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5 Key Components of Being Financially Literate

Updated on June 26, 2011

Financial literacy is a goal that all of us should have. It means that we understand our money. Many people choose to be ignorant about their own personal finances as well as about financial issues in general. That’s because money creates a lot of loaded emotions for many people. However, willful ignorance of your money only exacerbates the problems that money may be causing in your life. Choosing financial literacy means that you separate out the emotions from the facts and look realistically at your financial picture so that you can make smart and logical decisions that improve your finances today and for the future.

There are many, many small financial literacy steps that you can take but there are really only five major components of financial literacy that you need to know about to get started on this important path. They are as follows:

1. Gain a thorough understanding of where all of your money goes. This is really tough for a lot of people to do but it’s the most important thing that you can do for yourself if you want to make smart choices about your finances. You need to really look honestly at all of your expenses. This includes:

o   Fixed expenses. You need to make a list of all of your fixed expenses that you pay monthly. Car payments, rent or mortgage payments, utility bills, ongoing medical expenses and loan repayment amounts are all included in this part of your expenses.

o   Daily expenses. The little bits of money that you spend here and there can add up really quickly if you aren’t paying attention. That’s why it’s so important to track your spending so that you know where your money is going. You should track your spending over the course of a month and see how much you spend regularly on things like groceries, going to the movies, dining out, etc.

o   Variable expenses. These are expenses that regularly come up but aren’t as regular as fixed expenses (which happen monthly). They can include annual expenses such as property taxes and tuition payments as well as the “unexpected” expenses like car repairs.

By looking at honestly at where all of your money is going, you’re giving yourself a thorough education in what’s going on with your finances. You can’t deal with your money until you understand how much is being spent and where it’s going.

2. Take a close look at all of your income after related expenses. Knowing where your money goes is only half the battle. You can’t create a budget with that information alone. You need to also understand where your money is coming from and how much is coming in. The only way to know if you need to save more and / or earn more is to be able to compare what’s going out with what’s coming in. So, look at your income. Make sure that you consider your gross income from absolutely all of your income sources, deduct any related expenses (such as taxes) and then come up with a number that is your monthly or annual net income.

3. Understand your credit and debt situation. If you thought that looking at your expenses was bad, you’re really going to hate this part of becoming financially literate. Nevertheless, you cannot skip this step because getting your debt under control is crucial to being a financially smart individual.

There are three key steps to understanding your credit and debt situation:

o   Get a copy of your credit report. You need to make sure that you have full access to all of the information that the credit reporting bureaus have about you. You are allowed to get one free credit report from each of the three bureaus annually. You may also get an additional free credit report from each of them annually if you are unemployed. Take advantage of your access to this information. First, make sure that all of the information on the report is accurate and dispute anything that is incorrect. Second, use the information to review your existing debt.

o   List all of your debt including the details. This means that you list the company that you owe money to (such as Credit Card Company #1), the amount owed (such as $10000), the amount of interest that you are paying (such as 15.99%) and any other information that you consider to be pertinent. As you become more and more financially savvy, you’ll be able to consolidate debt and pay it down. You need to have this information at hand to pay it down properly in the quickest and smartest way possible.

o   Learn more about credit and debt in general. While you’re going through this process, you may find that there are aspects of your debt that you don’t understand. For example, you may not know how to consolidate debt or you may be unsure what it means that you have a variable APR instead of a fixed rate APR. As these questions come up, address them head on by learning about them. Getting this type of financial education as you need it is what financial literacy is really all about.

4. Identify your financial problems and set goals to resolve those problems. The first three components of the financial literacy process will provide you with the information that you need to identify most of your financial problems. For example, you may see that you have more money going out than coming in so you need to set a goal to close that gap. You also want to consider whether you have any additional financial problems that aren’t addressed by the financial facts that you’re uncovering. For example, if you experience high levels of anxiety during this process then you may have emotional issues around money that need to be address in a therapeutic setting. Or if you find that you can’t discuss financial literacy with your spouse then you may have financial issues in the marriage that must be addressed. Brainstorm what all of your financial problems are and then make short-term and long-term goals to start addressing and resolving those problems. The goals should be achievable things that you can track and measure. In other words, the goal would not be “make enough money” but rather “earn x amount of dollars in x amount of months”.

5. Surround yourself with a team of people who can help you with your financial literacy. There are a lot of professional people as well as people in your personal life who can help support your growth in financial literacy. In term of professionals, you may want to hire someone to help with your taxes, get a teacher who can educate you about debt or go to a psychologist who specializes in financial issues. On the personal side, it’s important that you learn to talk about money appropriately with the major people in your life who have a stake in your finances (such as a spouse or adult children). Surrounding yourself with the right people is crucial to making the whole process work.

Comments

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  • mwatkins profile image

    mwatkins 7 years ago from Portland, Oregon & Vancouver BC

    Bravo - In a marriage or partnership, financial responsibility is the responsibility of BOTH adults. Retired men AND women who left paying the bills up to their mate are often found sadly unaware of how to take over this process in the event of a sudden illness or (god forbid) a death and this one area can wreak havoc on an already stressed life if caught unaware - Great hub!

  • Hello, hello, profile image

    Hello, hello, 7 years ago from London, UK

    Great hub but the problem is where to find the right financial people?

  • Simone Smith profile image

    Simone Haruko Smith 7 years ago from San Francisco

    Fabulous overview. I appreciate the sound advice! I especially like your note about surrounding oneself with the right people - that's key, since asking NON-experts about financial issues can lead to a lot of financial trouble ^_^;;

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