Why Is Financial Literacy Important? A Guide
Millennials are often characterized as having large amounts of student loan debt, stagnant wages, and an aversion to credit — three critical reasons why we need to educate ourselves on personal finance.
This generation is comparatively undereducated about money, scoring an average of 44 percent on the recent Personal Finance Index — an assessment of financial literacy — compared with a score of 50 percent by the general population. On top of this, 36 percent of millennials are financially fragile and unable to come up with $2,000 in the event of an unexpected need, according to a study conducted by the Global Financial Literacy Excellence Center (GFLEC), demonstrating the need for wide-ranging financial education.
I want to share a couple of financial literacy lessons I learned and how they changed my life for the better. As a millennial myself, my financial education has provided me with simple skills that help me manage money every day.
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The Power of Interest
For years I took on student loans without batting an eyelash. Even my $81,000 total didn’t bother me too much because I’d pay it back “eventually.”
It wasn’t until I actually calculated the interest that I realized how much I would pay over time.
At my worst point, I was paying more than $300 per month in interest alone, and it killed me.
That was the kick in the pants I needed to take action on my student loans.
On the flip side, interest can be a very powerful tool to help build wealth. Compound interest, or interest that accrues on interest, can help millennials build a hefty nest egg if they start saving for retirement now. Millennials can do that through an employer-sponsored 401(k), or by creating an Individual Retirement Account (or IRA, for short).
Let me give you an example. If at age 25, you can only afford to save $50 a month, and you assume a very conservative 4 percent return monthly, at age 65 you would have a whopping $240,000, according to this handy compound interest calculator. And chances are you would save more because you would be earning more over this time. Fifty dollars is a night out. I think it’s well worth the sacrifice.
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Learning about personal finance motivated me to start tracking my income and expenses. I was shocked to find how much I spent on $5 coffees and eating out— I love these simple pleasures, but no one needs them every day. Once I realized I needed to spend less than I earned and I actually saw the numbers in black and white, I started to make changes in my habits.
I began to calculate how much of my income was being spent on certain items. Instead of looking at that meal out at its current price, I thought in terms of, “That’s an hour of work” or “I’d have to work a full day to pay for that.” That financial mentality changed everything for me.
In addition, I started to calculate how much of my income was going toward rent. Typically, you want your rent to be 30 percent or less of your income. When I lived in NYC, my rent was 50 percent of my income. Because of that, I needed to make changes elsewhere in my budget.
Millennials have a lot of competing priorities, from paying off student loans to saving for retirement or even making a down payment on a property. Learning how to manage your money can help you accomplish those things with the least amount of stress.
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You Can Learn, Too
If you’re a millennial looking to become financially literate, start by taking the following steps:
- Track your income and expenses.
- Know how much you owe (student loans, credit cards, etc.).
- Calculate interest on your debt.
- Begin investing through a 401(k) at your job. If your job doesn’t offer one, consider investing through a traditional or Roth IRA.
- Once you’ve started, keep track of your retirement savings with tools like Blooom.
- Read financial articles, books, etc.
- Save money. Even $25 a week makes a difference over time.
- Pay it forward. Someone gives to you, and you give to the next person. This could be time, money, or expertise. Let’s face it, it just makes the world a better place.
All these steps are essential in developing financial literacy, but the most important action you can take early in your career is investing.
“Earnings, consuming, and saving come pretty naturally as your career grows over the years. However, investing is the one area that most millennials are challenged with once they make money,” says Samuel Rad, a UCLA instructor and financial adviser in Los Angeles.
“Most millennials came into the workforce right as the Great Recession took place, and therefore are very skeptical of investing, especially in the stock market,” Rad continues. “However, in order to build maximum wealth, it is essential to get familiar with investing — and the younger you start, the better off you are.”
In short, developing a balanced budget comes naturally as you progress in your career. But early, low-risk investments can do you a world of good for your future financial wealth.
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Why Is Financial Literacy Important? The Bottom Line
There isn’t much time to waste. The sooner you learn to manage money, the happier you’ll be.
Financial education helped me go from paying only the minimum on my student loans to now putting several thousand dollars a month toward debt. Imagine what changes you can make in your life simply by strengthening your own financial awareness.