Do I buy or rent? How much should I save for retirement? Is a Roth better than my company’s 401K? What’s the difference between index funds & mutual funds? What’s the rule of 72?

Everyday we are inundated with questions from our children, colleagues or your favourite barista. Some are simple-ish: Do I stop for coffee even though I’m running late? But others are a bit tricky especially when you don’t have the vocabulary or knowledge to begin making a decision. Financial literacy is crucial for several reasons but today we will discuss three: informed decision making, avoiding debt and quality of life.

Financial literacy equips you with the knowledge needed to make informed decisions when it comes to investments, insurance, retirement planning, and major financial purchases (e.g., buying a home). Understanding financial concepts such as interest rates, credit scores, and loans can help you avoid excessive debt and make wise borrowing decisions. This knowledge can prevent the accumulation of high-interest debt that can be difficult to pay off. Financial literacy can improve your quality of life by reducing stress related to financial issues and enhancing overall well-being. When you are financially literate you tend to have more control over your finances and experience less financial anxiety.

Here’s an example of how financial literacy can help you make better decisions, avoid debt and reduce financial related stress. Let’s consider a hypothetical individual named Monica. Monica has a basic understanding of financial concepts, such as budgeting, saving, and credit. She practices financial literacy by creating a monthly budget to track her income and expenses.

1. Budgeting: Monica knows that her monthly net income is $5,000, and she has allocated specific amounts for rent, utilities, groceries, transportation, and other expenses in her budget.
2. Emergency Fund: She also understands the importance of having an emergency fund. Financial literacy has taught her to set aside a portion of her income into a high-yield savings account for unexpected expenses, such as a job loss. She also understands that since she is 52 years old, there is a catch-up provisions in the tax code that allows her to increase her tax-advantaged savings in several types of retirement accounts. Her total contribution potential to IRAs is $8k in 2024.
3. Avoiding Impulse Purchases: Monica is aware of the risks of impulse spending. When she encounters an attractive but unnecessary item, she reminds herself of her budget and her financial goal of buying a home. This financial goal helps her resist the temptation to buy things on a whim and stay focused on her savings goal .
4. Credit Card Usage: Monica use to use a credit card to extend her pay day but now understands that carrying a balance on her credit card incurs interest charges; her card charges 28.99% (yikes)! Now, she uses her card for convenience and pays her credit card bill in full each month to avoid paying high-interest charges.
5. Debt-to-Income Ratio: She has learned about the importance of monitoring her debt-to-income ratio. This ratio compares her debt payments to her income. She knows that keeping this ratio low is crucial for avoiding excessive debt but also helps with her mortgage application.
6. Sleeping better at night: Monica now understands that impulse purchases were limiting her ability to prepare for her future, but also her ability to just sleep at night. Her overspending was part of the reason that she had no emergency fund. Learning to delay instant gratification and using her budget to monitor spending has allowed her to save three months of living expenses – first time in life!!!!

As a result of her financial literacy, Monica is able to live within her means, maintain a balanced budget, and avoid accumulating high-interest debt. Her understanding of financial concepts and her commitment to responsible financial practices help her prevent the need for unnecessary loans and credit card debt. This, in turn, contributes to her financial stability and security, reducing the risk of falling into a cycle of debt that can be difficult to escape.

Remember to keep Enjoying the Journey.