What is financial literacy and how can a layman acquire it?


What is financial literacy?

A literate person knows how to use letters, words, and sentences to communicate. Literacy provides control over writing.

A financially literate person knows how to use financial behavior and products to control the life outcomes he/she cares about.

For example, a financially literate 21 year old who wants to retire at 65 will know that he/she needs to save between 10 and 15 percent of pay, invest in a diversified fund with 60–90 percent stock, pay less than 50 basis points in total fees, and not take out money from their plan.

A financially literate homebuyer will understand the relationship between downpayment size and maximum loan amount, the relationship between interest rates, loan types, and monthly payments, and the impact of taxes, insurance, and other fees on monthly expenses. They will also understand that at first they will be paying mostly interest and after a while they will be paying off more and more of the principal that they borrowed.

How can you be financially literate?

A quick way to get the benefits of being financially literate without investing the time to learn a lot is to find a trusted financial advisor (preferably someone who works for a flat fee rather than for commission). Unfortunately, this can be costly. Another shortcut is to find a trusted “all-in-one” solution - e.g. financial services companies that offer good products and low fees plus advice. But these approaches can go wrong fast if you pick a bad provider who leads you to make decisions that don’t end up serving your goals.

The only sure way to becoming financially literate is to become a student again. You can get a financially planning textbook, but most people don’t like to learn that way. Another way to end up financially savvy is to do research before making financial decisions using a variety of online sources. The research should revolve around understanding the outcomes likely under different scenarios - “if I take this action, these outcomes are likely.” And most importantly, learn from your past decisions (don’t let that stock loss you had to take go to waste - diversify next time).

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