What Is Financial Literacy?

Financial literacy is the ability to understand and make use of a variety of

financial skills, including personal financial management, budgeting, and
investing. It also means comprehending certain financial principles and
concepts, such as the time value of money, compound interest, managing
debt, and financial planning.

Achieving financial literacy can help individuals to avoid making poor

financial decisions. It can help them become self-sufficient and achieve
financial stability. Key steps to attaining financial literacy include learning
how to create a budget, track spending, pay off debt, and plan for
retirement.

Educating yourself on these topics also involves learning how money

works, setting and achieving financial goals, becoming aware of
unethical/discriminatory financial practices, and managing financial
challenges that life throws your way.

The Importance of Financial Literacy

In its National Financial Capability Study the Financial Industry Regulatory
Authority (FINRA) found that Americans’ with higher levels of financial
literacy were more likely to make ends meet, spend less of their income,
create a three-month emergency fund, and open a retirement account than
those with lower financial literacy.1

Making informed financial decisions is more important than ever. Take

retirement planning. Many workers once relied on pension plans to fund
their retirement lives, with the financial burden and decision-making for
pension funds borne by the companies or governments that sponsored
them.

Today, few workers get pensions; instead some are offered the option of
participating in a 401(k) plan. This involves decisions that employees
themselves have to make about contribution levels and investment
choices. Those without employer options need to actively seek out and
open individual retirement accounts (IRAs) and other tax-advantaged
retirement accounts.

Add to this people’s increasing life spans (leading to longer

retirements), Social Security benefits that barely support basic survival,
complicated health and other insurance options, more complex savings
and investment instruments to select from—and a plethora of choices from
banks, credit unions, brokerage firms, credit card companies, and more.
It’s clear that financial literacy is a must for making thoughtful and informed
decisions, avoiding unnecessary levels of debt, helping family members
through these complex decisions, and having adequate income in
retirement.

Personal Finance Basics

Personal finance is where financial literacy translates into individual
financial decision-making. How do you manage your money? Which
savings and investment vehicles are you using? Personal finance is about
making and meeting your financial goals, whether you want to own a
home, help other members of your family, save for your children’s college
education, support causes that you care about, plan for retirement, or
anything else.

Among other topics, it encompasses banking, budgeting, handling debt

and credit, and investing. Let’s take a look at these basics to get you
started.

Introduction to Bank Accounts

A bank account is typically the first financial account that you’ll open. Bank
accounts can hold and build the money you'll need for major purchases
and life events. Here’s some background on bank accounts and why they
are step one in creating a stable financial future.

Why Do I Need a Bank Account?

Though the majority of Americans do have bank accounts, 6% of

households in the United States still don’t have one.2 Why is it so
important to open a bank account? Because it’s safer than holding cash.
Assets held in a bank are harder to steal, and in the U.S., they’re generally
insured by the Federal Deposit Insurance Corporation (FDIC) .3 That
means you should always have access to your cash, even if every
customer decided to withdraw their money at the same time.

Many financial transactions require you to have a bank account to:

 Use a debit or credit card

 Use payment apps like Venmo or PayPal
 Write a check
 Use an ATM
 Buy or rent a home
 Receive your paycheck from your employer
 Earn interest on your money
Online vs. Brick-and-Mortar Banks

When you think of a bank, you probably picture a building. This is called a
brick-and-mortar bank. Many brick-and-mortar banks also allow you to
open accounts and manage your money online.

Some banks are only online and have no physical buildings. These banks
typically offer the same services as brick-and-mortar banks, aside from the
ability to visit them in person.

Which Type of Bank Can I Use?

Retail banks: This is the most common type of bank at which people have
accounts. Retail banks are for-profit companies that offer checking and
savings accounts, loans, credit cards, and insurance. Retail banks can
have physical, in-person buildings that you can visit or they can be online
only. Most offer both options. Banks’ online technology tends to be
advanced, and they often have more locations and ATMs nationwide than
credit unions do.

Credit unions: Credit unions provide savings and checking accounts,

issue loans, and offer other financial products, just like banks do. However,
they are not-for-profit organizations owned by their members. Credit
unions tend to have lower fees and better interest rates on savings
accounts and loans. Credit unions are sometimes known for providing
more personalized customer service, though they usually have far fewer
branches and ATMs.

Assets held in a credit union are insured by the National Credit Union

Administration (NCUA), which is equivalent to the FDIC for banks.4

What Types of Bank Accounts Can I Open?

There are three main types of bank accounts that the average person may
want to open:

1. Savings account: A savings account is an interest-bearing deposit

account held at a bank or other financial institution. Savings accounts
typically pay a low interest rate, but their safety and reliability make them a
sensible option for saving available cash for short-term needs.

They usually have some legal limitations on how often you can withdraw
money. However, they’re generally very flexible so they’re ideal for building
an emergency fund, saving for a short-term goal like buying a car or going
on vacation, or simply storing extra cash that you don’t need in your
checking account.5

2. Checking account: A checking account is also a deposit account at a

bank or other financial institution that allows you to make deposits and
withdrawals. Checking accounts are very liquid, meaning that they allow
numerous withdrawals per month (as opposed to less liquid savings or
investment accounts) though they earn little to no interest.

Money can be deposited at banks and ATMs, through direct deposit, or

through another type of electronic transfer. Account holders can withdraw
funds via banks and ATMs, by writing checks, or using debit cards linked
to their accounts.

You may be able to find a checking account with no fees. Others have
monthly and other charges (such as for overdrafts or using an out-of-
network ATM) based on, for example, how much you keep in the account
or whether there’s a direct deposit paycheck or automatic-withdrawal
mortgage payment connected to the account.

Lifeline and second-chance accounts, available at some banks, can help

those who have difficulty qualifying for a traditional checking account.

3. High-yield savings account : A high-yield savings account usually pays

a much higher rate of interest than a standard savings account. The
tradeoff for earning more interest on your money is that high-yield
accounts tend to require bigger initial deposits, larger minimum balances,
and higher fees.

 
You might be able to open a high-yield savings account at your current
bank, but online banks tend to have the highest interest rates.

What’s An Emergency Fund?

An emergency fund is not a specific type of bank account but can be any
source of cash that you’ve saved to help you handle financial hardships
like job losses, medical bills, or car repairs. Here's how they work:

 Most people use a separate savings account for their emergency

savings.
 The account should eventually total enough to cover at least three to
six months’ worth of expenses.
 Emergency fund money should be off-limits for paying regular
expenses.
Introduction to Credit Cards
You know them as the plastic cards that (almost) everyone carries in their
wallets. Credit cards are accounts that let you borrow money from the
credit card issuer and pay it back over time. For every month that you don’t
pay back the money in full, you’ll be charged interest on your
remaining balance. Note that some credit cards, called charge cards,
require you to pay your balance in full each month. However, these are
less common.

What’s the Difference Between Credit and Debit Cards?

Here is the difference:

Debit cards take money directly out of your checking account. You can’t
borrow money with debit cards, which means that you can’t spend more
cash than you have in the bank. And debit cards don’t help you to build
a credit history and credit rating.

Credit cards allow you to borrow money and do not pull cash from your
bank account. This can be helpful for large, unexpected purchases. But
carrying a balance every month—not paying back in full the money that
you borrowed—means that you’ll owe interest to the credit card issuer. In
fact, as of Q4 2022, Americans owed $986 billion in credit card debt.6 So
be very careful about spending more money than you have, because debt
can build up quickly and become difficult to pay off.

On the other hand, using a credit card judiciously and paying your credit
card bills on time helps you establish a credit history and a good credit
rating. It’s important to build a good credit rating not only to qualify for the
best credit cards but also because you will get more favorable interest
rates on car loans, personal loans, and mortgages.

What Is APR?

APR stands for annual percentage rate. This is the amount of interest that
you’ll owe the credit card issuer on any unpaid balance. You’ll want to pay
close attention to this number when you apply for a credit card. A higher
number can cost you hundreds or even thousands of dollars if you carry a
large balance over time. The median APR today is about 23%, but your
rate may be higher if you have bad credit. Interest rates also tend to vary
by the type of credit card.

Which Credit Card Should I Choose?

Credit scores have a big impact on your odds of getting approved for a
credit card. Understanding what range your score falls into can help you
narrow the options as you decide on the cards for which you may apply.
Beyond your credit score, you’ll also need to decide which perks best suit
your lifestyle and spending habits.

If you’ve never had a credit card before, or if you have bad credit, you’ll

likely need to apply for either a secured credit card or a subprime credit
card. By using one of these and paying back on time, you can raise your
credit score and earn the right to credit at better rates.

If you have a fair to good credit score, you can choose from a variety of
credit card types, such as:

 Travel rewards cards. These credit cards offer points redeemable

for travel—including flights, hotels, and rental cars—with each dollar
you spend.
 Cash-back cards. If you don’t travel often—or don’t want to deal
with converting points into real-life perks—a cash-back card might
be the best fit for you. Every month, you’ll receive a small portion of
your spending back, in cash or as a credit to your statement.
 Balance transfer cards. If you have balances on other cards with
high interest rates, transferring your balance to a lower-rate credit
card could save you money, help you pay off balances, and help
improve your credit score.
 Low- or No-APR cards. If you routinely carry a balance from month
to month, switching to a credit card with a low or no APR could save
you hundreds of dollars per year in interest payments.

Be aware of your protections under the Equal Credit Opportunity

Act.7 Research credit opportunities and available interest rates, and be
sure that you are offered the best rates for your particular credit history
and financial situation.

How to Create a Budget

Creating a budget is one of the simplest and most effective ways to control
your spending, saving, and investing. You can’t begin to improve your
financial health if you don’t know where your money is going, so
start tracking your expenses against your income. Then set clear goals.

 
One budget template that helps individuals reach their goals, manage their
money, and save for emergencies and retirement is the 50/20/30 budget
rule: spending 50% on needs, 20% on savings, and 30% on wants.
How Do I Create a Budget?

Budgeting starts with tracking how much money you receive and spend
every month. You can do this in an Excel sheet, on paper, or with
a budgeting app. It’s up to you. However you decide to track, clearly lay
out the following:

 Income: List all sources of money that you receive in a month, with

the dollar amount. This can include paychecks, investment income,
alimony, settlements, and money that you make from side jobs or
other projects, such as selling crafts.
 Expenses: List every purchase that you make in a month, split into
two categories: fixed expenses and discretionary spending. Review
your bank statements, credit card statements, and brokerage
account statements to be sure to capture them all. Fixed
expenses are the purchases that you must make every month. Their
amounts don’t change (or change very little) and are considered
essential. They include rent/mortgage payments, loan payments,
and utilities. Discretionary spending is nonessential spending or
varying purchases for things like restaurant meals, shopping,
clothes, and travel. Consider them wants rather than needs.
 Savings: Record the amount of money that you’re able to save each
month, whether it’s in cash, cash deposited into a bank account, or
money that you add to an investment account or retirement account
like an IRA or 401(k) (if your employer offers one).

Subtract your total expenses from your total income to get the amount of
money you have left at the end of the month. Now that you have a clear
picture of money coming in, money going out, and money saved, you can
identify which expenses you can cut back on, if necessary.

If you don’t already have one, put your extra money into an emergency
fund until you’ve saved at least three to six months’ worth of expenses (in
case of a job loss or other emergency). Don’t use this money for
discretionary spending. The key is to keep it safe and grow it for times
when your income decreases or stops.

How to Start Investing 

Once you have enough savings to start investing, you’ll want to learn the
basics of where and how to invest your money. Decide what to invest in
and how much to invest by understanding the risks (and potential rewards)
of different types of investments.

What Is the Stock Market?

The stock market refers to the collection of markets and exchanges where
stock buying and selling takes place. The terms “stock market” and “stock
exchange” can be used interchangeably. And even though it’s called a
stock market, other financial securities, such as exchange-traded funds
(ETFs), corporate bonds, and derivatives based on stocks, commodities,
currencies, and bonds, are also traded there. There are multiple stock
trading venues. The leading stock exchanges in the U.S. include the New
York Stock Exchange (NYSE), Nasdaq, and the Cboe Options Exchange.

How Do I Invest?

To buy stocks, you need to use a broker. This is a professional person or

digital platform whose job it is to handle the transaction for you. For new
investors, there are three basic categories of brokers:

1. A full-service broker who manages your investment transactions and

provides advice for a fee.
2. An online/discount broker that executes your transactions and
provides advice depending on how much you have
invested. Examples include Fidelity, TD Ameritrade, and Charles
Schwab.
3. A robo-advisor that executes your trades and can pick investments
for you with little human assistance. Examples include Betterment,
Wealthfront, and Schwab Intelligent Portfolios.

What Should I Invest in?

There’s no right answer for everyone. Which securities you buy, and how
much you buy, will depend on the amount of money that you have
available for investing and how much risk you’re willing to take to try to
earn a higher return. Here are the most common securities to invest in,
listed in descending order of risk:

Stocks: A stock (also known as “shares” or “equity”) is a type of

investment that signifies partial ownership in the issuing company. This
entitles the stockholder to a proportion of the corporation’s assets and
earnings.

Owning stock gives you the right to vote in shareholder meetings, receive
dividends (which come from the company’s profits) if and when they are
distributed, and sell your shares to somebody else.

The price of a stock fluctuates throughout the day and can depend on
many factors, including the company’s performance, the domestic
economy, the global economy, the day’s news, and more. Stocks can rise
in value, fall in value, or even become worthless, making them
more volatile and potentially riskier than many other types of investments.

ETFs: An exchange-traded fund, or ETF, consists of a collection of

securities, such as stocks. It often tracks an underlying index. ETFs can
invest in any number of industry sectors or use various strategies.

Think of an ETF as a pie containing many different securities. When you

buy shares of an ETF, you’re buying a slice of the pie, which contains
slivers of the securities inside. This lets you purchase a variety of many
stocks at once, with the ease and convenience of only one purchase—the
ETF.

In many ways, ETFs are similar to mutual funds. For instance, they both
offer instant diversification and are professionally managed. However,
ETFs are listed on exchanges and ETF shares trade throughout the day
just like ordinary stocks.

Investing in ETFs is considered less risky than investing in individual

stocks because there are many securities inside the ETF. If some of those
securities fall in value, others may stay steady or rise in value.

Mutual funds: A mutual fund is a type of investment consisting of

a portfolio of stocks, bonds, or other securities. Mutual funds give small or
individual investors access to diversified, professionally managed
portfolios at a low price.

There are many categories of mutual funds, representing the kinds of

securities in which they invest, their investment objectives, and the type of
returns that they seek. Most employer-sponsored retirement plans invest in
mutual funds.

Investing in shares of a mutual fund is different from investing in individual

shares of stock because a mutual fund owns many different stocks (or
other securities). Unlike stocks or ETFs that trade at varying prices
throughout the day, mutual fund purchases and redemptions take place
only at the end of each trading day and at a fund's net asset value (NAV).
Similar to ETFs, mutual funds are considered less risky than stocks
because of their diversification.

 
Mutual funds charge annual fees, called expense ratios, and in some
cases, commissions.
Bonds: Bonds are issued by companies, municipalities, states, and
sovereign governments to finance projects and operations. When an
investor buys a bond, they’re effectively lending their money to the bond
issuer, with the promise of repayment plus interest. A bond’s coupon
rate is the interest rate that the investor will earn.

A bond is referred to as a fixed-income instrument because bonds

traditionally have paid a fixed interest rate to investors, although some
bonds pay variable interest rates. Bond prices inversely correlate with
interest rates. When rates go up, bond prices fall, and vice versa. Bonds
have maturity dates, which are the point in time when the principal amount
must be paid back to the investor in full or the issuer will risk default.

Bonds are rated by how likely the issuer is to pay you back. Higher-rated
bonds, known as investment grade bonds, are viewed as safer and more
stable. Such offerings are tied to publicly traded corporations and
government entities that boast positive outlooks.

Investment grade bonds receive “AAA” to “BBB-” ratings from Standard

and Poor’s and “Aaa” to “Baa3” ratings from Moody’s.89 Bonds with higher
ratings will usually pay lower rates of interest than those with lower ratings.
U.S. Treasury bonds are the most common AAA-rated bond securities.

Are Banks Safe?

Most bank accounts in the United States are insured by the Federal
Deposit Insurance Corporation (FDIC) up to certain limits, currently defined
as “up to at least $250,000 per depositor, per FDIC-insured bank, per
ownership category.”10 If you have a great deal of money to put in the
bank, you can make sure that it’s all covered by opening multiple
accounts.

Is It Safe to Invest in the Stock Market?

Stocks are inherently risky—some more than others—and you can lose
money if their share prices fall. Brokerage accounts are insured by
the Securities Investor Protection Corporation  for up to $500,000 in
securities and cash. However, that applies only if the brokerage firm fails
and is unable to repay its customers. It does not cover normal investor
losses.11

What Is the Safest Investment?

U.S. Treasury securities, including bonds, bills, and notes, are backed by
the U.S. government and generally are considered the safest investments
in the world. However, these kinds of investments tend to pay low rates of
interest, so investors do face a risk that inflation may erode the purchasing
power of their money over time.

The Bottom Line

The topics in this article are just the beginning of a financial education, but
they cover the most important and frequently used products, tools, and tips
for getting started. If you’re ready to learn more, check out these additional
resources from Investopedia: