LECTURE 2

IMPORTANCE OF FINANCIAL LITERACY[1]

Learning financial literacy has the following benefits:

1 – Personal Financial Planning and Management

Individuals who gain financial knowledge develop various sources of income. They prepare a monthly budget and borrow carefully. Financial knowledge ensures diligent financial management—enough savings for a rainy day.

2 – Identify Fake Schemes

Contemporarily, financial fraud is rising—chit funds, pyramid schemes, Ponzi schemes, carding, etc. A financially literate person will evade shady schemes. It is the perfect antidote to get-rich-quick schemes. 

3 – Spread Investment Awareness

Financial education does not occur in a vacuum. It is not an isolated incident. Educating one individual creates a chain reaction. Such an individual would make efforts to educate family, friends, students, colleagues, etc. A financially literate individual may conduct seminars, teach in colleges, write articles and books, mentor students, etc.

Everyone is interested in finance; everyone is a stakeholder. Therefore, financial literacy is a movement; “FIRE” is a good example.

4 – Succession Planning

It is often said that the poor plan for Saturday night whereas the rich plan for three generations. By being financially prudent, individuals impart valuable knowledge to their children. Moreover, they plan their succession and leave sufficient money for their successors.

5 – Refrains from Herd Mentality

The financially literate don’t follow random public opinion. They get to the bottom of every financial trend. They are more immune to incorrect market speculation. They make cautious investors, but in the long run, the profits add up.

6 – Financial Planning and Decision Making

Setting up an emergency fund and a retirement plan is very important—the earlier, the better.

Financial Literacy Example

Let us assume that both Jacob and Esau earn $6000 every month. Jacob is financially literate and, therefore, allocates his salary as follows:

Spending = $3700.

Investing in Mutual Funds = $1000.

Emergency Fund = $500.

Savings Account = $800.

At the end of the year, Jacob invests $12,000 in mutual funds and $9,600 into his savings account. On average, the total appreciation of the money in mutual funds was 13%, i.e., $1,560, and the savings account yielded an interest of $360.

On the other hand, Esau doesn’t have any financial knowledge and thus spends impulsively without any planning. He leaves the remainder in his salary account—it returns very low interest. Consequentially, Esau spent money on unnecessary items and ran out of cash.

SCOPE OF FINANCIAL LITERACY.

The intellectual understanding of financial concepts and skills such as budgeting, investing, borrowing, taxation, and personal financial planning is referred to as financial literacy. Lacking the knowledge of these skills leads to financial illiteracy. Financial illiteracy results in budget inaccuracy, higher expenses than income, debt accumulation, a poor credit score, financial fraud victim, and other undesirable repercussions. The purpose of financial literacy is to assist people in better understanding financial concepts so that they can better manage their money. It is a life skill that must be mastered in order to be financially successful.

Being financially literate provides a variety of benefits that can improve an individual’s standard of living by increasing financial security. It aids in the betterment of personal financial management. Personal finance is a process which involves the acquisition, practice, and application of a wide range of financial skills. The scope of financial literacy encompasses a wide range of skills.

Scope of Financial Literacy:[2]

Managing Income

Managing Expenses

Managing Debt

Create Saving

Investing

Tax Planning

Healthy Credit Score

1. Managing Income: A human being’s basic necessities are food, shelter, and clothes. How can we meet these essential requirements? We need to buy food, clothing, and a place to live (house). We need money to buy anything. From where are we going to acquire this money?

The term ‘income’ refers to the amount of money that comes into the household in the form of earnings. This money could come from a variety of sources. Salary from a job, part-time jobs, rent from a house or shop, bank interest, or the sale of shares and other investments are all examples of sources of income. It could also be a profit from your household produce or from the use of your abilities. To ensure some savings, the expenditure must be lower than the income. You must plan your spending in order to stay inside your budget. This is called as ‘managing income,’ and it means spending intelligently so that all of your demands are covered. You will need to create a ‘spending plan’ for this.

• Managing Expenses: Expenditure refers to the money we spend from our earnings to acquire various items to meet our requirements. Income brings money into a household, whereas expenditure takes money away, making it unavailable for other users. Managing expenses is a disciplined approach to spending income. It is based on an individual’s or family’s overall income. It enables an individual or family to live within their income while simultaneously saving for future needs and emergencies. The general rule for managing income and expenses is that income must exceed expenses. We are more likely to spend more than we have if we do not develop a budget plan. As a result, if our expenditure exceeds our income, we may be forced to borrow money to meet our demands. As a result, distinguishing between necessary and unnecessary expenses will keep a person from drowning in debt.
• Managing Debt: Debt is nothing but borrowed money. In other words, it is money that does not belong to you. For example, if a person borrows money from a bank, uses a credit card, or takes out a short-term loan. All of this is added to the debt. Debt is generally regarded as bad. As a result, knowing debt is critical. However, not everyone can afford to buy a house, a car, or pay a college fee in cash. Borrowing a loan is the only way out in such situations. The most crucial thing is to distinguish between good and bad debt. Furthermore, avoiding bad debt as much as feasible is always preferable. This covers the fundamentals of managing debt. Borrowing money for things essential for a living is considered good debt. For example, purchasing a home or paying for a college fee. On the other hand, bad debt is borrowing money for needless expenses. For example, using a credit card to purchase luxury clothing or electronic devices.
• Creating Saving: a portion of an individual or a family’s income should also be set aside for future use. This money is set aside is regarded as savings, and it can be utilized for any purpose in the future. Savings and shorts financial security, a secure present and a bright future he stopped long term wealth can be built through prudent financial planning. It is possible to save money by keeping track of one spending patterns a result of Saving; one can easily accomplish the following:
• Instil financial discipline: One can attain financial discipline in excel in life by saving money regularly.
• Complete financial goals: Financial goals are targets you hope to achieve over a set period using your financial resources. For example, buying a house, a kid’s education, and retirement savings.
• Create an emergency fund: An emergency fund serves as a safety net in the event of unforeseen circumstances. At least six months’ worth of income should be saved in the fund.
• Investing: Rather than keeping money in a bank account, it can be diverted to investment avenues. Investing is about creating and growing wealth so you can live a secure and happy life. Saving money is not difficult if done systematically. After executing effective budgeting, any surplus should be channelized toward investing. Investing will help individuals achieve their financial goals like buying a house, child education, marriage, and planning. It’s all about investing in a strategy that will help you earn substantial profits over time. The investment will assist in the generation of additional monthly income as well as considerable benefits. It is also possible to attain financial goals while allocating funds to retirement savings. Equities, debt instruments, mutual funds, real estate, and gold or some of the most popular investment options.
• Tax Planning: Taxes can significantly reduce your annual earnings. On the other hand, tax planning is a legitimate way of decreasing your tax payment in any particular financial year. It assists you in making the best use of the text as exemptions, deductions, and perks provided by the government to reduce your burden. Tax planning is the process of saving money by lowering your tax liability. The Income Tax Act of 1961 contains a number of provisions that allow you to claim deductions and save money on taxes. Aside from investing alternatives, there are several additional expenses for which you can claim a deduction. This includes tuition for up to two children, house loan repayment, health insurance premiums, medical payments for specified conditions, contributions, and so on. Tax planning is essential if you want to make the most of what the government has to offer. Tax planning aids in the smooth operation of the financial planning processes. Tax planning aids in the allocation of taxable income to various investment schemes. Tax saving is a long-term effort, and tax planning and investment are many closely linked.
• Healthy Credit Score: A credit score measures a person’s ability to repay a debt. It’s a numerical representation of their creditworthiness. It is typically expressed as a number based on the individual’s payback history and credit files across various loan and credit agencies. The credit bureaus determine a credit score based on a proprietary formula. When generating a credit score, they analyze various characteristics such as credit history and payback behaviour, among others. A credit score ranges from 300 to 900 points; if your credit score is between 750 to 900, it is regarded as good for availing of credit services such as loans and credit cards.

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[1] Vaidya, D. (n.d.). Wall Street Mojo. Financial Literacy. Retrieved July 23, 2022, from https://www.wallstreetmojo.com/financial-literacy/

[2] Umair, M., & V, B. (2021). Financial Literacy (pp. 7-10). Mumbai, India: Himalaya Publishing House.