Why Financial Literacy is More Important Today Than Ever Before
Introduction to the article
Any article on the topic of finance is going to be packed full of information. Here at Cyclic Digital, our aim is to provide as much information as we can, but in an easy-to-read and easy-to-understand format. To do this, we use hyperlinks for additional texts that will provide you with further information should you need it.
So, when it comes to finance, the world today is very different to that of the past thirty years. But what has been going on to create such a change?
Well, first there has been the emergence of cryptocurrency and blockchain technology. Second, there is the war in Ukraine, or Russia’s ‘Special Military Operation’ as its leader, Vladimir Putin, calls it. This has led to the dual problems beyond those two countries of a fuel crisis and major shortage of some of the world’s most commonly used agricultural products, cereal crops and sunflower seeds. The overall result is the re-emergence of a word that has been absent from our lexicon for around forty years and not used in a negative sense since well well before the economic crisis that began in 2008 after the collapse of Lehman Brothers. That word is ‘inflation’.
Financial literacy helps you to make sound financial decisions
So, how can inflation affect you? Well, first of all, you have to understand exactly what inflation is and what it is based on. In simple terms, the rate of inflation is calculated based on the cost of a fixed range (a shopping basket!) of products and services over a set period of time. If the overall price of everything increases, then that is called inflation; while if the cost falls, that is known as deflation.
Now, for those of you who are not financially literate, the above explanation may suffice. However, there are some of you who may be asking the question “Over what period of time is inflation calculated?” Now, that is a good and critical question, to which there is no fixed answer.
However, in general terms, inflation is calculated on a rolling-year basis. In other words, if the rate of inflation is at 6%, that means that your ‘shopping basket’ of goods and services now costs 6% more than it did at the same time last year. It will be described as an ‘annual inflation rate of 6%’. Alternatively, some inflation rates are described as a ‘monthly inflation rate’.
There are two primary indexes used in America for calculating the rate of inflation, the Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCE). The former relates principally to consumer-only-related items in the ‘shopping basket’ and therefore is highly sensitive to fluctuations in the price of food and energy. In the U.S. you can get a monthly statement from the Bureau of Labor Statistics on the state of the CPI. PCE also includes ‘hidden costs’ in its ‘shopping basket’ which usually includes such things as staff pension costs, premise rental costs, etc., and the Bureau of Statistical Analysis produces a monthly index of this.
According to Forbes: “The Bureau of Labor Statistics (BLS) calculates CPI inflation by gathering spending data from tens of thousands of regular consumers around the U.S. It tracks a basket of commonly purchased goods and services, including things like food, gasoline, computers, prescription drugs, college tuition and mortgage payments, to gauge how prices generally change over time.”
So, you may now be asking yourself what inflation has to do with financial literacy. The answer to that has multiple answers, as follows, primarily because inflation either directly or indirectly affects the entire world of finance:
- Financial literacy helps you to budget more effectively
So many of us have access to multiple sources of finance. However, there are two problems with this. First, not many of us fully understand the ‘true cost of finance’ as none of us like reading the small print and all we are concerned about is getting the loan. Second, easy access to borrowed money reduces the emphasis that should be placed on living on a budget, so many more people today tend to live off ‘credit’ which, in itself, makes the cost of living more expensive. Only, if we are not financially literate, we don’t really understand why. Did you know that for adult Americans, on average, they each have 3.84 credit cards, and at the end of 2020 there were 365 million open credit card accounts?
According to Investopedia: “Financial literacy is the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing. The meaning of financial literacy is the foundation of your relationship with money, and it is a lifelong journey of learning. The earlier you start, the better off you will be because education is the key to success when it comes to money.” That all makes perfect sense to us.
In addition, budgeting isn’t just about money needed for today. Your budget can also include short-, medium- and long -term investments, it can include allocations for insurance, repayment of student debt, payments into a personal pension fund. Budgeting isn’t just about making sure there’s enough food in the fridge each week, although it does help…
- Financial literacy helps to give you a greater sense of financial inclusion
One of the problems with the world of finance is that anyone and everyone involved in the industry seems to talk a different language and anything and everything to do with finance seems exceptionally complicated. While the language may be difficult to understand, that doesn’t mean that the actual aspects of finance also need to be.
Understanding what APR stands for (annual percentage rate) and the difference between compound and simple interest rates is not hugely complicated; but when you see seven or eight unusual terms and abbreviations in a document, it is not easy to feel a sense of financial inclusion. It almost becomes a case of them (people in the finance industry) and us (you), as if working independently, though under the auspices of achieving the same goal – your financial stability and wellbeing.
The ultimate goal of Cyclic Digital is to make a meaningful contribution to society. This is primarily via our digital games for good. But we endeavour to reinforce our games with articles such as this one; and as such, we try our best to make sure all terms and abbreviations are explained in ways that do not include technical jargon to make us sound impressive!
- Financial literacy will help you tremendously with your investments
One of the most important areas in finance is investing. Each and every one of us relies heavily on the success of financial investments, though few of us actually know that. The results of the investment of businesses, whether large or small, can have a tremendous impact on our lives, since if their investments fail, it is we, the consumer, who usually has to ‘pick up the tab’.
As an example of a ‘hidden investment’, let’s look at the commercial aviation industry. Labor and fuel costs are the two major running costs of an airline. Now, the cost of labor is generally static or it will increase incrementally by an agreed sum over an agreed period of time. This makes budgeting simple, which is a relief as, on average, labor costs account for 32% of an airline’s running costs. Fuel, which accounts for approximately 17% of an airline’s running costs, is a different ball game altogether as an airline cannot control the cost of aviation fuel. In recent months, the financial consequences of this have become all too clear; and not just for airlines, it has also affected anyone who has a car or truck.
So, to reduce the risk of the cost of fuel unexpectedly increasing by a substantial amount (10% or higher) airlines invest in aviation fuel through a system called ‘hedging’. Through hedging, airlines agree to buy aviation fuel they will need over the next year at an agreed, fixed price. In so doing, they can set the price of tickets based on what they know the cost of fuel is going to be. Some airlines may buy 90% of their fuel as a hedging purchase; others may feel that the cost of fuel may well fall over the period of a year, so choose perhaps to agree a ‘hedged price’ for 30% of its next year’s fuel requirement.
While ‘serous investors’ may well become involved in the futures market, for most, investment comes in the form of buying stocks and shares in a business where one hopes to receive an annual dividend as well as seeing an increase in the value of the shares you have bought. Investing also involves something as simple as depositing money in a savings account; but can also include investing in a new business that a friend may be starting up. Investments have the primary goal of increasing your financial wealth over time.
- Financial literacy makes successful financial planning more likely
Unlike financial budgeting, financial planning tends to look more at the ‘big picture’; and also adopts a mid- and long-term view of your finances. According to Intuit, financial planning: “enables you to control your expenses, incomes, and investments to manage your finances. Financial planning guides you towards making practical decisions about spending and saving, so you can achieve stability and reach your goals.”
The problem is that, when it comes to financial planning, there is so much that can be involved because you are looking at not just short-term goals, but also medium- and long-term goals, which will involve the use of multiple (and often complex) financial tools, many of which never even existed before the ‘technological revolution’, or the arrival of the PC as we prefer to say.
Sound financial planning also helps to extract you from living a ‘hand-to-mouth’ existence or ‘living from paycheck to paycheck’. Instead, sound financial planning will help you to plan for a ‘rainy day’ and will ensure that you have taken the necessary financial precautions to create a safety net in case there is an unexpected event, such as hospitalization and a need to cover additional medical expenses, or you unexpectedly lose your job. While many Americans became dependent on COVID relief checks and other government windfalls and handouts, that need not have been the case for many if they had been engaged in previous financial planning, and the government handouts could then have been seen as a ‘bonus’ as opposed to a ‘lifeline’.
- Financial literacy will help you when it comes time for retirement
As a consumer, or just as an individual, greater emphasis is now being placed on you to become responsible for your pension as many company and state schemes are being wound down. But how do you know where to begin when it comes to creating a pension fund? Beyond this, while there are numerous fund managers out there, many of them try to avoid any genuine sense of responsibility for their actions by putting the onus on you to choose where your funds are invested. If you are not financially literate, how will you know what to suggest when clearly the professionals don’t themselves know?! According to the US Government Census, life expectancy in the US has increased from 69.7 years fifty years ago, to 79.4 years in 2015, which means that your pension becomes even more critical to an enjoyable and comfortable retirement.
One of the greatest problems facing investors today is the remarkably complex and broad range of investment opportunities and tools currently available, as well as a very complex tax system that is subject to change with each new presidency. Overseas investment is more commonplace while few people understand or know about the benefits of a provident fund. The range of financial services available almost demands you have an excellent level of financial literacy simply to know which financial adviser will suit you best!
- Financial literacy will help you with personal insurance policies
One area that many forget to consider when carrying out any financial planning is personal insurance. What will happen to your family if you were no longer around? How will your family be able to stay in your home if you’re not there to pay the mortgage? Personal insurance isn’t just about you either. What about your partner and how would you cope if they were not around? Are you adequately covered, insurance-wise, if you are taken seriously unwell and have to take several weeks or months off work? What will happen if you have an accident? At a time when you should be concentrating 100% on getting better, worrying about the mountain of debt you are creating will not help.
- The role of Gamification in the field of finance
According to UNICEF: “In early childhood, children learn best through play-based, hands-on experiences.” According to eLearningIndustry: “Gamification for learning can be beneficial because games instill lifelong skills such as problem-solving, critical thinking, social awareness, cooperation, and collaboration.” Here at Cyclic Digital we strongly believe in making sure that the sharing of lifestyle knowledge, and including knowledge relating to finance, should not just be important, but enjoyable. That is why we have made it possible for gamification to play a significant role in improving financial awareness and understanding, and so dramatically improve financial literacy.
As you have no doubt gathered by now, successful personal financial management relies very heavily on having a high degree of financial literacy. If you feel you don’t have this, then why not search out our financial literacy game app, Cyclic Town? Playing this should enhance your financial literacy and hence help you well plan out your future financial life.
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