Econ 101: Basic Money Moves You May Have Missed in Lecture
Financial literacy is incredibly important for modern life, yet it’s barely taught in schools. We’ll answer the question, “Why is financial literacy important?”
March 1, 2022
The term “financial literacy” refers to the ability to understand and effectively use various financial skills — including budgeting, debt management, investing and more.
Why is financial literacy important?
We live in a society where money influences nearly every aspect of our lives. Because of this simple fact, understanding money is arguably one of the most important skills to have.
Unfortunately, financial education is sorely missing from our schools at all levels. “Home economics” classes have been largely eliminated from elementary and high schools (65% of high school graduates never took a single financial course), and even colleges don’t teach much about finance — unless students opt to pursue finance-related degrees.
The result of our lack of financial education is that many Americans score poorly on financial literacy surveys. One survey asked American adults a series of basic personal finance questions to gauge overall financial literacy. On average, participants answered just 52% of questions correctly — meaning that they were incorrect nearly half of the time.
This article answers the question of why financial literacy is important and also goes over some of the most important financial literacy topics that everyone should learn about.
Why is financial literacy important?
Most of us interact with money every day of our lives. From the purchases we make to the careers we pursue, nearly everything revolves around money — whether we like it or not.
Financial literacy is vital if we want to get ahead in life.
Skills like budgeting can help us get out of debt and find financial freedom. Understanding supply and demand can help us negotiate a better job offer. And getting started with investing can help us prepare for our future.
Even if you don’t enjoy thinking about finance, understanding the basics is important. In fact, if you understand finance, you can automate as much as possible so that you don’t have to think about money as much
How to become financially literate
Learning finance is just like learning any other skill: First, you study the principles, and then you implement your learning into your day-to-day actions.
Implementing your new knowledge is particularly important when it comes to finance. You can read all you want about investing — but until you actually take the leap and open an investment account, you won’t make any progress towards your goals.
Why is financial literacy important? It equips us with all the knowledge and skills to successfully manage our money. It’s always important, but one could argue that it gets more important as we get older and have more financial responsibilities.
Key financial literacy topics to understand
Finance is a huge topic to tackle, but let’s start with the basics. What concepts should everyday Americans understand in order to get a handle on their finances?
To simplify, we’ve used two distinct sections: One on key economic concepts that affect the overall economy, and one on personal finance topics that are more relevant to how you manage your own money.
Opportunity cost looks at the tradeoffs in any given situation. When you make a decision, the opportunity cost is the cost of the alternative that you gave up to make that decision.
For example, when you purchase an optional item — say a restaurant meal — the opportunity cost is the alternative uses you could have for that money. You could have used the funds to pay down debt or to invest for your future.
This broad concept applies to every decision in life — but it’s particularly relevant for financial decisions.
The sunk cost fallacy describes the tendency for us to continue certain endeavors simply because we have already invested time, money or other resources into them. Often, the more logical approach would be to abandon these endeavors and move on — but the sunk cost fallacy tends to lead us to continue even when it’s not the optimal choice.
For example, say you start a business and run it for several years. The business loses money each year, but you continue it because you have already invested substantial time and money in it. The logical option may be to shut the business down for good, but the sunk cost fallacy can make it psychologically difficult to do so.
A cost-benefit analysis is just what it sounds like: Comparing the costs of something to the benefits it provides. This could be for a purchase — a new vehicle, for instance — a service, or nearly any other transaction that involves a direct cost.
It can also apply to time. Is the cost of your time for a given activity worth the benefits that you receive from that activity?
Cost-benefit analysis is an excellent way to gauge spending decisions. By taking a closer look at how you spend your time and money, you can start focusing more on the activities and purchases that provide the most benefit.
Supply and demand
The principle of supply and demand is one of the defining characteristics of the market system. The concept essentially explains the relationship between how much supply of a given item or service affects demand, and vice versa — particularly as it relates to the price of an item.
Supply and demand affects all of us, often in ways that might not seem obvious at first. For example, when demand is strong for labor — as it currently is — workers who can supply skilled labor may have more bargaining power to negotiate a better salary.
Personal financial literacy
Quite simply, budgeting is managing how much money comes in vs. how much money goes out. It starts by figuring out where your money is going each month, usually by tracking your spending.
With this data, you can start making a budget. There are a few different types of budgeting approaches that you can try out to find what works best for you.
Budgeting is exceptionally important, regardless of your income level. Without a budget, it’s very easy to spend 100% of your income — or even more, which creates debt.
With a reported 56% of Americans living paycheck-to-paycheck, it’s clear to see that budgeting could be one of the most important financial literacy concepts to understand.
Investing is vital for long-term financial freedom. It’s a key component of preparing for retirement, and it can also help you save for mid-term financial goals like buying a house or taking your dream vacation.
Learning about investing doesn’t necessarily need to be complicated. The basic principle is to invest early and often — and to use a diversified investment portfolio of stocks, bonds, and other assets. By using index funds, you can invest in a diversified basket of stocks all at once.
Learn more in our investing basics guide.
The vast majority of American households are in debt — and the average debt is a whopping $92,727. This figure includes all types of debt, from mortgages to student loans and credit cards.
Debt is necessary for many situations, but there’s a big difference between so-called “good debt” like a mortgage, and high-interest debt, such as credit cards. If you have high-interest debt, paying it off should be among your top financial priorities.
Understanding how debt works can help give you the tools to improve your financial situation.
If credit card debt is holding you back from your financial goals, check out Tally† Tally is a powerful personal finance app offering a lower-interest line of credit that may help qualifying Americans get out of debt faster. Learn how Tally works here.
Credit score basics
Your credit score affects your ability to get a loan, rent an apartment, or even get a job in some cases. Having a good credit score can give you a huge boost towards meeting your financial goals, while a low credit score can hold you back.
Your credit score is calculated based on several factors, including:
Credit history length
Credit mix (the different types of loans or credit you have)
New credit (how many new accounts you have opened recently)
Understanding how your score is calculated — and how to improve it — is very important when it comes to getting a handle on your finances.
Understanding the basic concepts of economics and personal finance can give us a huge advantage in life.
Regardless of your income level, background, career or goals, learning more about personal finance can benefit everyone.
While the concepts discussed above cover many of the basics, there’s a lot to learn about money. For more informative guides, explore the rest of the Tally personal finance blog.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.