What Is Financial Literacy? Why Is It Important?

Financial literacy is the combination of financial, credit, and debt management knowledge required to make financially responsible decisions in our daily lives. Paying off debt, creating a budget, and understanding the differences between various financial instruments are all examples of financial literacy.

To summarise, financial literacy has a tangible impact on families as they attempt to balance their budgets, purchase a home, fund their children’s education, or plan for retirement.

People in advanced economies, as well as those in economically emerging or developing economies, are affected by a lack of financial literacy. Nations around the world are dealing with consumers who do not understand financial basics, from Brazil to Bulgaria to India.

Why is financial literacy important?

AECF/ Stock Image | Few are prepared as financial decision-making grows more complex

Consumers who are financially literate not only manage their money more confidently, but they also have a better chance of dealing with the inevitable ups and downs of their financial lives by understanding how to prevent and manage issues as they arise.

This can include keeping a close eye on their bank and credit card accounts to detect potential fraud as soon as possible or being able to recover quickly from a costly unexpected car repair due to ample cash savings. Financial literacy, on the other hand, can help consumers save diligently for things that are important to them, such as a vacation or their child’s college education.

Fundamental components of financial literacy

There are 5 fundamental components of financial literacy. these include:


Greg McBride/ Bankrate | To achieve financial success, knowledge is key

There are four main uses for money that determine a budget in budgeting: spending, investing, saving, and giving away.

Creating the right balance among the primary uses of money enables people to better allocate their income, resulting in financial security and prosperity.

In general, a budget should be constructed in such a way that it pays off all existing debt while also allowing for savings and beneficial investments.


To become financially literate, one must first learn about key components of investing. Interest rates, price levels, diversification, risk mitigation, and indexes are some of the components that should be learned to ensure profitable investments.

Learning about important investment components enables people to make better financial decisions, which may result in an increase in income.


In most cases, almost every individual is required to borrow money at one point in their life. To ensure borrowing is done effectively, an understanding of interest rates, compound interest, time value of money, payment periods, and loan structure is crucial.


Greg McBride/ Bankrate | Financial literacy can help Americans feel confident about the decisions they make on a daily basis

Understanding the various types of taxation and how they affect an individual’s net income is critical for achieving financial literacy. Each source of income is taxed differently, whether it is employment, investment, rental, inheritance, or unexpected.

Understanding the various income tax rates promotes economic stability and improves financial performance through income management.

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