Many people never learned the financial literacy basics when they were younger. When you don’t understand how finances work on a fundamental level, managing your money is a lot harder. When you’re financially literate, you have both the skills and the knowledge needed to manage your money well.
But just what are the basics of financial literacy? If you never learned essential financial terms and money-management concepts, don’t worry—the next best time to start learning is now!
What Are the Five Principles of Financial Literacy?
You may have heard that financial literacy has five core components:
- Earning
- Saving and investing
- Protecting
- Spending
- Borrowing
Here’s a general overview of these financial education essentials.
1. Earning
At first, this principle may sound like little more than going to work and collecting a paycheck. However, it’s not just about your take-home pay. Instead, the earning principle is about thoroughly understanding your income and making it work for you. For example:
- Finding out which taxes are withheld from your paycheck
- Learning about estimated tax payments if you’re self-employed
- Discovering various workplace benefits (like retirement plans and health insurance)
2. Saving and Investing
Saving and investing are vital wealth-building concepts that will serve you well throughout your life. When it comes to saving your money (and later investing some of those savings), budgeting fundamentals are vital.
When you create a budget, you have a measurable way to see if you’re on track to meet your savings and other financial goals. If you don’t know where to start, many experts suggest a 50/30/20 structure. This is a plan for a budget where you allocate your monthly earnings in this way:
- 50% needs
- 30% wants
- 20% savings
Saving and investing often go hand-in-hand. However, many financial experts suggest building an emergency fund that covers at least three months of expenses before you start investing.
Many people begin their investment journey by contributing to an IRA, 401(k), or another retirement account. Investments often grow over time, so you may be able to make your money go further by investing wisely. If you’re ready to explore other investment options, it’s a good idea to talk to a qualified financial advisor first.
3. Protecting
Understanding saving and investing terms is important, but so is protecting your money from fraud, identity theft, and unforeseen financial emergencies. Here are some solid protection strategies:
- Monitoring for identity theft and signs of fraud
- Keeping organized financial records
- Selectively choosing health insurance and other insurance policies
Some people make the mistake of thinking that if they don’t have a high income, it’s not worth taking the time to protect their money. However, the protecting principle isn’t directly about guarding your money—it’s more about safeguarding yourself from financially precarious situations.
4. Spending
This principle is all about being mindful of how you spend your money. If you don’t already have a budget, try tracking your spending for a few weeks or months. You’ll gain useful insights, and you’ll probably identify a few areas where you could cut back.
Some expenses, like housing, food, and medical care, are unavoidable. However, to ensure your spending aligns with what you want for the future, it’s a good idea to set short- and long-term financial goals.
When you’re working toward a particular goal (such as going on a vacation or buying a house), it’s often easier to save money instead of spending it right away.
5. Borrowing
Understanding the fundamentals of borrowing is an essential part of understanding personal finance as a whole. Even if you don’t intend to routinely rely on credit, there’s a good chance that you’ll need to borrow money at some point in the future.
If you’ve never had debt and credit explained to you, you may be unsure of the relationship between borrowing and your credit score. Here’s a brief overview:
- When you borrow, you gain access to immediate credit and repay the loan amount plus interest
- If you have a high credit score, you may qualify for better interest rates
- Low credit scores could result in a denied application
Even if you aren’t planning to borrow money anytime soon, it’s wise to get in the habit of regularly paying attention to your creditworthiness.
Go Beyond the Financial Literacy Basics
If you’re wondering, “How do I become financially literate?” the good news is that there are plenty of resources available to you. Whether you prefer listening to podcasts, following financial influencers, or reading articles, there’s no one “right” way to pick up the financial literacy basics.
A little research goes a long way, and even just spending a few minutes each day can pay off. When you apply the principles you learn to your finances, you’ll soon be managing your money with confidence.
