What Is Financial Literacy and Why Is It Essential?

Your level of financial literacy can mean the difference between living comfortably and struggling to survive between paychecks. It can determine when you retire, where you live, and what opportunities you give your kids. Every decision you make with your money affects not only the present moment but also the future.

When you apply for a credit card, buy a home, or put money in a savings account, your financial literacy skills will be tested. That raises the question, what is financial literacy exactly?

In this article, we'll dig into the details of what it means to be financially literate. We'll also explain how it can affect your life and why teaching money management concepts to your kids is so meaningful. Better yet, we'll help you figure out how to make that education happen in a way that actually works.

What Is Financial Literacy?

Financial literacy is the ability to understand and effectively use financial skills, such as budgeting, opening a savings account, and improving credit. As people work toward becoming financially literate, they learn how to successfully manage their money so that they can achieve their goals.

Financial literacy skills are also the foundation for financial competency. While literacy refers exclusively to building knowledge about finance, people achieve financial competency when they start making better decisions and changing their behaviors.

Keep in mind that the shift from literacy to competency doesn't happen automatically. It develops as people experience real-world challenges and make continual efforts to overcome them.

When teaching kids about financial literacy, it's especially important to emphasize that the path to competency isn't always a straight line. People fail and make bad choices, but that doesn't mean all is lost. Studying financial concepts at a young age allows people to learn through trial and error when the stakes aren't as high.

Why Is Financial Literacy Important?

It's impossible to overstate the importance of financial literacy. It helps people build better habits and a healthier relationship with money. This, in turn, empowers them to create the life they want for themselves.

Financial Literacy in the Modern World

Although financial literacy has always been important, the development of new types of investments, technologies, and currencies has made it more essential than ever. Credit and debit cards, "buy now, pay later" services, and digital wallets make it easier to spend recklessly without considering where your money is going or how much debt you're accumulating.

According to a 2022 report from the Pew Research Center, 41% of Americans didn't use cash for any of their transactions over the prior year, and experts project that cashless transactions will continue to dominate the financial landscape. As people shift away from cash, it becomes increasingly important for people to understand how every decision can affect their financial well-being.

Some of the situations you might experience if you lack financial literacy include:

• Accumulating an unsustainable debt burden
• Having a poor credit score
• Filing for bankruptcy
• Losing your home to foreclosure
• Delaying your retirement

Ultimately, people are more likely to struggle with money if they've never learned about personal finance.

Societal Impacts of Financial Literacy

In addition to affecting individuals, each person's financial literacy also shapes their society and the world. When entire generations are unprepared to manage their finances, they're more likely to take on debts that they can't afford. Over time, this pattern of poor decision-making could lead to an economic crash or downturn that creates problems for everyone.

Financial literacy doesn't guarantee that any one person will become wealthy or that the economy will thrive — there's a whole host of other factors that influence both of those outcomes. However, it does significantly improve the chances that people will adopt more effective financial strategies that benefit themselves and the people around them.

Benefits of Financial Literacy

In a financially literate society, people live with less uncertainty. At a personal and community level, they experience a variety of benefits, including:

• Avoiding costly mistakes: Financial literacy helps prevent choices that cost substantial money, such as carrying high debt levels. These types of mistakes can affect your life plans long into the future.
• Preparing for emergencies: A person who has a good grasp on their finances can get ready for the unexpected. They're more likely to save money for hard times like illnesses or accidents.
• Achieving financial goals: Financial literacy also makes you better equipped to bring your vision to life. Buying a home, retiring, or simply taking an annual vacation is more achievable when you understand your finances.
• Lowering stress: In 2023, 70% of Americans reported feeling stressed about their finances. Financial literacy reduces the strain and lets you spend less time worrying about whether you're making the right choices.

Generally speaking, financial literacy translates to a higher quality of life. Knowing about financial instruments and other key aspects of finance increases your confidence and allows you to contribute to a stronger society.

What Are the Main Components of Financial Literacy?

There's a lot to cover when you study financial literacy, from simple subjects like opening a bank account to more complex topics like compound interest. However, there are a few core principles that serve as the bedrock.

Budgeting

When it comes to financial literacy topics, budgeting is at the top of the list. With a budget, you plan how you'll use your income for different kinds of expenses, including your household needs, entertainment, and savings. In practical terms, however, it can be much more difficult to put a budget into place, especially if you've never learned what one should look like.

Developing an effective budget helps people avoid living paycheck to paycheck. It also makes their spending more predictable because they know exactly how much money they have available and where it needs to go. Once you understand budgeting, you can build on that knowledge to develop more advanced financial skills.

Saving

Another of the most important concepts of financial literacy is starting, growing, and maintaining your savings. When you save money, you become more financially secure and can work toward your short and long-term goals. You're also less likely to go into unnecessary debt when paying for things you need or want, such as car repairs or vacations.

Financially literate people understand that they need to have different kinds of savings to serve different purposes. For instance, you might have one account for retirement, another for fun expenses like trips, and a separate account for emergency savings.

Managing Debt

It's not unusual or even necessarily bad to have debt, but learning how it can affect you is one of the most important aspects of financial literacy. People often have multiple types of debt, such as:

• Student loans
• Auto loans
• Mortgages
• Personal loans
• Credit cards

It's vital to understand the difference between good and bad debt and how each can affect your credit score. Financial literacy helps people of all ages avoid getting trapped in a never-ending cycle of debt. This often happens if you only make the minimum payments on your loans or credit cards.

Investing

Making wise investments is key to achieving your financial goals. That's why investing is a central topic in many financial literacy lessons. Signing up for a retirement account and knowing what types of investments to make helps ensure that people put their money in the places where it will serve them best.

For kids, learning about investing usually starts with basic skills. As children get older, they learn about more specific issues, including different investment types. They'll also see the importance of diversification and how it can influence their overall financial health.

Building and Maintaining Credit

Credit is one of the most critical principles of financial literacy because it can have serious long-term repercussions. Bad credit makes it difficult to qualify for a mortgage or get good interest rates on loans. As part of financial literacy, people learn what determines a credit score and what types of actions might strengthen or weaken it.

While most kids don't have credit cards in their names, that doesn't mean they don't need to understand the concept. They should learn how to build credit over time and understand the dangers of becoming overly reliant on credit cards. This will prepare them to make more informed financial decisions and avoid getting buried in debt.

Financial Literacy for Kids

People sometimes assume that children don't need to know about personal finances because they don't bring in a steady income or make decisions for their families. In reality, education in financial literacy is one of the best gifts that anyone can give their child.

Why Kids Need Financial Literacy

Most parents dream of a better future for their children, one that allows them to follow their dreams while also breaking free of financial stress. One of the best ways to make both of those things happen is by providing lessons in financial literacy.

When kids understand money, it sets them up for a better future and gives them plenty of time to develop money management skills. Kids who learn about finances are more comfortable talking openly about money and get to learn from their mistakes at a time when a single error doesn't cost them everything, including the roof over their heads.

Some parents mistakenly assume that they don't need to talk to their kids about money because they're learning everything they need to know in school. Unfortunately, many schools are already short on the time they need to cover core subjects. As a result, they often don't include financial literacy in their curriculum.

That means that kids who don't learn about it at home may not have the chance to develop the skills they'll need as adults. Parents and caregivers can remedy that problem by finding ways to bring financial literacy into their home lives.

How to Teach Kids About Financial Literacy

With so many competing responsibilities, it can be tough for parents to find time to teach financial literacy skills. It's especially problematic when parents never learn financial concepts themselves. They might feel at a loss when it's time to teach their kids.

The first step is to make financial literacy a part of your everyday life by including it in your regular conversations with your kids. For example, when you eat at a restaurant, set a budget for your meal and talk about the menu prices.

There are also many tools available that focus specifically on financial literacy for kids. Take advantage of them to make financial literacy more accessible and engaging for your family.

Using Books and Resources

Unless they're trained in finance and education, most parents don't want to make financial literacy lessons from scratch. The good news is that more and more authors are addressing this problem by writing financial literacy books for kids.

Even very young children can learn much from whimsical preschool-level books covering saving and spending. Reading and discussing these books exposes kids to the information they'll need down the road.

With a quick online search, parents can find pre-made lessons explaining basic financial concepts. A lesson plan for financial literacy often includes definitions in simple language that you can use to explain the subject to your kids. It might also describe an activity that allows them to practice what they learn.

Playing Games

When you make learning fun, kids are much more likely to want to take part in it and to remember what you tell them. Financial literacy games for kids cover topics like saving, spending, and investing in a way that makes money exciting and positive.

There are many money-saving apps for kids, but only one of them includes a bank account, a debit card, and a fully-developed game. GravyStack is a gamified banking platform for kids and teens. It teaches them about a variety of financial literacy concepts and lets them complete different tasks, including:

• Earning money
• Separating income into save, spend, and share jars
• Investing in stocks
• Making contributions to charities
• Playing budgeting, saving, and investing games for kids

Rather than dreading a nightly conversation about how important it is to manage their money, your kids will look forward to playing games and watching their money grow on GravyStack.

Examples of Financial Literacy

When kids go to school, they often ask why they must learn about abstract topics that will never apply to their lives. When it comes to financial literacy, it's easy to explain why their lessons are worthwhile. Put it into context by discussing what these financial literacy examples look like in the real world:

• Creating a budget for your family
• Comparing and selecting the best loan terms when you buy a new car
• Choosing how much money to contribute to your retirement fund each month
• Deciding whether to apply for a loan based on your current credit score
• Applying for different types of financial aid to attend college

Each of those situations could have very positive or negative effects depending on how you approach them. A young student who never learned about financial literacy, for instance, might not know about loan opportunities with lower interest rates, causing them to carry unnecessary debt long after they graduate.

As another example, imagine that you're making a decent salary but spending almost everything you bring home. You don't put anything in an emergency savings account because you feel that your paycheck is enough to get by, regardless of what happens. You might be lucky and never encounter an emergency, but you could also lose your job or find yourself temporarily unable to work because of an injury.

Without an emergency fund, you might resort to paying your bills with credit cards. You could also accumulate significant late fees, putting you in additional debt. By the time you get back to work, you've fallen into a perilous financial position that leaves you struggling to keep up with even your most essential bills.

This is a very real possibility for the 22% of Americans who have no emergency savings. It underscores that financial literacy has the power to reshape your life for years or decades to come.

Make a Lifelong Impact on Your Kids with Financial Literacy

Whether you've never heard of financial literacy or studied finance in college, teaching kids about money is a unique challenge. It's also one of the most crucial contributions you can make to their future happiness. They'll make smarter decisions and live a higher quality of life when they eventually leave the nest.

Financial literacy is way less complicated with GravyStack. Kids can earn, save, and play, all while learning what they need to know about money management. Sign up today to help your kids create a world where money is a source of stability instead of anxiety.