Many people have little understanding of finances, how credit works, and the potential hit to financial well-being that poor financial decisions can create for many, many years. In fact, a lack of financial understanding has been signaled as one of the main reasons many Americans struggle with saving and investing.
Some changes in consumer habits and financial products have made it harder for Americans to manage their finances. In the past, most people used cash for daily purchases. Today, credit cards are more frequently used. In 2019 credit use accounted for 23% of payments, up from 21% in 2017.
The way we shop has also changed. Online shopping is now the top choice for many, which can make it easy to use and overextend credit, an all-too-convenient way to accumulate debt quickly. Meanwhile, credit card companies, banks, and other financial institutions are inundating consumers with credit opportunities—the ability to apply for credit cards or pay off one card with another. Without the proper knowledge, it is easy to get into financial trouble.
What Is Financial Literacy?
Financial literacy is the confluence of financial, credit, and debt management knowledge that is necessary to make financially responsible decisions—choices that are integral to our everyday lives. Financial literacy includes understanding how a checking account works, what using a credit card really means, and how to avoid debt. In sum, financial literacy has a material impact on families as they try to balance their budget, buy a home, fund their children’s education, and ensure an income at retirement.
Consumers in advanced economies also fail to demonstrate a strong grasp of financial principles that can help them understand and negotiate the financial landscape, manage financial risks effectively, and avoid financial pitfalls. Nations globally, from Korea to Australia to Germany, are faced with populations that do not understand financial basics.
The level of financial literacy may vary with education and income levels, but evidence shows that highly educated consumers with high incomes can be just as ignorant about financial issues as less-educated, lower-income consumers (though, in general, the latter do tend to be less financially literate). And consumers perceive financial decision-making and education as difficult and anxiety-producing.
Why Financial Literacy Matters
Five trends are converging that demonstrate the importance of making thoughtful and informed decisions about finances.
Financial literacy is crucial to help consumers manage these factors and save enough to provide adequate income in retirement while avoiding high levels of debt that might result in bankruptcy, defaults, and foreclosures. Yet in its Report on the Economic Well-Being of U.S. Households in 2019, the Board of Governors of the Federal Reserve System found that many Americans are unprepared for retirement. One-fourth indicated that they have no retirement savings, and fewer than four in 10 of those not yet retired felt that their retirement savings are on track.
Low financial literacy has left millennials—the largest share of the American workforce—unprepared for a severe financial crisis. Even among those who report having high knowledge about personal finance, only 19% answered questions about fundamental financial concepts correctly. Forty-three percent report using expensive alternative financial services, such as payday loans and pawnshops. More than half lack an emergency fund to cover three months’ expenses, and 37% are financially fragile (defined as unable or unlikely to be able to come up with $2,000 within a month in the event of an emergency). Millennials also carry large amounts of student loan and mortgage debt—in fact, 44% say they have too much debt.
While these may seem like individual problems, they have a broader effect on the entire population than previously believed. All one needs to do is look at the financial crisis of 2008 to see the financial impact on the entire economy that arose from a lack of understanding of mortgage products (and therefore a vulnerability to predatory lending). Financial literacy is an issue with broad implications for economic health, and an improvement can help lead the way to a global economy that is competitive and strong.
The Bottom Line
Any improvement in financial literacy will have a profound impact on consumers and their ability to provide for their future. Recent trends are making it all the more imperative that consumers understand basic finances because they are being asked to shoulder more of the burden of investment decisions in their retirement accounts, all while having to decipher more-complex financial products and options. Becoming financially literate is not easy, but once mastered, it can ease life’s burdens tremendously.
Article Credit: https://www.investopedia.com/articles/investing/100615/why-financial-literacy-and-education-so-important.asp
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