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Basics of Financial Literacy

What Is Financial Literacy?

Financial literacy is the ability to understand and effectively use various
financial skills, including personal financial management, budgeting,
and investing.
When you are financially literate, you have the essential foundations of a
smart relationship with money that will start a lifelong journey of
learning about the financial aspects of your life. The earlier you start the
better off you will be, because education is the key to success when it
comes to money.
The term “financial literacy” refers to a variety of important financial
skills and concepts.
People who are financially literate are generally less vulnerable to
financial fraud.
A strong foundation of financial literacy can help support various life
goals, such as saving for education or retirement, using debt responsibly,
and running a business.
Key aspects to financial literacy include knowing how to create a
budget, plan for retirement, manage debt, and track personal spending.
Financial literacy can be obtained through reading books, listening to
podcasts, subscribing to financial content, or talking to a financial
professional.
Definitions of financial literacy

There is a diversity of definitions used by bodies such

as NGOs and think tanks, but in its broadest sense, financial literacy is
an understanding of money.Some of the definitions below are closely
aligned with "skills and knowledge", whereas others take broader views,
and some are from academic research which is tested and validated:
 Effectively taking decisions about money management and ability
to make informed decisions is called financial literacy.
 To survive in modern society individuals need to have knowledge
about financial literacy
 Ability to use financial concepts in daily life and make optimal
financial decisions is called financial literacy
 Financial literacy is an ability to effectively manage the economic
well-being of individuals with knowledge and financial skills.
 The Government Accountability Office definition (2010) is "the
ability to make informed judgments and to take effective actions
regarding the current and future use and management of money. It
includes the challenges associated with life events such as a job
loss, saving for retirement, or paying for a child’s education."

Understanding Financial Literacy

Financial literacy also requires the experience of financial principles and
concepts, such as financial planning, compound interest, debt
management, efficient investment strategies, and money-time value.
Financial illiteracy can lead to poor financial choices which can have
negative effects on an individual's financial well-being.
The key steps to improve financial literacy include: - Learning the skills
to create a budget - Ability to track expenses - Learning the strategies to
pay off debt - Planning for retirement effectively
Such measures can also include financial specialist counselling.
Educating about finances involves understanding how money works,
developing and achieving financial goals, and handling internal and
external financial challenges.
Benefits of Financial Literacy
Financial literacy focuses on the ability to manage personal finance
effectively, which requires experience of making appropriate personal
finance choices, such as savings, insurance, real estate, college
payments, budgeting, retirement and tax planning.
Those who understand finances should be able to answer questions
concerning transactions, such as whether an item is required, whether it
is accessible, and whether it is an asset or a liability.
This field illustrates a person's habits and perceptions towards money
related to his or her daily life. The financial literacy demonstrates how
an adult makes financial decisions. This expertise will help an individual
build a financial road map to define their income, their expenses, and
their liabilities. This subject also affects small business owners, who
contribute significantly to economic growth and stability.

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.

Scope of Financial Literacy

Although many skills might fall under the umbrella of financial literacy,
popular examples include household budgeting, learning how to manage
and pay off debts, and evaluating the tradeoffs between different credit
and investment products. These skills often require at least a working
knowledge of key financial concepts, such as compound interest and
the time value of money.
Other products, such as mortgages, student loans, health insurance,
and self-directed investment accounts, have also grown in importance.
This has made it even more imperative for individuals to understand
how to use them responsibly.
Financial literacy can cover short-term financial strategy as well as long-
term financial strategy, and which strategy you take will depend on
several factors, such as your age, time horizon, and risk tolerance.
Financial literacy encompasses knowing how investment decisions made
today will impact your tax liabilities in the future.
This also includes knowing which investment vehicles are best to use
when saving, whether for a financial goal like buying a home or for
retirement. This is not to add the novelties in finance such as e-wallets,
digital money, buy now/pay later, P2P lending, and other new financial
products that can be convenient and cost-effective but require potential
consumers to be educated to assess them adequately to their advantage.
Why Financial Literacy Matters
From day-to-day expenses to long-term budget forecasting, financial
literacy is crucial for managing these factors. It is important to plan and
save enough to provide adequate income in retirement while avoiding
high levels of debt that might result in bankruptcy, defaults, and
foreclosures.

Benefits of Financial Literacy

Being financially literate is a skill that brings forth an assortment of
benefits that can improve the standard of living for individuals through
an increase in financial stability.
Listed below are the assortment of benefits of being financially literate:
  Ability to make better financial decisions
 Effective management of money and debt
 Greater equipped to reach financial goals
 Reduction of expenses through better regulation
 Less financial stress and anxiety
 Increase in ethical decision-making when selecting insurance,
loans, investments, and using a credit card
 Effective creation of a structured budget
 Making steps to becoming financially literate is an important
component of life that can ensure financial solidity, reduce anxiety,
and stimulate the achievement of financial goals.

Strategies to Improve Financial Literacy Skills

Developing financial literacy to improve your personal finances involves
learning and practicing a variety of skills related to budgeting,
managing, and paying off debts, and understanding credit and
investment products. The good news is that, no matter where you are in
life and financially, it’s never too late to start practicing good financial
habits.
Here are several practical strategies to consider.
Create a Budget
Track how much money you receive each month against how much you
spend on an Excel sheet, on paper, or with a budgeting app. Your budget
should include income (paychecks, investments, alimony), fixed
expenses (rent/mortgage payments, utilities, loan payments),
discretionary spending (nonessentials such as eating out, shopping, and
travel), and savings.
Pay Yourself First
To build savings, this reverse budgeting strategy involves choosing a
savings goal, such as paying for higher education, deciding how much
you want to contribute toward it each month, and setting that amount
aside before you divvy up the rest of your expenses.
Pay Bills Promptly
Stay on top of monthly bills, making sure that payments consistently
arrive on time. Consider taking advantage of automatic debits from a
checking account or bill-pay apps and sign up for payment reminders
(by email, phone, or text).
Get Your Credit Report
Once a year, consumers can request a free credit report from the three
major credit bureaus—Equifax, Experian, and TransUnion—through the
federally created website AnnualCreditReport.com.7 Review these
reports and dispute any errors by informing the credit bureau of
inaccuracies. Because you can get three of them, consider spacing out
your requests throughout the year to monitor yourself regularly.
Financial Well-Being
The definition of financial well-being that we propose is based on the
consumer perspective revealed by the nearly 60 hours of open-ended
interviews our research team conducted. Our research suggests financial
well-being can be defined as a state of being wherein you:
Have control over day-to-day, month-to-month finances;
Have the capacity to absorb a financial shock
Are on track to meet your financial goals; and
Have the financial freedom to make the choices that allow you to enjoy
life.Because individuals value different things, traditional measures such
as income or net worth,while important, do not necessarily or fully
capture this last aspect of financial well-being.
We then sought to identify the specific types of knowledge, behavior,
and personal traits that help people achieve greater financial well-being.
Our research focused on those personal drivers of well-being that may
be influenced by financial education and other decision-making
supports.
Of course many factors beyond an individual’s control play a significant
role in financial outcomes, but our research asks, “Given people’s
current financial circumstances, how can they make the best of their
situation?”
The hypotheses we propose about key drivers of financial well-being
were developed by synthesizing three methodologies in this project—
literature reviews, consumer and financial practitioner interviews, and
ongoing and iterative consultation with an expert panel. The hypotheses
fall into three categories: financial behaviors, financial knowledge, and
personal traits.
Financial behaviors
Four types of behaviors are hypothesized to support financial well-
being:
Effective routine money management, which encompasses often
unconscious habits, intuitions, and decision-making shortcuts
(heuristics);
Financial research and knowledge-seeking, which support purposeful,
informed financial decision-making;
Financial planning and goal-setting, which give purpose and structure
to individual financial decisions; and
Following through on financial decisions, the final step between
intentions and desired outcomes.
People have higher levels of financial well-being when they Ask, Plan,
and Act, coupled with a strong habit or tendency to live within their
means in terms of their day-to-day financial choices.
Financial knowledge
In both published research and our interviewees’ responses, we found
that the link between knowledge and behavior is always affected by
individual characteristics like personality, attitudes, and non-cognitive
skills, and by context. Our primary hypothesis about the type of
knowledge that supports financial well-being is a set of skills we call
“financial ability,” which encompasses:
 Knowing when and how to find reliable information to make a
financial decision;
 Knowing how to process financial information to make sound
financial decisions; and
 Knowing how to execute financial decisions, adapting as necessary
to stay on track.
A growing consensus points toward this notion of financial ability: that
in addition to a knowledge component, financial literacy has an action
component—that is, the ability or skills to put financial knowledge to
use.
Personal traits
Personal attitudes and beliefs, non-cognitive skills, and personality traits
all influence financial behavior and play a role in mediating the
connection between knowledge and behavior. Based on our research, we
hypothesize that the following four types of personal traits are likely to
affect financial well-being through their influence on behavior and/or
preferences and expectations:
 Comparing yourself to your own standards, not to others (internal
frame of reference);
  Being highly motived to stay on track in the face of obstacles
(perseverance);
 Having a tendency to plan for the future, control impulses, and
think creatively to address unexpected challenges (executive
functioning); and
 Believing in your ability to influence your financial outcomes
(financial self-efficacy).

Importance Of Financial Literacy In Achieving Financial Stability

As a non-profit organization focused on improving economic conditions
and well-being, we recognize the critical importance of financial literacy
in achieving financial stability. Here are some key points on the
importance of financial literacy:
Empowerment: Financial literacy empowers individuals and families to
make informed decisions about their money and take control of their
financial lives.
Prevention: Financial literacy can help prevent individuals from falling
into debt and financial insecurity, which can have long-lasting negative
impacts on individuals, families, and communities.
Education: Financial literacy education can help individuals understand
the importance of financial planning, budgeting, saving, and investing,
and how to do so effectively.
Economic Growth: Financially literate individuals can contribute to
economic growth and stability, as they are more likely to start and grow
small businesses, invest in the stock market, and save for retirement.
Improved Well-Being: Financial stability and security can lead to
improved well-being, as individuals are less likely to experience stress,
anxiety, and other negative mental health impacts associated with
financial insecurity.
Access to Resources: Financially literate individuals have better access
to financial resources, such as loans and credit, which can help them
achieve their financial goals.
Sustainable Development: Financial literacy is critical for sustainable
development, as it can help individuals and communities make informed
decisions about how to allocate financial resources in a way that
promotes long-term economic growth and stability.

Financial Goals And Planning

Financial goals are the personal, big-picture objectives you set for how
you'll save and spend money. They can be things you hope to achieve in
the short term or further down the road. Either way, it's often easier to
reach your goals if you identify them in advance.
Why are financial goals important?
Financial goals are important because they can help fund your lifestyle,
helping you meet both personal and professional objectives.. It's helpful
to divide them into short, medium and long-term objectives. In the short
term, it's helpful to reduce debt, create a savings account and create a
budget that accommodates your lifestyle. In the medium and long term,
it's useful to focus on financial stability and retirement planning. These
are some of the benefits of creating financial goals:
 It can lead to financial freedom.
 It increases your chances of having a comfortable retirement.
 It can help you reduce or eliminate debt.
 It can help you save money for emergency situations
 It can help you and your family have a better lifestyle
How To Set Financial Goals For Your Future
Setting short-term financial goals, as well as mid-term and long-term, is
an important step toward becoming financially secure. If you aren’t
working toward anything specific, you’re likely to spend more than you
should. You’ll then come up short when you need money for unexpected
bills, not to mention when you want to retire. You might get stuck in a
vicious cycle of credit card debt and feel like you never have enough
cash to get properly insured, leaving you more vulnerable than you need
to be to handle some of life’s major risks.

Short-Term Financial Goals

Setting short-term financial goals gives you the foundation and the
confidence boost that you'll need to achieve the bigger goals that take
more time. These first steps can relatively easy to achieve in as little as a
year: Create a budget and stick with it. Build an emergency fund. Pay
down the credit card debt that's holding you back.
Midterm Financial Goals
When you’ve created a budget, established an emergency fund, and paid
off your credit card debt—or at least made a good dent in those three
short-term goals—it’s time to start working toward midterm financial
goals. These goals will create a bridge between your short- and long-
term financial goals.
Financial literacy is the possession of skills, knowledge, and behaviors
that allow an individual to make informed decisions regarding money.
Financial literacy, financial education and financial knowledge are used
interchangeably.[1] Financially unsophisticated individuals cannot plan
financially because of their poor financial knowledge. Financially
sophisticated individuals are good at financial calculations; for example
they understand compound interest, which helps them to engage in low-
credit borrowing. Most of the time, unsophisticated individuals pay high
costs for their debt borrowing

Understanding Basic Financial Concepts

Money
Money is a recognised medium of exchange in the economy. It is an
asset that can be stored and used in the form of currency, or as value.

Currency
Currency is the physical form of money in the form of coins and rupees.
Each country typically has its own currency as a medium of exchange,
issued by the central bank. In India, the Government of India (GoI) and
Reserve Bank of India (RBI) are the issuers of the currency, i.e. Indian
Rupees

Bank
A bank is a government authorised financial institution which acts as a
custodian of money deposited by account holders and uses the collected
funds to extend loans to individuals and businesses while charging
interest on the same.
Account
An account is a repository of the funds held by a bank on behalf of the
account holder. An account can be of various kinds, and is identified by
a unique account number issued to the account holder.

Saving
Savings is the amount of money that is remaining from income, after the
expenses are made. Investment An investment refers to an asset acquired
with the objective of generating income or appreciation.

Internet Banking
Electronic payment system that enables customers of a bank or other
financial institution to conduct a range of financial transactions through
the financial institution's website.

Investing
It means you’re setting your money aside for longer – term goals.
There’s no guarantee that the money you invest will grow. In fact, it is
normal for investments to rise and fall in value over time. But in the long
run, investments can earn a lot more than you can usually make in a
savings account.

Investment in Securities Market

Securities can be broadly classified into two types: Equities and
Debts. Securities are sold in the securities market

Primary Market: Company directly issues Securities for the first time
e.g. IPO (Initial Public Offer)

Secondary Market: Trading of securities in Stock Exchanges e.g.

BSE, NSE, etc.
 • Equity is a part of a company, also known as stock or share. When
you buy shares of a company, you basically own a part of that
company and can expect a share of profit when the company
makes profits.
• Debt Securities are those instruments such as bond, debenture,
promissory note etc. with a fixed amount, a maturity date and
usually with a specific rate of interest. These are often less risky
than equities.
• A Mutual Fund pools money from many investors and invests in
stocks, bonds, short-term money-market instruments, other
securities or assets, or some combination of these investments.

Investment Opportunity And Financial Products

1.Banks
Bank deposits are safe investments as all bank deposits are insured upto
a maximum of Rs.100,000 under the Deposit Insurance & Credit
Guarantee Scheme of India. Banks are subject to control and regulated
by the Reserve Bank of India. They offer various types of deposits,
depending on the needs of the customer. Bank deposits are preferred
more for their liquidity and safety than for the returns thereon. It is
possible to get loans up to 75 - 90% of the deposit amount from banks
against fixed deposit receipts.

Types of Deposits
Savings Bank Account
As the name suggests this type of account is suitable for people who
have a definite income and are looking to save money. For example, the
people who get salaries or the people who work as laborers. This type of
account can be opened with a minimum initial deposit that varies from
bank to bank. Money can be deposited at any time in this account.
Bank Fixed Deposit (Bank FDs)

This type of deposit account allows the deposit to be made of an amount

for a specified period. This period of deposit may range from 15 days to
three years or more during which no withdrawal is allowed. However,
on request, the depositor can encash the amount before its maturity. In
that case, banks give lower interest than what was agreed upon. The
interest on a fixed deposit account can be withdrawn at certain intervals
of time. At the end of the period, the deposit may be withdrawn or
renewed for a further period. Banks also grant a loan on the security of
the fixed deposit receipt.

Recurring Deposit

While opening the account a person has to agree to deposit a fixed

amount once in a month for a certain period. The total deposit along
with the interest therein is payable on maturity. The account can be
opened by a person individually, or jointly with another, or by the
guardian in the name of a minor.

Current Deposit Account

Big businessmen, companies, and institutions such as schools, colleges,
and hospitals have to make payment through their bank accounts. Since
there are restrictions on the number of withdrawals from a savings bank
account, that type of account is not suitable for them. They need to have
an account from which withdrawal can be made any number of times.
2. Government Schemes

Tax Savings Schemes

The Government of India has launched Income Tax Saving Schemes
including:
 National Savings Certificates (NSC)
 Public Provident Fund (PPF)
 Post Office Scheme (POS)

3. Mutual Funds
A mutual fund pools money from many investors and invests the money
in stocks, bonds, short-term money-market instruments, other securities
or assets, or some combination of these investments. The combined
holdings the mutual fund owns are known as its portfolio. Each unit
represents an investor’s proportionate ownership of the fund’s holdings
and the income those holdings generate.
Types of Mutual Funds
Each fund has a predetermined investment objective that tailors the
fund’s assets, regions of investments and investment strategies.

Equity Funds (Stocks)

 Fixed-income funds (bonds)
 Money market funds
 Open-ended Funds
 Closed-end Funds
 Money Market Funds
 Bond/Income Funds
 Balanced Funds
 Foreign/International Funds
Inflation and Its Effect on Investment
Inflation refers to rise in price of goods and services. Over time, as cost
of goods and services increases, the ability of a unit of money, say one
rupee or Rs.100, to buy goods and services keeps declining. In other
words, Purchasing power of money decreases. It is important to take into
account the effects of inflation on your investments during financial
planning.
 When you are planning your investment, it is critical that you take
into account the effects of inflations on your investments. At its
most basic level, inflation is simply a rise in prices. Over time, as
the cost of goods and services increase, the value of a rupee is
going to go down because you won’t be able to purchase as much
with those rupees as you could have in the last month or last year.
 How does inflation affect my investment decision? A Vada pav
which used to cost Rs.2 five years back now the same costs Rs.7.
The cost increase is not as a result of increase in quantity or better
quality. The increase is a result of increase in prices of ingredients
which have increased as a result of inflation.
 Inflation is greatly feared by investors because it grinds away the
value of your investment. Example:- If you invest Rs.1,000 in a
one year fixed deposit that will return 5% over that year, you will
be giving up Rs.1,000 right now for Rs.1,050 in 1 year. If over the
course of that year there is an inflation rate of 6%, your expenses
which were Rs.1,000 in the previous year will increase to Rs.1,060
at the end of the year. Thus even after investing your money for 1
year you are worse off compared to the previous year because the
returns delivered by your investments has been below the inflation
rate.
 What are the steps that an investor can take to avoid the adverse
effects of inflation? Try to determine your “real rate of return”
which is the return you can expect after factoring in the effects of
 inflation. In addition to being aware of the current rate of inflation,
it is crucial to be aware of what inflation rate the experts are
anticipating. Both the value of current investments and the
attractiveness of future investments will change depending on the
outlook for inflation. Also remember fixed income investments are
particularly vulnerable to the effects of inflation. If you are locked
into a particular interest rate, and inflation increases your earnings
will not keep up and you will earn a negative return.

Time Value of Money

 As time passes you will realise that if 10 years back you could
afford to purchase a full lunch for Rs.10, today you might afford to
get a few pieces of vegetables only. This means that the value of a
thousand rupee note would be higher today than after five years.
Although the note is the same, you can do much more with the
money if you have it now because over time you can earn more
interest on your money. By receiving Rs.1,000 today you are
poised to increase the future value of your money by investing and
gaining interest over a five year period.

 At the most basic level the time value of money demonstrates that
time literally is money - the value of the money you have now is
not the same as it will be in the future and vice versa.

Management of spending and financial discipline.

Financial discipline is a consistent practice of spending, saving, and
investing wisely to ensure effective management of financial resources and
accumulate wealth in the long run. It centers on adhering to a budget,
preventing debt, and achieving financial stability. Disciplined decision-
making is vital for long-term success in personal finance or business.
Overspending in business can lead to debts, disorganized finances
erode investor confidence, and, in extreme cases, result in bankruptcy. Hence,
financial discipline is crucial for stability, growth, and resilience in both
personal and business finances

Financial Discipline In Business

Explained
Financial discipline in business aims to manage the company’s financial
resources responsibly and efficiently. Some of these actions include sticking to
budgetary constraints, exercising control over expenses, making informed
financial decisions, and maintaining an equilibrium between income and
expenditures.

Many companies are hiring ‘behind the curve’ or off-role employees to

curb human resource expenses. Some giant businesses like Meta are
reassessing their staff levels and laying off people. Whatsoever is the strategy,
these firms believe that a financially disciplined organization can achieve long-
term business stability and sustainability.

It plays a crucial role in resource management, identifying uncertainties, and

fulfilling financial obligations for stepping towards success. It builds confidence
among investors and contributes to the overall financial well-being of the
business. Further, the companies can have positive cash with wise monetary
decisions.

Moreover, startups with limited money in the initial stage of business can go a
long way with efficient financial management. However, a financial plan or
budget on paper is not enough to achieve long-term goals; it is essential to train
employees to implement these strategies successfully. The chief financial
officers (CFOs) of many companies are adopting innovative ways of
encouraging their staff to be financially aware and responsible.

However, strict adherence to financial constraints may hinder innovation, as

companies might be hesitant to invest in new and creative ventures, resulting in
skipped growth opportunities in a dynamic market. This rigid approach can also
 hurt employee morale when deprived of certain benefits or training
opportunities. Moreover, only focusing on short-term financial goals leads to
limited long-term investments and strategic initiatives. These limitations may
setback the company in a competitive environment.

Some of the financial discipline tips for individuals that can help
them achieve their personal finance goals and independence:

 Develop a Budget: Construct a budget that clearly outlines

income, expenses, and savings objectives for a comprehensive financial
overview.
 Establish Financial Goals: Define both short-term and long-term
financial objectives to provide purpose and direction for the money
matter decisions.
 Emphasize Savings: Allocate a portion of the income towards savings
before considering discretionary spending, facilitating the creation of a
financial safety net.
 Curtail Impulsive Purchases: Adhere to the budget to mitigate
immediate spending to evaluate the necessity of each expense.
 Monitor Expenditures: Regularly track the spending to identify areas
with a scope for saving money.
 Build an Emergency Fund: Keep aside some money to cover unforeseen
expenses, reducing reliance on credit during unexpected financial
challenges.
 Debt Management: Minimize reliance on credit cards for non-essential
purchases and work towards promptly repaying existing debts.
 Smart Investing: Gain knowledge on various investment options and
adopt long-term strategies for wealth accumulation.
 Adopt a Minimalistic Lifestyle: Resist lifestyle improvement by
spending little on luxury items consistently.
 Continuous Financial Education: Learn more about personal
finance, investment, and economic trends to make well-informed
financial decisions.