What is Financial literacy?

The importance of financial literacy and the lack of financial education

In an uncertain world, good personal finance management becomes a necessity for all savers to ensure their financial wellbeing.

Nevertheless, the lack of financial education remains strong in most countries, including in wealthy European or North American countries.

The trend in US data shows that American personal finance knowledge has even fallen.

Based on the National Financial Capable of Companies Survey in 2020, only 43% of Americans are financially literate and able to answer questions about basic financial concepts such as credit, inflation and budget.

The situation is not particularly better in other countries.

In France, the results of a CREDOC survey on the financial literacy skills of French investors shows that only one person out of two knows that €100 invested at 2% per year leads to a capital of €102 after one year. One person in four manages to find, from a list of three possible answers, the definition of a bond. Only 45% know what a mutual fund is and 52% know the principle of a dividend.

This lack of financial education increases inequalities. These studies show that it is correlated with gender (women have less financial education than men) and financial resources. There is therefore a strong need to improve financial education worldwide.

But what do we mean exactly by financial literacy?

What is financial literacy?

Financial literacy has been defined in a number of ways by international institutions and researchers on the subject.

First, a distinction can be made between financial literacy and financial education. 

Financial literacy implies both to have financial knowledge and to apply them to one’s personal finance, while financial education refers more to financial knowledge itself.

The OECD, for example, defines financial literacy as not only the knowledge and understanding of basic financial concepts and risks, but also the skills, motivation and confidence to apply that knowledge towards financial decisions.

Financial literacy subdivision

Second, financial literacy can be subdivided in financial literacy related to budgeting/money management (bank account, savings account, credit card debt, credit scores, spending money, spending habits, checking account …) to investments (financial goals, stock market, financial planning, retirement savings…) and to economics (inflation, crises…).

Example of definitions

Below is the definition used by the European regulators (EIOPA, EBA and ESMA) at their March 2022 conference on financial well being.

Financial literacy is defined according to 5 pillars linked to personal finances:

• Earning money: salary, different incomes (real estate…), bank accounts.

• Spending: how to manage major purchases and what is the maximum amount to spend according to the available monthly adequate income? (credit card, financial capability…)

• Saving and investing: saving, if feasible, a part of one’ s monthly income in order to build up a financial stability, ideally investing through adapted financial products allowing the savings to grow

• Borrowing and debt management: how to borrow money wisely and to avoid toxic loans with high interest rates to decrease financial stress?

• Protecting: always ensuring that the financial situation is (as much as possible) secure by taking out appropriate insurance

According to Investopedia, financial literacy education is “the ability to understand and effectively use various financial literacy 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. “

According to the United States Treasury’s Financial Literacy and Education Commission, financial literacy is “the ability to use knowledge and skills to manage financial resources effectively for a lifetime of financial wellbeing.”