Business Magazine

What Really Is Financial Literacy?

Posted on the 21 May 2015 by Sgyounginvestment

If we're academically literate, it doesn't mean we are financially literate. In fact, we can be the smartest and score many As in our exams subjects but still have no idea how to plan for our financial life. University graduates are still getting into money problems because of a lack of financial literacy.

While academic results are important, it is only the beginning of our life. A diploma or degree opens the first door to our career and the rest of our lives depends on how we manage it. When we start working, get married, buy a house and have children, managing money becomes an everyday affair. How well do we score if there is a financial literacy exam?

More often than not, we jump right into investment thinking that it is the most important aspect of financial planning. That is the direct opposite of what we should do. Going right into investment without learning the other aspects of financial literacy is like building a house without any foundation.

Recently, there was a report on the Straits Times that Singapore posts largest decline in financial literacy across Asia Pacific. This is an annual survey conducted by MasterCard. In the whole Asia Pacific region, Taiwan came out first while Singapore ranked sixth, behind Malaysia which came in fifth.

Financial literacy is basically broken down into 3 parts as per the MasterCard financial literacy survey:

  1. Basic Money Management
  2. Financial Planning
  3. Investment

Let me explain on each components so we roughly know what is financial literacy and the things we need to learn in order to manage our money better

What Really Is Financial Literacy?

1. Basic Money Management

Basic money management consists of budgeting, saving and using debt wisely. This is the basic of financial literacy. Some questions we can ask ourselves are: "Do we spend more than we earn? Are we taking on too much debt? Will we still be financially healthy if we lose our jobs?"

For the above 3 questions, what we can do is firstly, budget our money well and make sure we do not spend more than we earn. Secondly, do not take on too much debt even for housing purposes. A general guideline is not to have total debts of more than 60% of our monthly salary and not more than 30% of our monthly salary for housing. This is also the current MAS rule on debt. So, if you earn $3000, make sure you do not pay more than $900 per month for housing and not more than $1800 for your total debt. Thirdly, have an emergency fund saved up for rainy days. You should ideally have more than 6 months of your monthly expenses stored in an emergency fund. This will tide you through in the event you lose your job.

Although financial planning can be done through a financial advisor, it is best that we understand it ourselves too. Financial planning is planning for our long term financial needs such as retirement. This requires the understanding of various financial planning products such as insurance and investment products. We can use these tools to fulfil our long term financial needs.

In financial planning, protection always comes first. Insurance is an important element in our lives especially with the rising cost of living and medical bills. We should understand how medical insurance works and know which one to get which is best for ourselves. We should understand how to insure ourselves in the event of death or even disability. Do you know that you can get the same insurance coverage at 10 times cheaper? Do you know that you can get insurance coverage to replace a portion of your income in the event of disability?

There are many insurance products out there in the market but always remember that the purpose of insurance is really JUST for insurance. For example, getting a term insurance will be cheaper as compared to a whole life plan if we want higher insurance coverage in the event of death. A disability income insurance plan will replace a portion of our income in the event we become disabled and can no longer work. A hospitalisation and surgical insurance will cover a portion of our hospitalisation bills according to the plans we purchase.

Apart from insurance, retirement planning is also important. The earlier we start, the easier it is to plan for retirement. Retirement planning requires the understanding of inflation and the time value of money. If we leave our money in the bank earning little interest, it would be very hard to reach our retirement goals. Even if we save a lot, it will be very hard to retire if our money does not grow higher than the inflation rate.

A simple way to long term retirement planning is to use an excel spreadsheet to visualise how our savings will grow and if we have enough money for retirement. Here's an example of a person who saves $1500 per month and invest it at an annual return of 5%:

Notice that I put in 2 values for with investment and without investment. See the difference for yourself. A person who invests his or her money at just 5% return will have almost 3 times more, 30 years from now, than a person who does not invest. This is what I meant by it is very hard to reach our retirement goals if we leave our money in the bank (assuming bank's interest rates stay lower than inflation). Also, the earlier we start, the bigger difference we will see in the growth of our money. Time plays a part in growing our money. This brings us to the last point on investment.

3. Investment
When it comes to investment, many of us get confused. How exactly do I start investing is a common question. The right way to start investing is firstly to understand our risk profile. Do we want low risk, medium risk or high risk investment? There are different products for different risk profiles. A low risk investor can choose to invest in bonds which gives regular income plus it is principle guaranteed if we hold it to maturity. A medium to high risk investor can choose to invest in mutual funds such as an index ETF or buy stocks directly from the stock market.

Secondly, after identifying the product to invest, we need to understand the product. Do you understand what is a bond or how does it work? Do you know what components are in a mutual funds or understand what is an index ETF? Do you understand when to buy a stock or evaluate a company's financial statement? It may seem like there are a lot to learn but in our current generation, it is easy to get all the information we need. Read books on stocks investing or even attend investment courses if you need.

But, bear in mind that a lot of courses out there are not worth attending. Some red flags are if they promise high profits after attending their courses or they subscribe to the notion of quick money with low risk. To say the truth, we don't need to spend thousands of dollars to learn investing. A couple of hundred dollars will be enough. You can even learn investment skills for free if you're lucky to have friends who are already investing for a number of years.

Check-list for Financial Literacy
There you go, we have expanded on the 3 basic components of financial literacy which are basic money management, financial planning and investment.

Here is a check list on the things we need to know for financial literacy:

  • Budgeting
  • Debt management
  • Emergency Fund
  • Insurance products
  • Retirement planning
  • Inflation
  • Compound interest
  • Investment products
  • Risk profile of investment

Take a step by step approach towards financial literacy. We can all be financially literate if we want to. Now you know what to learn, its time to start learning.

Back to Featured Articles on Logo Paperblog