Financial literacy is a collection of skills and information that enables a person to make educated and effective financial decisions using all of their resources.
Financial literacy refers to a person’s knowledge and awareness of many financial topics that help a person to achieve the lifestyle he/she wants. This subject focuses on the ability to handle personal money effectively and involves the knowledge to make proper personal finance choices such as investment, insurance, college payments, real estate, budgeting, retirement plans, and tax planning.
Financial literacy also entails an understanding of financial principles and ideas such as budgeting, compound interest, debt management, profit-saving strategies, and the time value of money.
Financial illiteracy may lead to bad financial decisions, which can have a detrimental influence on an individual’s financial well-being. Financial literacy is a fluid idea. Individuals can benefit from properly managing their capital and allocating it, but neglecting financial management might have a negative impact on them.
According to RBI, Financial literacy can broadly be defined as “providing familiarity with and understanding of financial market products, especially rewards and risks, in order making informed choices”.
Why an individual need to be financially literate?
Budgeting: A budget is telling your money where to go instead of thinking where it went. Budgeting helps you to put aside cash and amounts for monthly expenses so you can see exactly how your money is leaving your account and whether the percentage is appropriate for your income. Budgeting provides you a clear picture of your finances and assists you in sticking to a savings goal.
50:30:20 budget rule- The basic rule is to divide up after-tax income and allocate it to spend: 50% on needs (basic necessities-food, rent, clothing), 30% on wants (desire- car, new house, luxury), and set aside 20% to savings and investments.
The rule is a framework designed to assist people in managing their finances and saving for emergencies and retirement. With time, as your income increase, the amount which a person set-asides for saving and investments should also increase.
Choosing the best option: There are a plethora of lenders today, including banks, financial institutions, non-banking financial companies, insurance companies, brokerage firms, credit unions, asset management firms, and so on, that offer consumers a variety of investment options. There are many YouTubers and social media influencers who don’t have any background in the finance field but they promote various financial and investing platforms. Financial literacy lets you decide on the best alternative rather than shooting in the dark.
Dynamic market: With a combination of both local and foreign participants, technical improvements, e-trading, and other factors, the market are turbulent and ever-changing, causing contradicting perspectives in the minds of investors. Financial literacy may help you avoid such ambiguity by giving you a clear picture of where to invest your money when to switch investments, and so on.
Retirement planning: Saving and investing are both phrases that refer to the future. What you save or invest in now can assist you in the future. To gain a holistic perspective of the types of funds you may invest in and where to place your money so it doubles over time, you must first comprehend the stock market and the money market. This is a safe bet that will provide you with a higher return over a longer period of time, allowing you to plan out your retirement. This may seem like a long shot, but it will be worth it and will support you in your future.
The complexity of various investment options: Today’s investing and savings solutions are more sophisticated than ever before, Consumers are being asked to pick between many product alternatives with varied interest rates and maturities, decisions they are not fully prepared to make. Decisions on complicated financial instruments with a wide variety of possibilities can have an influence on a consumer’s capacity to buy a house, fund a college education, or save for retirement, further confusing financial decisions.
Individuals who are well-informed and financially literate contribute to economic stability by making prudent investments that assist to infuse cash into the economy. You may avoid being a victim of various frauds if you have financial literacy. The more financially literate you are, the better decisions you will make with your finances, so the more money you have and the more effective you could be with your money. A person might have the best-paying job in the world and could still be broke in terms of finances. Just because a person makes more money doesn’t mean he/she could be better at managing it.
Note: Article by Rahul Khismatrao under the guidance of CA Brijmohan Lavaniya