Because it affects practically every area of life, there is no way to overstate how important financial literacy is. Although there are various interpretations, the basic definition outlines it as someone’s ability to manage money and upkeep favorable spending patterns.
Unfortunately, as per the seasoned advisor with over 15 years of experience in the investment field, Cindy Couyoumjian, the number of people who lack the basic comprehension of financial operations is staggering. As a certified planner with one insurance and seven security licenses, she owns and operates Cinergy Financial. So, according to experienced specialists like Ms. Couyoumjian, why is financial literacy significant?
Based on the report from 2017, approximately 41% of Americans utilize some form of budgeting. When accounting for the totality of the adult American population, there are roughly 100 million people who do not record and cross-reference any of their income and expenses. That means that, while there has been a lot of growth in this area, the room for improvement still exists.
The reason why this should be worrisome is that budgeting is the easiest way to achieve financial freedom and overcome liabilities. With the number of modern resources that exist now, people do not even have to bother writing anything down. Instead, they can employ smartphone applications and computer programs that automatically integrate into their bank accounts. That way, they can start making periodic budgets with predetermined expenditure levels, income forecasts, and cash flow analyses. Improving efficiency in each of those areas would lead to better financial literacy. One-hundred million people in the nation are not taking the necessary step to do so, though.
For most younger people, absent accountants and financial gurus, long-term savings are not exactly a common topic. Why? Because most younger individuals have no idea how things like retirement funds and accounts operate. Sadly, the lack of knowledge of these types of concepts is one of the most blatant indicators that the person is financially illiterate.
As per Ms. Couyoumjian, the simplest way to get started is to learn the difference between traditional and Roth individual retirement accounts, or IRAs. While they both aim to increase someone’s savings through investments, they get taxed differently. Traditional accounts are great in the present as the taxpayer can deduct contributions from their annual gross income. Whenever the taxpayer withdraws the funds from the account, however, they will have to include them into their ordinary income. Doing so helps offset the deduction that they took earlier in life.
Roth accounts are the polar opposite of the aforementioned as they do not allow any deductions. Instead, people will receive their tax benefit by being able to withdraw tax-free funds later in life. If someone deducts $200,000 from their Roth account right after their retirement at the age of 65, per se, that $200,000 will not have to go towards the calculation of the adjusted gross income, or AGI. Failing to understand such differences, regardless of how simple they are, is something that people who lack financial literacy often struggle with.
Dangers of Debt
Succumbing to long-term debt is one of the most dangerous issues that millions of Americans face. Whether it be credit card, auto, home, student, or foreign debt, the U.S. has somehow climbed up to $22 trillion in liabilities owed to various entities and countries across the world. According to the current estimate, each taxpayer is responsible for approximately $183,624, and, courtesy of the low median salary and the fact that the debt grows every second, it would take around 398 million years for them to pay that off.
Well, one of the main culprits of such unfathomable debt is the lack of financial literacy. Just think about the fact that students and alumni owe almost $1.5 trillion. By taking the time to learn the most basic concepts of finance, it is fair to say that someone’s chance of going bankrupt and having to liquidate assets to cover such debt will be much lower.
Besides allowing people to create budgets, improve savings, and avoid debt, financial literacy also helps with some basic responsibilities in life. For example, possessing a good foundation of knowledge will help with the tax filing process, insurance acquisition, and many other obligations that people face daily. Just consider, for instance, how much easier it is for a financially literate person to decipher complex contracts than it is for those who has absolutely no idea what APR and present values stand for.
Impacts on the Economy
Based on the previous points relating to the national debt, Cindy Couyoumjian reminds that improving the understanding of how the industry operates could translate to a better economy. If people enter the job market or university programs with a solid foundation of financial knowledge, the odds of the U.S. debt continuing to skyrocket will fall.
After all, if there are fewer individuals who struggle to make sound spending decisions, the overall economy should approach an equilibrium. It is important to note that, given that the debt amounts to trillions of dollars, it would take millions of people to facilitate a noticeable change. Hence why it may be time to start implementing mandatory finance courses on all educational levels.
Finally, financial literacy is important because it determines how someone manages their credit; those who are familiar with the system will know what spending limits lead to higher scores. Someone who has no such skills will seldom understand how to leverage borrowing to improve their standing. Subsequently, getting approved for large transactions becomes harder, putting collateral down becomes the new norm, and the odds of properly paying off high-interest loans plummet.