Why is financial literacy important?

In order to ensure financial stability/a healthy relationship with money, you must have a basic understanding of key financial concepts (e.g. how a mortgage works) as well as some simple money management rules (e.g. 'rainy day' savings).

Quick Facts:

• Over 6 million UK citizens don’t think they will ever be debt free

• Over 4 million UK citizens are thought to be in serious financial difficulty

• The average person in the UK owes £8,000 (on top of any mortgage debt)

With 50% of the UK population considered ‘financially vulnerable’, and over 65% of school teachers claiming the finance related curriculum in schools is ineffective, there is a clear problem that stems from an inability to educate children before they encounter the financial ‘traps’ they will face.

Two people who have earned the same amount of money throughout their career could be in vastly different positions at the end of their careers. If you want to secure yourself a safe retirement and protection from monetary hardship, you will need to be financially literate.

This may not make sense at first. How can people that earn the same amount be in different financial positions? However, this is a lot more common than one may think. Let’s use a hypothetical example of Jack and Lucy to illustrate how influential financial literacy can be:

Jack and Lucy met on a teaching graduate scheme and now teach at the same secondary school. Let’s assume they have both had the same pay of £30,000 per year ever since in their 40-year careers for simplicity.

However, they have dealt with their money in contrasting ways. Lucy has always had a budget, tracked her spending, managed her debt and tried to slot away a good chunk of her income. To reduce her spending, she could have stopped ordering takeout, bought cheap and petrol efficient cars, and purchased a house which was not unnecessarily large. These are not significant sacrifices by any means. This has resulted in Lucy putting 20% of her income into her pension. Due to tax relief on pension contributions, £7500 would be deposited each year. Whereas Jack has spent the vast majority of his income ever since he started working; he eats out multiple times a week, has leased multiple expensive cars, and has therefore only managed to put 3% (£1,125 with tax relief) of his income into his pension annually. Let us use current tax rates for all 40 years to show how their total savings would have grown. This model assumes a return on their savings of 7% a year, which is the average inflation-adjusted growth of the S&P 500.

The results are staggering. Lucy would end her career with £1,497,263 in her pension whereas Jack would have £234,571. Lucy and Jack will have vastly different retirements for marginal differences in their lifestyle. However, financial literacy is not just important for retirement. It is important for any sort of financial decision. For example, you may want to pay off your student loan. You may want to get a graduate education. You may want to quit your job and live in a van for a year. Irrespective of your financial goals, financial literacy is required to achieve them.

Despite the benefits, financial illiteracy is rampant in the UK. 50% of the UK is considered to be “financially vulnerable” according to Credit Angel. Being financially inept can cause people to become victims of predatory lending, such as payday loan schemes, amongst other poor financial decisions. People are manipulated into these loans which have interest rates up to 1500%. Financial literacy can help prevent poor decisions like these.

To go about improving your financial literacy, there are a few things you can do. To start off, it is good to keep a budget to see exactly where your money is going every month. You may be surprised at how much you have been spending on those morning Starbucks coffees, for example. Next, there is a lot of personal finance media available. There is a range of good books, podcasts, and YouTube videos you can consume to improve your financial know-how. There are even online communities such as the UK personal finance subreddit which provide advice. Finally, you could consult a fee-only financial advisor to receive professional financial advice tailored to your goals and values. Commission-based financial advisors may sell you financial products which are not in your interests in order to earn a commission, so avoid them.

Overall, financial literacy is a skill which you must master to achieve your financial goals and stability. Improving your knowledge is an investment which will give you invaluable returns for the rest of your life.