The Importance of Financial Literacy

by | Jan 23, 2021

We all get them…stacks of envelopes in the junk mail pile, all offering low-interest credit cards. Emails offering “amazing deals” and “once in a lifetime” chances to use a new credit card to pay off existing debt. This steady stream of offers of easy credit is having an impact.

The importance of financial literacy cannot be understated. According to the Center for Retirement Research at Boston College, Americans put an additional $52.4 billion dollars on their credit cards in 2015 alone, leading to an overall increase of $72 billion dollars of credit card debt. The numbers continue to rise. By the end of 2016, outstanding credit card debt reached a new high: over $1 trillion. It appears that our society’s current trend away from cash and toward credit card purchases has taken hold. Today, online shopping reigns, making it ever easier to slide into overextended credit and debt.

One contributing factor? Lack of financial literacy. Here’s why a financial education is so important.

A lack of knowledge about how credit works can lead to decisions that have significant (and detrimental) financial impact for years to come.

1. 401k Advisors Help You Decipher Your Current Plan

Before you start the 401k rollover process, meet with your 401k advisor to discuss your options. Bring your current plan’s most recent statement and documentation with you, so you’ll know:

  • Your current balance
  • How much you’ve contributed
  • How much your employer matched
  • Your account’s growth

You should also contact your plan administrator and have them walk you through the 401(k) rollover process. Your advisor will work with you to identify which funds your account is invested in the portfolio and its associated growth patterns.

Your advisor will work with you to identify which funds your account is invested in and its associated growth patterns.

No Financial Literacy Means No Financial Strategies 

A 2016 study of more than 27,000 Americans, sponsored by FINRA’s Investor Education Foundation, found that 63 percent of respondents couldn’t answer more than three questions correctly on a five-question basic financial literacy test. Sample question: If you take out a $100 dollar loan with a 20 percent interest rate, how much interest will you pay in a year? Correct answer: $20. Two-thirds of respondents got the wrong answer, and one-third responded that they didn’t know how to calculate interest at all.

Why does this matter? Because without a basic financial understanding, it’s very easy to accumulate debt. A lack of knowledge about how credit works can lead to decisions that have significant (and detrimental) financial impact for years to come. The issue is especially pronounced when it comes to planning ahead, saving, and investing for retirement. The FINRA report found that 50 percent of Americans lack enough savings to cover three months, let alone the funds needed to support them in retirement. 

What does “financial literacy” encompass? At a minimum, a basic understanding of issues such as: 

  • What are checking accounts and how do they work
  • Understanding of credit
  • How investing works
  • The best methods for avoiding debt

Investment Professionals: Financial Literacy Is Critical

Every investor should be able to understand the importance of financial literacy, but it’s easy to see why financial literacy has largely fallen by the wayside in light of several societal trends. Take, for instance, retirement planning. In past generations, pensions were relatively common and provided security in retirement. Pension funds were managed and supported by employers or the government, with little consumer involvement. Today, pensions are rare and most Americans are expected to take charge of their own retirement planning, utilizing options such as 401(k) or IRA plans to prepare. Past generations also relied heavily on Social Security, a safety net that, today, doesn’t provide enough funds to support a comfortable retirement. Some even warn that the program may not remain solvent, making it an unreliable factor when planning for the future. 

Complex investment options may also contribute to a lack of financial literacy. One of the most problematic questions in the FINRA study had to do with bonds; specifically, what happens to bond prices when interest rates drop? The answer: Bond prices rise. Only 28 percent of respondents answered this question correctly. Given the sheer volume of investment products, vehicles and options available, it’s not hard to see why so many consumers feel overwhelmed and confused when it comes to investment planning. (That’s where fee only financial advisors really come in handy!)

Financial literacy is the key to making informed decisions about one’s finances. Such decisions have lasting impact, underscoring the importance of at having, at the very least, a basic understanding of issues such as credit, saving and investing. 

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