either be primary or secondary. Primary income refers to the income earned from a regular day job, while secondary income is over and above the primary income. It could be generated from small trading businesses or other part-time gigs such as content creation, freelancing assignments, teaching jobs or renting an electronic device that is not in use regularly. 

Saving

Savings are money not spent and that is available for future use. Savings can be accelerated by keeping track of expenses, using financial products such as credit cards, and understanding various financial products and services to maximise benefits from financial products such as insurance, mortgage options, and student loans. The objective here is to minimise expenses and save money. It can be done through bank savings, insurance savings, retirement or pension funds or investment funds. New age digital options such as P2P lending, interest-free EMI options, pay wallets, and other digital payments can also be leveraged to save money. It is important to understand the product or service to optimise the benefits of such options.

Budgeting

Budgeting includes allocating money for expenses and for investments in different financial goals. The proportion and ratio of allocation to each of the financial goals can be determined based on the kind of goal and the amount of money needed to fund the goal. An important element of budgeting is decision-making regarding how much to spend and how much to save. The 50-30-20 rule can be a good method to start with, where 50% of the money earned is spent on essential needs such as food, clothing and shelter. Of the remaining 50%, 30% is spent on luxuries or desires such as entertainment or subscriptions, and the last 20% is saved for future needs to achieve financial goals.

Paying off debt

Making credit card payments on time, clearing bills on time, and managing loans on time help in paying off debt. Paying off debt reduces recurring expenses by way of saving on interest costs, which in turn helps in additional savings.

Investing

Determining the right investment that will help compound money and reduce investment related risks is another key principle of financial literacy. This is a specialised area where one must analyse feasible portfolios and make diversified investments that serve the purpose of wealth creation and risk minimisation.

Numerous investment products and services are available in the market, and one has to make use of financial skills to decide the optimum one based on the financial goals. The general investment portfolios are real estate, stocks and shares, commodities such as gold, silver, or copper, mutual funds, exchange-traded funds and bank savings. Each of these portfolios has its own elements of risks and rewards. The portfolios that generate high returns could have high risk elements too. The risk vs. reward analysis is, therefore, a critical element in investment decisions.

Conclusion

It is important to take the first step and “start” the financial journey by being financially literate. While it is always a good time, an early start would be a game changer in the financial journey to success. Like other essential skills such as time management, critical thinking, decision making, etc., financial literacy is also a skill that will immensely benefit everyone, particularly youngsters. This is an area that calls for immediate attention, and institutions such as schools and colleges should make efforts to create financial awareness at an early age so students can benefit from the financial knowledge they derive.

References

• https://www.investopedia.com/terms/f/financial-literacy.asp
• https://www.investopedia.com/financial-goals-for-students-7151682