Financial knowledge isn’t financial literacy, nor is financial behavior financial literacy. Knowledge is not a great indicator of behavior. The human condition is replete with examples of suboptimal behaviors coexisting with ample knowledge. If knowledge were a stand-alone solution, we could quickly eradicate addiction and the obesity epidemic. Knowledge is essential, but not causal for behavior.

Financial literacy is best viewed as a skill set, and knowledge is obviously a component of skill. A skill is merely a repeatable competence — the ability to create an appropriate behavior. Financial literacy can’t be comprised of either knowledge without behavior or behavior without knowledge. Neither is in the form of a repeatable competence. Financial literacy occurs at the intersection of knowledge and behavior. Both are required elements to demonstrate repeatable financial skills.

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Financial Literacy’s Virtuous Cycle

The question of firsts for the chicken and the egg is a great question to look at in the context of financial literacy. You cannot have a chicken unless you first have an egg, but you cannot have an egg unless you first have a chicken. Both are beginnings. Both are necessary prerequisites of the other.

Together, they form a reinforcing cycle. You get ongoing growth as the cycle continues. It doesn’t matter where you enter the cycle. You can enter wherever it’s easiest and reap the benefits of both chickens and eggs.

We can learn about finance in a variety of ways, through formal classrooms or online courses, through stories, through quizzes and games. And we also learn from doing.

The more we practice and apply financial concepts, the better and more skilled we become.

Financial knowledge begets behaviors and financial behaviors beget knowledge. We enter a virtuous cycle of personal finance. Being in and using the financial system intelligently makes us better at personal finance.

The Dynamics of Financial Knowledge and Financial Behavior

Financial knowledge is very dynamic, at least at some levels. The base levels stay fairly consistent. Conceptually, budgeting today isn’t much different than it was 100 years ago.

Investing, on the other hand, is vastly different. The evolution of financial systems and products has been nothing short of profound. And the evolution shows no indication of slowing anytime soon. Financial knowledge has a base that can be learned, but keeping up requires some degree of ongoing effort.

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Financial behaviors are less dynamic. Planning your finances, spending within your means, and making sound financial decisions are roughly the same across time. The environment they occur in continues to get more complex and hence requires greater analysis, but the fundamental financial behaviors are virtually unchanged.

Systems Thinking and Technology

An aspect of financial decision-making that is often overlooked is in the application of general systems theory. In a system, a change in one thing results in a variety of other changes. There isn’t a sole isolated cause and effect — one change alters the whole system.

Financial matters work as a system. Changes don’t occur in isolation. A change of a single thing can cause numerous other changes.

For example, changing your retirement contributions doesn’t change only your future retirement accumulation. It changes your present cash flow, your income taxes, etc. And the change to your taxes also changes your cash flow. If you make contributions as a percentage of income, it also changes your future taxes and future cash flow. It’s not a simple stand-alone change.

That said, it’s not horrifically complex, either. But financial knowledge is crucial for understanding what changes will happen and which of them will matter to you.

Technology can be a great aid and will likely become more and more helpful as time goes on. Apps, calculators, and other yet-to-be-seen tools will continue to enable us to do more and see more. They increase our power tremendously. But power without knowledge is dangerous. Technology enhances our ability to perform in an environment that we understand.

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Complexity and Decision-Making

Elements of financial decision-making are timeless. The environment, however, continues to become increasingly complex. We continue to have more options. We continue to have an increasing burden placed on individuals. And we continue to have more consequences. With more consequences comes more responsibility.

Informed decisions are more effective decisions, but no one size fits all. Especially not in financial matters.

Decisions of whether to lease or to buy, whether to rent or to own, and even extreme decisions such as to live completely credit-free or debt-free are not simple decisions with the same answer or set of answers for everyone. We have a lot of choices because we need a lot of choices. Individuals have vastly different financial situations and vastly different financial needs and wants.

The increased complexity we have affords us greater options and greater opportunities. But we need the financial knowledge and skills to take advantage of those opportunities.

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Perfection Is Not the Goal

The goal of financial literacy is not to achieve perfection, but to make effective and efficient use of our resources. It’s not even to maximize those resources. Maximizing our resources isn’t actually possible, as it can only be determined in hindsight in a variable environment. This seems academic, but it is extremely important and practical.

We cannot make perfect financial decisions when there are future variables involved. Trying to make perfect decisions will reduce our effectiveness. Effective decisions are part of the goal.

Effectiveness, as a solution, is a zone. That zone most likely contains the peak that is perfection, but we just need to get nicely and comfortably safely into a zone that has a high probability of a favorable outcome. This is how we make long-term financial decisions. We don’t try for perfection, which we know is impossible. We try for the greatest likelihood of a favorable outcome.

Financial literacy doesn’t result in perfect decisions. Financial literacy will prevent you from making the worst decisions and improve the quality of the outcomes of your other financial decisions. Not making costly mistakes combined with doing quite a bit better on average will produce far superior results. That’s where we want to arrive.

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The Bottom Line on Financial Knowledge and Behavior

Behavior is always the key determinant of success. You can improve your financial behaviors by improving your financial knowledge and putting it into practice. You can reinforce your performance in personal finance’s virtuous cycle so that your long-term results continue to improve. And that’s financial literacy: the intersection of financial knowledge and financial behavior.