Financial literacy is the cognitive understanding of financial components and skills such as budgeting, investing, borrowing, taxation, and personal financial management. The absence of such skills is referred to as being financially illiterate.

Fundamental Components of Financial Literacy

Financial literacy consists of several financial components and skills that allow an individual to gain knowledge regarding the effective management of money and debt.

Below are the fundamental components of financial literacy that should be learned.

1. Budgeting

In budgeting, there are four main uses for money that determine a budget: spending, investing, saving, and giving away.

Creating the right balance throughout the primary uses of money allows individuals to better allocate their income, resulting in financial security and prosperity.

In general, a budget should be composed in a way that pays off all existing debt while leaving money aside for saving and making beneficial investments.

2. Investing

To become financially literate, an individual must learn about key components in regards to investing. Some of the components that should be learned to ensure favorable investments are interest rates, price levels, diversification, risk mitigation, and indexes.

Learning about crucial investment components allows individuals to make smarter financial decisions that may result in an increased inflow of income.

3. Borrowing

In most cases, almost every individual is required to borrow money at one point in their life. To ensure borrowing is done effectively, an understanding of interest rates, compound interest, time value of money, payment periods, and loan structure is crucial.

If the criteria above are understood sufficiently, an individual’s financial literacy will increase, which will provide practical borrowing guidelines and reduce long-term financial stress.

4. Taxation

Gaining knowledge about the different forms of taxation and how they impact an individual’s net income is crucial for obtaining financial literacy. Whether it be employment, investment, rental, inheritance, or unexpected, each source of income is taxed differently.

Awareness of the different income tax rates permits economic stability and increases financial performance through income management.

5. Personal Financial Management

The most important criteria, personal financial management, includes an entire mix of all of the components listed above.

Financial security is ensured by balancing the mix of financial components above to solidify and increase investments and savings while reducing borrowing and debt.

Achieving an in-depth knowledge of the financial components discussed above guarantees an increase in an individual’s financial literacy.