Financial literacy: 5 basic concepts to know
July 27, 2023 7 min read
There’s a lot to the world of personal finance. Maybe you’re new to managing your own finances. Maybe you’re taking on new financial responsibilities. Maybe you just want to give yourself a refresher. Whatever the case, it can be hard to know where to start or how to ensure you’re making the right choices.
Learn more about what it means to be financially literate and a few basic concepts to help you get started.
- Financial literacy involves concepts like budgeting, building and improving credit, saving, borrowing and repaying debt, and investing.
- Becoming more financially literate might make big financial decisions related to loans, major purchases and investments less daunting.
- There’s no shortage of places to learn more about finances, but it’s important to learn from trustworthy sources.
What is financial literacy?
Financial literacy is about understanding concepts like budgeting, building and improving credit, saving, borrowing and repaying debt, and investing—and having the ability to apply them to real-life situations.
If financial well-being is the goal, financial literacy can be the first step toward achieving it. Becoming financially literate means learning basic concepts so you’re able to make more-informed decisions about your money and work toward your financial goals.
There’s no wrong time to make efforts to improve your financial literacy, and there’s always something new to learn when it comes to personal finance. The more financially literate you become, the more it could help you take actions that may ultimately bring you closer to a state of financial well-being.
Why is financial literacy important?
Becoming financially literate might help you manage money with greater ease and less stress. Taking time to understand the basics of personal finance can go a long way toward achieving your goals in the long run. It could help you handle the unexpected, whether it’s an opportunity or a setback.
Financial literacy 101: 5 concepts to know
There’s plenty to learn about financial topics, but breaking them down can help simplify things. To start, consider these five areas: budgeting, building and improving credit, saving, borrowing and repaying debt, and investing.
A key first step to take as you build your financial literacy is to learn healthy spending habits. One way to do this is by learning to budget. You could start by identifying monthly expenses to include in your budget, which can help you track your spending.
Budgeting can help ensure that you’re not overspending on nonessentials. And avoiding extra expenses can create more room for essentials and savings. There are many methods of budgeting, including:
- The 50-30-20 method: This method involves setting aside 50% of your take-home income for your needs, 30% for your wants and 20% for savings.
- The zero-based method: Monthly expenses and savings are subtracted from your take-home income and should reach zero, so every dollar is used with intention.
- The envelope method: This involves creating categories for all your monthly expenses and putting certain amounts of your take-home income into physical or digital envelopes for each category.
2. Building and improving credit
Your credit scores affect many areas of your financial life. Among other major decisions, your ability to buy a house, lease a car and apply for a credit card are all impacted significantly by how good your credit score is. That’s why knowing where your credit stands—and what steps you can take to improve your score—can be so important.
- Apply only for credit you need.
- Understand how closing credit cards might affect the length of your credit history.
- Keep your credit utilization ratio at 30% or below, a level recommended by the Consumer Financial Protection Bureau (CFPB).
- Monitor your credit reports for errors on a regular basis, and keep tabs on your credit scores for changes.
- Watch your debt-to-income (DTI) ratio. Generally, lenders like to see DTIs between 28% and 36%.
The more you can increase your creditworthiness, the more likely you’ll be to receive favorable terms and better interest rates on credit cards and other loans.
Learning to save is another important aspect of financial literacy. Saving can be done in many ways, including traditional savings accounts, retirement savings funds, investment portfolios and emergency funds.
It can be helpful to clearly define your savings goals so you know exactly how much you’ll need to put aside. Managing bills and other expenses at the same time can make saving seem difficult. But there are ways to save money while paying off debt.
4. Borrowing and repaying debt
At some point in your life, you’ll likely need to borrow money and take on some kind of debt to achieve a personal or financial goal or need, like attending college or completing renovations on your home.
Credit cards are another form of debt. And they can help with more than just everyday expenses. With responsible use, you can use a credit card to build credit. That means doing things like paying your statement balance on time each month and monitoring your credit utilization.
Understanding the impact that taking on debt will have on your finances and establishing a concrete plan for paying down that debt and paying it on time are crucial when it comes to being financially literate.
Learning about stocks, bonds, mutual funds and other types of investment opportunities might be a place to start. But it’s important to remember that investing involves risk. And there are different levels of risk and return, depending on the investment.
How to become financially literate
The world of personal finance is ever-evolving. Making financial literacy a lifelong pursuit can help you stay informed and put you on a path to financial well-being.
As you begin to educate yourself on these personal finance topics to become more financially literate, it’s wise to choose your informational resources carefully. Here are a few places you might start:
- MyMoney.gov: A financial education website that was developed by the U.S. Department of the Treasury’s Financial Literacy and Education Commission
- Consumer education: A section of the CFPB website that provides readers with tools and information that can help them make more-informed financial decisions
- Investor.gov: A website created by the U.S. Securities and Exchange Commission to help readers learn more about how to invest and protect their investments
- Consumer advice: A website created by the Federal Trade Commission to help readers learn how to report fraud, avoid scams and educate themselves about finances
- Learn & Grow: A section of Capital One’s website that features helpful articles specifically geared toward helping readers gain a better understanding of a wide variety of personal finance topics
Financial literacy in a nutshell
Developing financial literacy can be an important part of managing money and reaching your financial goals. And there are simple steps you can take to increase your financial knowledge and confidently apply what you learn.
You can get an idea of where your credit stands and monitor your progress with CreditWise from Capital One. It’s free, even if you’re not a Capital One customer, and using it won’t hurt your credit score. Plus, it has tools like the CreditWise Simulator to help when you have to make financial decisions.