7 Steps to Financial Literacy

Financial literacy is the knowledge of an individual of financial matters like budgeting, investing, banking,
and personal financial management, etc.

This is the knowledge that helps someone to take appropriate action regarding their financial affairs.

Being financially literate can change one’s ability to earn a livelihood, contribution to society and one’s
attitude toward money.

Financial literacy helps a person to achieve a financially balanced, responsible, and ethical lifestyle and
make appropriate financial choices during their lifetime. Studies have shown that financial literacy
greatly affects a person’s saving, investment, debt management and loan taking practices.

The Steps to Financial Literacy

Financial literacy is crucial to making appropriate financial choices throughout life.

The seven steps to help you to improve your financial knowledge and literacy.

These steps are:

1. Learn How to Budget

The first step to gain financial literacy is learning how to budget.

When you have a budget plan, you can spend money accordingly and will be able to save any extra to
use later in case of an emergency.

Without a budget plan, you will be unable to control your spending and, as a result of this overspending,
may suffer if your salary or allowance ends.

In order to make budget plan, you first need to note your monthly income and, second, track your
spending. You need to include all your fixed expenses like your rent, utility bills, loan payments and then
include variable expenses such as groceries, entertainment, etc. After tracking your major spending,
make sure to set your financial goals, saving money for example. There are two types of financial goal:
short-term goals (can be achieved within a year) and long-term goals (may take longer than a year, such
as retirement savings etc.).

After setting all these up, finalize your plan and make sure to follow it in order to achieve financial
balance.

2. Understand Your Credit Score

It is very important to understand your credit score. But why is your credit score important, how is it
calculated, and how can you do it?
When someone pays off their credit bills on time, they are viewed as trustworthy by the lender. They
begin to build a credit history and are afforded an improved credit score that will help them obtain
future loans. In the US, a credit score is a three-digit number from 300 to 850. A high score indicates
someone who is a low risk financially and who repays their credit bills on time, while a low score
indicates someone who is a credit risk and who has likely not previously paid their credit bills on time.

You should also be aware of your credit report, which is a summary of your financial situation. By
reviewing your credit report, you will be able to spot any errors or fraudulent entries and can take legal
steps to overcome the loss. This report may also help you to track your spending and improve your
credit score over time.

3. Open a Savings Account

A savings account will help you to save any extra money you have, is the best way to keep your money
safe and secure, and may even pay you interest, offer insurance and security.

A savings account also makes billing easier and more convenient for the user, while an ATM card is
portable and better than keeping cash in a wallet.

4. Understand Loans

It is important to understand the importance of paying off your debt/loans.

Having a debt-free life is a desirable dream for most individuals. There are two ways to pay off your debt
fast. One way is to identify the loan with the highest interest rate and pay this off first, hence reducing
the amount of interest you will need to pay in the long term. Once this debt is cleared, you can then
focus on paying off the loan with the second highest interest rate, and so on.

An alternative approach is to pay off all small debts first and then focus on the larger loans.

5. Expect Risk

It is crucial to be ready for unexpected risks with money put aside in case of emergency.

Many people don’t anticipate such risks and suffer as a result. Think about the Covid-19 crisis and how
many people all around the world suffered financial loss because they were not prepared.

Experts say that you should have a reserve of three to six months living expenses for use in case of an
emergency. When you are prepared for unexpected risks in this way, you will be able to keep a minor
financial crisis from turning into a major one. For example, if you were to lose your job, you should have
enough savings put aside to meet your monthly expenses until you can find a new job.

Unfortunately, some people become homeless after losing their job because they hadn’t anticipated this
risk.

6. Secure Your Future

It is also important to be ready for your retirement. Many people may think they are too late already,
but it is better late than never. Making an appropriate retirement plan is a crucial step in financial
literacy.

The first thing to do when planning your retirement is to consider your age and when you would like to
retire. You should then determine your retirement spending needs, like monthly bills, grocery bills and
medical expenses. Then calculate the investment rate of return and decide if your retirement fund will
be able to generate the required income after tax. After that save money and make appropriate
investments for your retirement.

7. Reduce Spending

If you wish to put more money aside as savings, you have two choices. You can either take on another
job to increase your income, or you reduce your outgoings or expenditure.

Spending can be reduced by planning your grocery shopping list carefully. For example, if you want to
buy two items but also want to reduce your spending at the same time, you need to identify the most
important item and buy that one first. The next month when your new salary comes in, you can buy the
second item. Dividing your spending over a period of several months in this way can help you to save
money. And reducing your spending will help you to reach your financial goals.

Key Takeaways

Financial literacy is the ability to make wise decisions with your money.

The five principles of financial literacy are earning, saving, borrowing, spending, and protecting assets.

Financial literacy helps you make better financial decisions and improves overall financial well-being.

Financial literacy skills include finding, understanding, and using resources for informed decision-
making.

Developing financial literacy skills promotes financial self-sufficiency and stability.

What Is Financial Literacy?

Financial literacy is the ability to understand the use of money as it applies to your personal finances,
according to the National Financial Educators Council.

It can help you make better decisions and is a key element in improving your behavior and planning
when it comes to your personal finances and overall financial wellness.

Financial Literacy Skills

Financial literacy skills include an ability to find, understand and use resources and information to help
you make informed decisions about your personal finances, according to the American Institutes for
Research.
Having these skills can provide the confidence, knowledge, and ability to make solid financial decisions.
Financial literacy skills promote financial self-sufficiency, stability, and well-being.

Why Is Financial Literacy Important?

Financial literacy is important because it empowers you to make informed and responsible financial
decisions. It helps you understand concepts like budgeting, saving, investing and debt management.

It allows you to make better decisions through problem-solving, critical thinking and having a grasp of
essential facts and concepts related to basic personal finance.

Building your financial literacy helps you create a secure future, avoid financial pitfalls and achieve your
financial goals.

The 5 Principles of Financial Literacy

Earning

Saving and investing

Borrowing and managing your debt

Spending and planning

Protecting your assets

These principles of financial literacy serve as a road map for good money management and are the
establishment of a solid financial foundation. Learning about them — and putting them into practice —
can improve your financial situation now and in the future.

Earn

Your income is the foundation of your personal finances. It is the basis for your lifestyle and your
financial future.

Implementing the Principle

Learn to live within your means and pay for your lifestyle without excessive debt.

Manage your income and workplace benefits.

Take advantage of employer matches for your 401(k) or similar retirement plans.

Find ways to put aside portions of your income for the future.

Set up automatic retirement plan contributions so you won’t be tempted to skip a contribution toward
your retirement.

Saving and Investing

Creating a budget will help you put aside money for savings and investments. This allows you to grow
your wealth and can empower you to make major financial plans such as buying a house or paying for
retirement.

Implementing the Principle

Monitor where your money is going each month.

Cut out optional expenses for things you can live without and put the money into savings or investments
such as an IRA, investment fund or annuity for retirement.

Create separate categories or “buckets” in which you can set money aside for specific goals from holiday
presents to vacations to home purchase to retirement.

Borrowing and Debt Management

Borrowing wisely will allow you to make major purchases while building your credit. This can help you
pay for a home, car or a college education. But avoid excessive debt that can eat into your ability to save
and invest in the future.

Implementing the Principle

Carefully weigh major loans to determine if you can afford them — make sure you live within your
means.

Review and compare interest rates before applying for a loan.

Keep debt to a minimum and easily manageable within your budget.

Pay your bills on time and make more than the minimum payment.

Monitor your credit score.

What is a wise strategy to stay out of debt?

What is a wise strategy to stay out of debt? - Featuring Chip Stapleton

Financial expert Chip Stapleton offers a wise strategy to get and stay out of debt that anyone can
practice.

Spending and Planning

When you get your paycheck, consider following the 50-30-20 budget or the 80-20 strategy.

Following the 50-30-20 budget means putting 50% of it toward needs, 30% toward wants and the
remaining 20% toward savings and investments. This is one of several personal finance strategies that
can help you keep your spending on track.
With the 80-20 budget, you “pay yourself first” by setting aside 20% for savings, then using the
remaining 80% for both fixed and variable expenses.

Implementing the Principle

Shop for the best value when making purchases.

When making a large purchase, consider whether it is a need or a want and consider whether buying it
is within your means.

Consider “paying yourself first” by making it a habit to set money for savings aside before anything else
to shape and drive your budget.

Protecting

You will need to protect your financial assets: savings, investments and your budget. This can take the
form of an emergency fund and insurance.

Implementing the Principle

Create an emergency fund — enough money to pay for three to six months of expenses.

Determine with your spouse or partner what constitutes an emergency and only dip into the fund for
those situations.

Purchase insurance to cover risk to yourself and your belongings. Consider homeowners or renters
insurance, health insurance, car insurance, disability insurance and life insurance.

How To Set Financial Goals

To set financial goals, start by distinguishing between short-term and long-term objectives. Short-term
goals focus on immediate needs or desires. Long-term goals encompass longer-term milestones like
retirement or buying a house.

Determine how much money you need to achieve each goal. You’ll need to consider factors like inflation
and time horizons — the amount of time left before your goal. You can break down the goals into
smaller milestones and create a timeline for accomplishment.

You can use tools like spreadsheets for budgeting apps to track your progress. And you should regularly
reassess and adjust your goals as circumstances change.

Celebrating milestones along the way will help you stay motivated.

How To Create a Budget

A budget is a plan for spending your money each month. Creating a budget will help make sure you
don’t run out of money before the month is up. You can also use it to save money to pay for long-term
goals.
Begin creating your budget by making a list of your monthly expenses.

Expenses can include:

Rent and other bills that are the same each month

Utilities and other bills that are different each month

Car insurance and other bills you may only pay once or twice a year

Clothes

Credit card bills

Entertainment

Food

Gas and transportation

School supplies

Unplanned expenses such as home or car repairs and medical expenses

Now, figure out your income. Write down how much money you make every month. Include all forms of
money, like paychecks, tips, side jobs or child support.

Finally, subtract your expenses from your total income. If the number is less than zero, you are spending
more than you make. You’ll need to look for places to cut back your expenses or find a way to make
more money.

If you get a number greater than zero, this is money you can budget each month toward savings or some
other financial goal

Using Your Budget

You can use your budget to make a plan at the beginning of each month on how you will spend the
money you earn.

Keep track of your spending by writing down everything you spent each day — or keep track using an
app. At the end of the month, you can see where your money went.

This can help you adjust your spending. You may discover expenses that you can cut back on — or
eliminate.

Use this knowledge to adjust your next month’s budget. If you do this every month, you’ll eventually
fine tune your spending and saving to make it more manageable and efficient. And it can help you start
saving more.
How To Save Money

To create savings, start by setting up a dedicated savings account. Making a separate account will help
you separate your savings from your everyday expenses.

Next, make regular deposits into this account, whether it’s weekly, monthly or based on your paycheck.
Consistency is key.

Automating your savings deposits can keep your deposits consistent. Direct deposits from your job
mean you won’t notice a portion of your income going into savings. Automated deposits can keep you
from skipping one. You also won’t forget to make a deposit.

By following these

simple steps, you will build up your savings over time.

How To Invest Money

When you invest your money, it’s essential to have a clear financial goal in mind. Most people invest for
retirement, but others invest for specific purposes like buying a home or paying for their children’s
education.

Starting with employer-sponsored retirement plans, such as 401(k)s, can be a great way to begin
investing, especially if your employer matches your contributions. By consistently putting money into
these plans, you can build significant savings over time.

Different investment options, such as stocks, bonds and mutual funds, come with different benefits and
risks. It’s essential to know the level of risk you’re comfortable with and balance that against your
financial goals. This balance varies from person to person, so understanding your risk tolerance is
crucial.

Finally, the amount you should invest depends on your unique financial situation and goals. It’s never
too late to start investing, but the earlier you begin, the more time your investment portfolio has to
grow.

How To Protect Your Assets

Insurance is important to protect your assets because it provides financial security in case of unexpected
events, such as accidents, natural disasters or lawsuits, minimizing the financial impact and helping
safeguard your hard-earned assets.

Types of Insurance for Protecting Your Assets

Life insurance

Disability insurance
Health insurance

Homeowners or renters insurance

Life Insurance

The most important reason for purchasing life insurance is to provide financial protection to named
beneficiaries in the event of the policyholder’s death.

You can also develop life insurance strategies to help achieve various financial goals, such as saving for
education, retirement, optimizing estate plans and supporting business succession plans.

Disability Insurance

Disability insurance is important because it protects your income in case you become disabled and can
no longer work.

It covers common but disabling injuries and illnesses that can prevent you from working for extended
periods of time, such as cancer or severe bodily injury. It can also provide an income source while you
are unable to work.

It is especially beneficial for sole providers or parents who need to support their families. People with
recurring injuries or those in physically demanding jobs should also consider disability insurance.

Health Insurance

Health insurance protects you against financial risks from high medical costs. It covers the most essential
medical benefits necessary to keep you healthy. And it helps you pay for treatment of injuries and
illnesses.

It also covers preventive care, which can detect a serious condition early. This can lead to early and less
complicated treatment. Health insurance is often provided by employers in the United States. But you
can also purchase health insurance on your own.

Homeowners or Renters Insurance

Homeowners and renters insurance protect your belongings if they are lost, damaged or destroyed
through theft, accident or acts of nature. Both can also protect you financially if someone is injured in
your home or apartment.

In the case of homeowners insurance, your whole home may be insured against loss or damage.

Common Financial Mistakes

Financial literacy can help you guard against some of the most common financial mistakes people make.
These include problems with credit card and student loan debt and predatory lending.

Credit Card Debt

The most common financial mistakes with credit card debt include overspending, making only minimum
payments and carrying high-interest balances.

To avoid the credit card debt trap, stay on budget and only charge what you can pay off each month to
avoid interest and build your credit score. It’s also wise to set up automated payments so you don’t miss
any, adding unnecessary interest and penalties to your bill.

Making more than minimum payments each month can help to pay off your debt faster.

Student Loan Debt

With student loan debt, common mistakes include borrowing more than necessary and not
understanding repayment options.

Tips for Avoiding Student Loan Debt

Apply for financial aid, grants and scholarships to reduce your reliance on loans.

Consider federal, state or nonprofit loans over private loans.

Only borrow what you need.

Pay interest while still in school to reduce the amount of debt.

Refinance your loans if interest rates go down.

Even before applying to college, student financial literacy should be a critical part of a young person’s
education.

Predatory Lending

Predatory lending mistakes involve falling for high-interest loans and deceptive lending practices.

To avoid becoming a victim, do your research and compare loans from several lenders. It’s best to avoid
high-interest loans, particularly those at interest rates that grow faster than you can repay them. Don’t
sign any loan agreements without understanding everything required for repayment.

Be cautious of phone calls, door-to-door or mail solicitation offering loans. These are often a sign of
predatory lending.

Financial Literacy Among Specific Demographics

Financial Literacy for Women

Low financial literacy rates among women significantly impact their lives, leading to increased effort,
longer debt repayment and lower earnings.
According to findings from The American College of Financial Services, 79% of women could not pass a
retirement income literacy quiz compared to 72% of men.

Women also face obstacles due to the wage gap, housing market disparities, divorce-related financial
consequences and inadequate retirement planning. But resources like the Women’s Institute for
Financial Education, WISER and FLOW provide assistance and guidance for financial empowerment.

Financial Literacy for the Black Community

The racial gap in financial literacy is significant in the black community, with African Americans scoring
substantially lower than white Americans.

Members of the black community in the U.S. answered only 37% of questions on a personal finance
survey correctly compared to 55% of white Americans, according to a study by the TIAA Institute and the
Global Financial Literacy Excellence Center.

African Americans struggle the most with insurance and risk comprehension, while debt management is
their strongest area.

Financial Literacy for Latinx Households

Financial literacy in the Latinx community lags well behind white Americans. But it is crucial for the U.S.
Latinx community, whose members face economic disadvantages and a significant wealth gap compared
to white Americans.

Financial literacy rates for the Latinx community were 38% on the 2022 TIAA Personal Finance Index,
compared to 50% for all adults on average and 55% for white Americans.

Limited access to education, low wages and fewer benefits contribute to the wealth disparity. Better
understanding financial literacy and utilizing available resources can help improve individuals’ financial
situations.

Financial Literacy for LGBTQ+ Individuals

LGBTQ+ workers earn 10% less than the average wages in the U.S., according to a 2021 survey from the
Human Rights Campaign.

More than 44% of the LGBTQ+ community report they struggle to maintain adequate savings. That’s six
points higher than the general population, according to a 2023 study. Among younger members of the
community. Nearly half of those aged 25 to 34 said they had poor spending habits they wanted to
improve or change.

There are free financial literacy resources tailored to LGBTQ+ individuals such as Healthy Rich and The
Debt Free Guys, with a companion podcast called Queer Money.

Financial Literacy for People with Disabilities

People with disabilities scored lower than the national average on a measure of financial literacy,
according to a study by the National Disability Institute and FINRA.

The study found that people with disabilities:

Scored lower when tested on basic financial concepts — 44% correct answers vs. a 53% national
average.

Had a lower perception of their financial knowledge — 70% saw themselves positively vs. an 81%
national average.

Have similar access to financial education — 20% were offered and participated in programs vs. a 22%
national average.

The National Disability Institute provides financial empowerment resources specifically tailored to
people with disabilities. These include financial education, capability and financial wellness resources.

Financial Literacy for Older Adults

Financial literacy among older Americans is a mixed picture.

The share of the population that can answer basic financial literacy questions increases with age. But it
drops off sharply at age 75 and older, according to a report by the U.S. Senate Special Committee on
Aging.

Common issues with financial literacy among older adults include a lack of knowledge about retirement
planning, health care costs and scams. Greater financial literacy knowledge can also help address the
financial abuse of older adults.

Financial Literacy for Veterans and Service Members

Financial literacy for veterans and service members is a significant problem, according to a report by the
U.S. Federal Reserve.

More than a third of service members reported difficulties in paying their bills and only half had an
emergency fund, according to a joint study by the U.S. Treasury Department and the President’s
Commission on Financial Literacy.

Transitioning out of the military leaves many veterans scrambling to adjust to civilian life, civilian health
coverage and creating a post-military budget.

Financial Literacy for First-Generation Americans

New immigrants and first-generation Americans face obstacles in financial literacy due to language and
cultural differences. These challenges affect banking, credit, taxes and Social Security.
Of the more than 44 million immigrants living in the U.S., about 14.8 million had family income below
200% of the federal poverty level, according to a 2022 study by the Migration Policy Institute.

“Although low-income immigrants are a minority of all immigrants, they are of particular interest to
policymakers and service providers seeking to support individuals and families who may need tailored
assistance to get on a path to upward economic mobility,” the study authors wrote.

Support is available through financial advisors specializing in immigrant needs and organizations like
Immigrant Finance and the International Rescue Committee. Community groups such as CASA and
Immigrants Rising also offer assistance.

Resources for Financial Literacy

The best resources for learning about financial literacy include financial experts. Look for reputable
websites, online courses and books by financial experts. Financial institutions, public media and
community organizations also offer educational videos and workshops.

These sources provide information and resources to build financial knowledge and decision-making
skills.

Financial Literacy Resources

U.S. Consumer Financial Protection Bureau

CFPB’s youth financial education programs offer beginner courses in financial literacy for people who
need a place to start.

FINRA

The Financial Industry Regulatory Authority, better known as FINRA, offers tools and courses through its
Investor Education Foundation to help you learn about personal finances and investing. You can access
many of its programs through local libraries.

Investor.gov

You can access free financial planning tools through Investor.gov, the official website of the U.S.
Securities and Exchange Commission. Tools include a Social Security estimator and a compound interest
calculator.

MyMoney.gov

MyMoney.gov from the Federal Financial Literacy and Education Commission focuses on the five
principles of financial literacy: earn, save and invest, spend, borrow and debt management, and protect.
It also includes tools and worksheets to help you plan your financial future.

Financial Literacy Resources for Older Americans

FDIC — Money Smart for Older Adults

Consumer Financial Protection Bureau — Working With Older Adults

National Council on Aging — Savvy Saving Seniors

Financial Literacy Resources for Veterans

The U.S. Department of Veterans Affairs provides a long list of financial literacy resources for veterans.
Nonprofit organizations such as the Wounded Warrior Project also provide financial literacy resources
for vets.

Key Terms

These are some key terms you should know when researching or studying financial literacy. You can find
more terms in the Annuity.org Glossary of Financial Terms.

Key Financial Literacy Terms

Financial Literacy

Financial literacy means having the knowledge and skills needed to make financial decisions, which will
promote your financial stability and well-being.

Budgeting

Budgeting is the process of prioritizing your needs and obligations and assigning portions of your income
toward those costs.

Credit Score

Your credit score is a number that financial institutions or credit bureaus assign to you based on your
credit history to help them measure the risk of extending credit to you.

Emergency Fund

Emergency funds are cash reserves you set aside for financial emergencies or other unplanned
expenses. They are typically equal to three to six months of your income or expenses.

Expenses

The amount of money you have to spend including for bills, rent, mortgage, food, transportation and
other costs associated with your lifestyle.

Income

Income is all money you earn including wages, salaries, tips and other pay.
Inflation

Inflation occurs when the prices of commonly used goods and services increase in cost over time,
impacting the personal finances of consumers.

Interest

Interest is the money charged by a lender when you borrow money through a loan, credit card
transaction or any other means of borrowing. Interest is also the money a bank, credit union or other
financial institution may pay you for depositing money in certain types of accounts.

Investment

Investments involve committing money to earn a financial return on investment, such as strategically
buying stocks, bonds or other assets with the plan to sell them when they increase in value.

Risk

Risk is your exposure to danger, harm or loss through any financial transaction, especially those you
make intending to profit from, such as an investment.

Source: U.S. Consumer Financial Protection Bureau

Frequently Asked Questions About Financial Literacy

What are the key components of financial literacy?

The five principles of financial literacy are knowing how to budget, save and invest your money, manage
your debt, plan for your financial future and protect your assets through risk management. You can
achieve these by building your financial knowledge, skills and behavior — and by setting realistic
financial goals.

How can you improve your financial literacy?

To improve your financial literacy, find ways to educate yourself about personal finance. Read about
money matters in magazines, newspapers and personal finance books. Learn to use financial
management tools through your online banking account or phone apps and talk with financial advisors,
teachers, professors or others about what to study and where to turn for help.

How can setting financial goals help you in the long run?

Setting financial goals gives you a clear roadmap for your financial journey. It allows you to prioritize
aspects of your personal finances while making informed decisions. Goals give purpose and enable you
to build wealth, reduce debt and build a secure future.
What does it mean to live within your means?

If you are living within your means, you are covering all your expenses with just your income — and not
going into debt. To live within your means, maintain a balanced budget, avoid excessive debt and put
your needs over your wants. By living within your means, you can avoid financial stress, build savings
and achieve long-term financial security.

Why is having an emergency fund essential?

Having an emergency fund provides a financial cushion during unexpected situations. It creates a safety
net to cover unforeseen medical bills, car repairs or job loss. An emergency fund reduces stress and
prevents the need for high-interest loans or going into debt.

Please seek the advice of a qualified professional before making financial decisions.