Last Updated: October 26, 2009
If it doesn't seem obvious, financial literacy — as study after study demonstrates — is perhaps one of the biggest problems that this country faces. Consider, for instance, these remarks by Annamaria Lusardi, a Dartmouth College professor who recently announced the creation of a new Financial Literacy Center, a collaborative effort among Dartmouth, the Wharton School, and RAND Corporation.
"Individuals and families are increasingly being asked to take command of their own financial well-being," she wrote in her blog, Financial Literacy and Ignorance. "They must determine not only where and how long to work, but also how much to save and how to allocate their pension assets, when to claim Social Security and pension benefits, and how to manage their assets throughout a potentially long retirement period. These decisions were always difficult, but they have become even more so today since increasingly intricate and hard-to-understand financial products are now accessible to many people who are actually quite ill-equipped to take on the task. As a result, widespread saving shortfalls and difficulties with debt are emerging as serious challenges to households already at risk. And without a doubt, the current financial crisis has underscored the reality that, as a nation, we are subject to deep systemic risk attributable in part to financial illiteracy. These facts threaten to undermine many Americans' hopes for a rewarding retirement."
To be sure, financial literacy can undermine your hopes for a rewarding retirement. But there are things you can do to improve your knowledge of money and improve the odds of having a rewarding retirement and financially secure life, according to FPA member John Comer, CFP® of Comer Consulting. Here's his check list that outlines what you can do to become smart about money.
- Knowing what is important to you. You have to know your values. Becoming literate about money means that you have to know what is and what isn't important to you.
- Creating a budget. Creating a budget isn't about denying yourself the things that you want. It's about creating a spending plan that helps you get the things you want, whether it's a new car, a vacation or a secure retirement. Make sure your spending is aligned with what it is important to you. In addition, take the time to understand money personality.
- Creating a budget is one thing. Tracking your income and spending against your budget is an equally important part of becoming financially literate. Some money will always slip through the cracks but by tracking your spending, you can put as much as possible to work on your short- and long-term goals.
- In the world of business, there are ratios to measure everything. Likewise, there are ratios to measure things in your personal world of money. You should develop an understanding of those ratios, including the following: Spend no more than 25 percent of your income on your mortgage or rent; Spend no more than 33 percent of your income on fixed expenses (including your mortgage or rent); Save 10 percent of your income; Give 10 percent to charity. Once you add in taxes, you will have 20 to 30 percent of your income available for variable expenses.
- Understanding the use and value of credit is extremely important to your financial health. Bankers start with the three Cs of credit: your Character or your willingness to repay the debt, your Capacity or the availability of funds to repay the debt — usually your income — and your Collateral or a second source of funds to repay the debt. Factors that represent your three Cs are converted to a number on your credit report. That report gives you an overview of how you are managing your debt.
- Having cash in the bank. It might seem trite, but it's important that you have at least three to six months of living expenses set aside in cash, a money market mutual fund or money market deposit account. In addition, have some flexibility in your monthly expenses (mentioned above as 20-30% of income for discretionary spending) so you can respond easily when your car needs maintenance or the dog gets sick. Those expenses (car maintenance and routine illnesses) do not happen every month but they are not emergencies — you know they will happen, you just do not know when.
- Besides ratios, it's important to become familiar with the language of money. Those include such words and phrases as time value of money; diversification; asset allocation; dollar-cost averaging; risk tolerance; and time horizon.
- Talking with a financial planner. Find a financial planner who might be right for you.
- Other resources that can help you become financially literate include:
- Explore right here on the Financial Planning Association Web site.
- Learn more about The Financial Literacy Project.
- MyMoney.gov is the U.S. government's Web site dedicated to teaching all Americans the basics about financial education. Whether you are planning to buy a home, balancing your checkbook, or investing in your 401k, the resources on MyMoney.gov can help you do it better.
- America Saves can help with tips and tools to help you set goals, develop strategies to reach those goals and to start saving.