In today’s complex financial landscape, American consumers have an ever-increasing number of demands for their money. They are repeatedly bombarded by texts, emails, and TV commercials hawking a product or service.

Although many advertisers have legitimate offerings, the ads may most appeal to consumers without a money management framework. Stated another way, these consumers may be lacking in financial literacy. Fortunately, says private equity expert Mark Hauser, improving financial literacy is within reach of individuals in every income bracket.

What is Financial Literacy?

The increasingly complex American economy demands an equally good understanding of its diverse components’ operation. Within the past several decades, the United States has gradually moved from a cash economy into a digital economy. Consumers purchase their goods and services with cards and electronic transfers, and they often complete many financial transactions via the Internet.

Learning how to navigate these financial networks is important. With that said, gaining a solid understanding of basic financial skills enables an individual to better manage their money. Specifically, they can adhere to a budget, live within their means, and establish a savings and/or investment program. Stated another way, they are financially literate.

Why Financial Literacy is Important

By taking time to improve their financial literacy, an individual can better manage their money and debt obligations. When they make more appropriate financial decisions, they’ll gradually become more financially stable and less anxious about money.

Higher financial literacy also enables an individual to make ethics-driven decisions about their financial undertakings. When someone purchases insurance or applies for a loan or credit card, they are more likely to smoothly execute the process. In addition, they are better able to understand the implications of unethical or irresponsible actions. 

Likewise, financially literate individuals are better equipped to handle mortgage or student loan repayment demands. When considering the purchase of investments or health insurance, Hauser Private Equity’s Mark Hauser notes that a financially literate person can make decisions based on objective criteria rather than emotion.

Not surprisingly, better financial literacy also enables an individual to work toward longer-term financial goals. Whether they want to operate a business, save for college, or build a retirement fund, solid financial literacy enables a better understanding of each financial objective.  

Substandard Financial Literacy Implications

If an individual doesn’t take time to build basic financial literacy skills, they may develop (or continue) poor spending habits. They may incur more debt than they can realistically repay. Down the line, they could be subject to bad credit, home foreclosure, bankruptcy, and other negative financial outcomes.

5 Key Components of Financial Literacy  

Mark Hauser notes that financial literacy encompasses five primary components. By gaining functional knowledge in each area, an individual is better positioned to manage their money and plan for the future.

#1 - Basic Budgeting Skills

Creating (and adhering to) a budget enables an individual to better manage their money. With a budget, the individual determines their monthly income and expenses. They also integrate their longer-term debt, such as a mortgage payment or a car loan, into the mix. If they regularly allocate a certain amount to a savings or investment plan, the budget should reflect these contributions.

Taken together, an easy-to-use budget template provides a workable financial framework for an individual or household. If they want to make a non-budgeted purchase, they should understand that immediate gratification may negatively impact their financial situation.

#2 - Responsible Loan Management

Individuals often borrow money to buy a car, a house, or other large items. By understanding how the loan process works, the borrower can obtain a loan that accomplishes their goal. If they have considered the loan’s financial implications, they will be able to meet their other financial obligations.

Specifically, an individual should learn how a specific loan structure works. They should understand how interest rates (and compound interest) impact the amount of money they owe. They should also determine whether prepayment penalties will apply if they pay the loan off early. Utilizing a paystub generator can significantly enhance your ability to manage finances responsibly by providing detailed paystubs records of income and taxes, which is crucial for budgeting, loan applications, and tax filing.

#3 - Well-rounded Investment Knowledge

A financially literate individual has a good general understanding of the investment industry. They have learned about the financial markets’ operation, the major players, and the workings of an investment cycle.

A financially literate person also understands the concept of risk management. They see that portfolio diversification can decrease risk while providing exposure to different asset classes. Retail investors’ asset classes include stocks, bonds, mutual funds, exchange-traded funds, and annuities, says private equity expert Mark Hauser.

Learning about investments isn’t a one-time undertaking. A financially literate consumer should continue to monitor the markets’ operation while keeping an eye on influencing factors such as the United States economy. They should also stay current on issues affecting relevant industries and/or companies.

Finally, as their life stage and financial needs change, financially literate individual constantly re-evaluates their investment goals. Working with a qualified financial professional sets the stage for optimal results.

#4 - Relevant Taxation Information

Americans are typically impacted by multiple types of taxation. Employees who earn income are subject to five types of payroll taxes. Federal, state, and local payroll taxes top the list. In addition, each employee has Social Security, Medicare, and unemployment taxes deducted from each paycheck. 

If an individual earns business income, owns or rents a property, receives an inheritance, or otherwise enjoys a financial windfall, they must pay taxes at a specific rate. Each income source has a different tax rate, and each state follows its taxation framework.

Learning about applicable forms of taxation, and understanding how they affect personal or business income, enables an individual to better manage their money. Consulting with a Certified Public Accountant (or CPA) or tax attorney is also recommended. These financial specialists have the skills and knowledge to help their clients stay on the right side of the tax laws.

#5 - Financial Management Acumen

By obtaining a solid foundation in each of the above areas, an individual has the skills to effectively manage their personal (and/or family) finances. They know how to keep the bills paid and funnel money into savings and/or investments.

Ideally, the individual has also established an Emergency Fund containing resources for unexpected (and substantial) expenses. Examples include an unplanned medical problem that prevents someone from earning income for some time. Alternatively, a vehicle’s blown engine may cause the need for an expensive car or truck repair. In any case, a highly liquid Emergency Fund should contain three to six months of household expenses.

5 Ways to Increase Financial Literacy

Every individual’s journey to financial literacy begins at a different point. Some people have a working knowledge of certain financial concepts while knowing very little about others.

To illustrate, an employee with a 401(k) may be aware of their fund’s investments but doesn’t know about other retirement planning vehicles. In another case, a person who receives a substantial raise doesn’t know whether paying off debt or investing the extra money is the better move.

Regardless of someone’s financial literacy level, taking steps to broaden their financial know-how makes sense. Over time, they’ll gain the knowledge to make more appropriate financial decisions. Each of these five tactics will contribute to the solution.

#1 - Delve Into Personal Finance Books

Even in today’s digital world, many people enjoy gleaning useful information from the pages of a real book. Larger brick-and-mortar bookstores and online retailers carry a good selection of personal finance books. Taking time to understand each concept, instead of speed-reading each chapter, will enable readers to best absorb the author’s knowledge.

#2 - Become a Financial Newsletter Subscriber

Trusted financial experts often produce free newsletters in which they share their knowledge on relevant and timely topics. Before signing up for a subscription, however, individuals should research the financial expert’s background and credentials.

#3 - Tune Into Informative Financial Podcasts

Today, the airwaves are full of financial podcasts. Credible financial experts often produce their podcast series. Alternatively, professional podcast hosts welcome a succession of business and financial industry luminaries. Listeners can take in a podcast while they commute, run errands, or perform other activities.

#4 - Consult with a Financial Expert

According to experienced financial investor Mark Hausr, gathering financial information from credible sources is important. However, research isn’t a substitute for a credentialed financial professional. Whether an individual needs assistance with basic money management or they have investment-related questions, the advisor can help their client develop a plan to work toward their goals. Mark Hauser emphasizes the importance of vetting financial professionals before relying on their advice.

#5 - Track Expenses with a Household Budget

This timeless advice still has value in the 21st century. Reviewing adult earners’ income and expenses enables an individual or family to determine the household cash flow. Equipped with this information, they can identify their financial goals and design a budget that makes progress toward them. An easy-to-use app or spreadsheet can provide a good budget template.

Financial Literacy Continues to Evolve

Economic trends continue to evolve, and debt and savings/investment vehicles change over time. By staying current on the latest developments, and perhaps consulting with a qualified financial professional, an individual can maintain a good financial literacy level.