5 Key Components of Financial Literacy to Know - Experian (2024)

Why Is Financial Literacy Important?

Financial literacy, or the knowledge needed to make good money choices, is important because it equips you with the knowhow to manage your money well, build security and reach your goals.

Financial literacy skills can also help reduce your financial stress. Those who are super-savvy about personal finance tend to make better financial decisions and avoid expensive borrowing habits, according to a 2022 FINRA National Financial Capability Study survey.

When compared with all respondents, those with high financial literacy are more likely to check these major boxes for financial health:

• Spend less than their income
• Have three months' worth of expenses set aside in emergency savings
• Have a plan for how much they'll need to retire
• Already have a retirement savings account such as a 401(k) or individual retirement account (IRA)

On the flip side, those with high financial literacy are less likely to report these potentially harmful credit moves:

• Making only minimum credit card payments
• Incurring late fees and over-limit fees
• Using a cash advance (which comes with high interest)
• Using risky or high-interest borrowing options such as payday loans

Five Key Components of Financial Literacy

What do you need to know to manage your money effectively? In general, you can divide up the key stuff of financial literacy into these five areas.

1. Budgeting

You can think of budgeting as the bedrock of your whole financial life. It's a plan for how you'll direct your income toward expenses, spending and savings goals.

Without a budget, it can be easy to fall into overspending and living paycheck to paycheck. A personal budget, on the other hand, can make meeting your financial obligations predictable.

To increase your budgeting skills:

• Learn about how to start a budget.
• Read tips for sticking to your budget.
• Learn about different budgeting methods and top-rated mobile budgeting apps.
• Get advice for how to recover if you go off your budget.

2. Saving

Saving is a crucial financial move because it's how you build security and work toward your money goals. Generally speaking, your first order of business should be setting up an emergency savings fund and aiming to keep around three to six months' worth of expenses socked away. Beyond that, saving in advance can help you afford anything you need or want, from unexpected car repairs to next summer's vacation, without going into debt.

To increase your saving skills:

• Learn about how to pay yourself first to make saving a habit.
• Find out how to set savings goals that motivate you, such as a home down payment fund.
• Know where you should keep your savings based on your goals.
• Try setting up sinking funds, a savings life hack that helps you reach mini goals.

3. Managing Debt

For better or for worse, debt is a common part of financial life. People borrow to achieve any number of goals. You might take out student loans to attend college, an auto loan when you need a new car or a mortgage when you're ready to buy a house. You might also use a credit card or a personal loan when you want to finance a purchase and pay it back over time.

But debt can also be destructive to your finances. To manage your debt well:

• Learn about the difference between good and bad debt.
• Understand the impacts of how you manage debt on your credit score, especially how you handle monthly payments.
• Understand what a grace period is and how paying off your credit cards each month lets you avoid paying interest.
• If you're carrying balances, learn how to get out of debt faster.

4. Investing

There's a common myth that investing is only for the super wealthy and out of reach for most people. In reality, investing is something everyone should begin as early as possible and doesn't require lots of money.

You can sign up for a retirement account, such as a 401(k) or IRA, and direct a portion of each paycheck into it to start saving for retirement now. That's even true if you only work part time. Experts recommend putting 10% to 15% of your income into your retirement investments, but even starting smaller—at, for example, 5% or 6%—is still a good move.

For context, if someone earns $850 per week pretax, putting 5% of that into retirement would mean contributing $42.50 per week. Invested in a 401(k) or IRA, that money could continue to grow and earn compound interest over time. As your income increases throughout your career, you can up your contributions to reach your retirement goals.

To increase your investing management skills:

• Understand the basics of retirement planning and how to start investing.
• Learn what diversification is and how it helps you manage investment risk.
• Consider the benefits of getting financial advice from a financial advisor.

5. Managing Credit

Good credit is a key piece of a solid financial foundation. When you build and maintain a good credit score, you'll have access to credit at better terms. For example, you'll be able to qualify for a mortgage when you need to buy a home and a lower-rate auto loan when you need a car. You'll also have an easier time qualifying for credit perks such as 0% introductory APR credit cards and rewards credit cards.

To increase your credit management skills:

• Learn what a credit score is and what impacts your credit.
• Take steps to build credit over time.
• Understand what causes decreases in your credit score.
• Sign up to monitor your credit for free through Experian for insights into what's currently impacting your score and advice on how to improve.

Be a Lifelong Financial Learner

Getting up to speed on the basics of personal money management can make navigating financial decisions easier. Reading up on financial literacy concepts can be a helpful primer. You can also look for helpful money resources such as free credit counseling, learn about how to find affordable financial advising and look for resources that are personally available to you.

For example, some workplaces offer free financial planning and counseling sessions. Ask your employer what's available to you. Another place to check for free financial literacy resources is at local community hubs; for example, many libraries offer personal finance programming to patrons. You can also take advantage of free online financial courses and check out helpful personal finance articles from Experian.