Share itIndia’s Independence Day Quiz India celebrated independence day on 15 August. It is a national holiday in India commemorating the nation’s independence from the United…
What is financial literacy and why is it so important? This post introduces financial literacy to young adults; ranging from students who are in a higher level of education to young people who have just started working. The post breaks down the subject of financial literacy into key sections, each focusing on a specific topic of the subject. If you go through the entire post you should be able to grasp the key concepts of financial literacy and apply those concepts into your real life.
1. Introduction to Financial Literacy
Money is an important instrument in life. Wise men say that money is not the most important thing in life and they might be true. However, money is actually the most important instrument when it comes to solving problems that require an economic exchange of value. Without money or the enough of it might restrict you from living a fuller life.
A sense of maturity is required to understand the true value of money. Money, in and by itself, is not very interesting or spectacular, but what money can do for you is really what is important. Money gives you freedom and choices at your disposal.
Today’s young adults face an overwhelming number of complex financial decisions. However, many are unprepared to make informed financial choices as they move into adulthood and many young adults cannot answer basic financial questions. Every young person, which includes high school students, college students, young working adults must inculcate financial literacy and hence improve their financial capacity.
This is one of the reasons why now most of the countries’ education system are including financial literacy as one of the core fundamental subjects in all levels of education; starting from Primary, through Secondary to Tertiary levels with each level addressing some aspect of financial literacy.
Due to an increasingly complex marketplace, students need greater knowledge about their personal finances and inculcate a positive habit and attitude towards money. Financial decisions made early in life can create habits that are difficult to break and eventually might affect students’ ability to become financially secure adults.
Why is Financial Literacy Necessary
Financial literacy allows you to understand the basic financial concepts of money and how to manage money for meeting your financial needs. In short, it provides directions toward personal finance. This might sound simpler. But in actual terms, it is not. Managing money is one of the most difficult tasks that you will face throughout your adult file.
Believe it or not, it can be easier and quicker to destroy credit than to build it. Making mistakes related to personal budgeting can ruin your credit and set you on a downward financial spiral for years. That’s why it’s important for young adults to develop basic financial skills as a foundation before gaining financial independence.
Financial literacy is the knowledge and understanding of how money works. It provides critical skills and know-how on how to make informed, effective financial decisions based on available resources and circumstances. The consequences of not learning to manage and understand basic financial concepts can severely affect the quality of life, leading to missed savings or worse yet, inadequate emergency funds, high debt, financial loss, and unfulfilled life goals.
Financial literacy is based upon providing individuals with sound financial knowledge and skills so that they can make informed financial decisions and take effective actions regarding their personal money management. The underlying message is aimed to adjust people’s core attitudes and beliefs so that a change in financial behaviour can help them reach a future of financial freedom and security.
2. Take a Quiz
Take a quiz to assess your current understanding of money and financial literacy.
Which of the following activities can pose the greatest threat to your wallet?
Spending without a plan can put you in a far greater risk. Not correctly managing your finances can cause you to overdraw your accounts, go over your credit limit, and rack up excessive amounts of debt.
Imagine that the interest rate on your savings account is 1 percent a year and inflation is 2 percent a year. After one year, would the money you saved and did not touch for the whole year, be able to buy more than it does today, exactly the same or less than today?
Less than today. Watch out for inflation! Inflation is a general increase in prices and fall in the purchasing value of money.
How much money should you keep in your emergency fund?
Experts recommend being prepared for unexpected expenses and life events by saving up at least 3 to 6 months worth of living expenses for emergencies.
If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?
Buying a single company's stock usually provides a safer return than a stock mutual fund.
False. Diversification means reducing risk by investing in a variety of assets. Mutual funds allow you to spread the risk of losing money among different investment tools.
Suppose you have $100 in a savings account earning 2 percent interest a year. After five years, how much would you have?
You’ll have more than $102 at the end of five years because your interest will compound over time. In other words, you earn interest on the money you save and on the interest, your savings earned in prior years. Here’s how the math works. A savings account with $100 and a 2 percent annual interest rate would earn $2 in interest for an ending balance of $102 by the end of the first year. Applying the same 2 percent interest rate, the $102 would earn $2.04 in the second year for an ending balance of $104.04 at the end of that year. Continuing in this same pattern, the savings account would grow to $110.41 by the end of the fifth year.
A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest over the life of the loan will be less.
Assuming the same interest rate for both loans, you will pay less in interest over the life of a 15-year loan than you would with a 30-year loan because you repay the principal at a faster rate. This also explains why the monthly payment for a 15-year loan is higher. Let’s say you get a 30-year mortgage at 6 percent on a $150,000 home. You will pay $899 a month in principal and interest charges. Over 30 years, you will pay $173,757 in interest alone. But a 15-year mortgage at the same rate will cost you less. You will pay $1,266 each month but only $77,841 in total interest—nearly $100,000 less.
Suppose you owe $1,000 on a loan and the interest rate you are charged is 20% per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?
Ignoring interest compounding, borrowing at 20 percent per year would lead to doubling in five years; someone who knew about interest on interest might have selected a number less than five. Someone who knows the 'rule of 72' heuristic would know that it would be about 3.6 years, which makes the correct answer "2 to 4 years." In finance, the rule of 72 is a method for estimating an investment's doubling time. The rule number (i.e., 72) is divided by the interest percentage per period to obtain the approximate number of periods (usually years) required for doubling. The other responses reflect a misunderstanding of the concept of interest accrual.
It’s ok to skip payments on your bills some months, as long as you pay the next month.
You should not skip your bills as it will affect your credit score.
What is not a method to improve your credit score?
3. Road to Financial Literacy
4. Setting Goals
The road to your financial literacy starts by setting up your short term and long term goals. Goals are needs, desires, dreams and/or wishes that you might have. More specifically they are what you want to do with your money.
Your financial goals will reflect your values and the things you care about in life. It could be people, possessions, causes, or a lifestyle that you aspire to. You keep our eyes on those goals as you plan your path to reach them. If your goals are specific enough, they will motivate you to balance your spending and savings in order to achieve them.
Your financial goals have to be SMART. Each of these goals should be Specific, Measurable, Achievable, Realistic and Time-bound.
A detailed section coming soon.
5. Budgeting – The first step to your Financial Plan
A starting point in improving financial condition and hence, enhancing your future is to develop a personal financial plan. One of the key elements of a personal financial plan is a financial budget or a spending plan. This spending plan helps you set aside the money for savings, achieve your financial goals and/or accumulate the amount you might want to invest in the future.
Most people refer to the word budget as a miserly spending habit. However, it is not exactly true. A budget, in other words, is actually a plan for spending money in an orderly fashion so as to improve your chances of using your money wisely and not spending more than what you earn. For most people, financial independence can only be achieved by following a set of rules laid down by a budget. Spending wisely is the key to control your money. Yet, more than 90 per cent of people do not have a budget in place or do not know how to develop one.
Developing a budget can be divided into a series of steps:
5.1 Establishing goals.
The first important objective for your financial plan is to set your financial goals. Setting financial goals generally improves the performance of your personal financial plan. A common approach to financial goal setting is to specify amounts of money you would like to earn and save at certain points in time. Financial goals could be yearly, quarterly or any duration that you would feel comfortable with. However, it is recommended to have short-term as well as long-term financial goals.
Decide what you or your family really need. If you are establishing a family budget, it is best to involve the entire family.
5.2 Estimating income.
Calculate how much you’re bringing in each month from salary, wages, tips, and any other sources of income. People whose entire income is derived from salary can readily estimate their income. However, if you have commissions based incomes, or incomes from investment then you will have to gather all approximate incomes and put them as variable incomes.
5.3 Estimating expenses.
Gather All Your Bills. Get your utility, credit card, mortgage bills, and whatever else you have to pay each month. Make a category for fixed expenses. After that list your variable spending. From groceries to gas, and from entertainment to clothing, start by allocating funds to each variable spending category. Try to approximate your figures based on how much you’ve spent in the past.
The best way to estimate expenses is to keep close track of what you are actually spending now. After listing all your expenses, perhaps after about a month, try to find some pattern, and if needed then further categorize the expenses into meaningful categories. You can, of course, modify the specific items to suit your particular spending patterns.
Always, try to plan for large expenses so that they are spaced at intervals over several years, for example, buying a house, renovating your house or buying a car. Follow up your budget to help you decide whether to continue your current of spending or to make changes. For instance, estimating your expenses might reveal that you are spending far too much on entertainment.
5.4 Comparing expenses and income.
Sum up the figures in your spending plan and compare with your income for the planning period. If the two figures balance, you are in a neutral financial condition. If your income exceeds your estimate of expenses, you may decide to satisfy more of your immediate needs, or set aside more money for future goals, or put the balance into savings or investment.
The true profit from your labour is the difference between your net income and your total expenses. Any household budget has some miscellaneous or unpredictable items each month. After working with your budget for several months, you should be able to make an accurate estimate of miscellaneous expenses. If your income is below your estimated expenses, you will have to embark on a cost-cutting campaign in your household.
5.5 Carrying out the budget.
After you have done your best job of putting your spending plan on paper or a spreadsheet, try it out for at least a few months. See how close it comes to reality. Keep accurate records to find out where your money is being spent. It is important to make all inputs to your expenditure and particularly useful if it is done at the end of every day so that you do not miss anything.
5.6 Evaluating the budget.
Compare what you spent with what you planned to spend. If your spending was quite different from your plan, find out why. If the plan did not provide for your needs, it must be revised. If the plan fits your needs but you had trouble sticking to it, then you might have to practice more self-discipline. Each succeeding budget should work better. As circumstances change, your budget will need revision. A budget is a changing, living document that serves as a guide to the proper management of your personal finances.
Why is Budgeting so Important?
Since budgeting allows you to create a spending plan for your money, it ensures that you will always have enough money for the things you need and the things that are important to you. Following a budget or spending plan will also keep you out of debt or help you work your way out of debt if you are currently in debt.
6. Future Value and the Effect of Compounding
We publish Tutorials, Life Stories, Commentaries, Quizzes and much more in all discipline. Follow us on Pinterest and/or Facebook to get the latest. Subscribe to our magazine in Flipboard (Faramira).