What is financial literacy? The five principles you must know

What is financial literacy? 

Financial literacy includes understanding financial knowledge, principles, and concepts and making use of a variety of skills to manage your money effectively and achieve your long-term goals.  

This financial knowledge includes:

• Learning about spending, saving, and borrowing money

• Understanding tax liabilities

• Understanding vital concepts such as the impact of compound interest

• Financial planning

• Debt management

• Choosing investments and financial products, such as a mortgage

Understanding these areas and gaining new skills should help you with many financial goals, including investing, retirement planning, and budgeting.  

Ultimately, financial literacy helps you make better and more informed financial decisions and improves your overall well-being.  

In the UK, financial literacy could be significantly improved.

According to Aberdeen’s Savings Ladder Index, which asked people the Global Financial Literacy Excellence Centre’s ‘Big 3’ questions, it found that 44% of UK adults have poor financial literacy. This is around 23.3 million UK adults.

Aberdeen’s research also found that people with low financial literacy are usually worse off than those with high financial literacy, even when their earnings are similar.

Improving financial literacy can help you significantly, from making wise investment decisions to planning for retirement. So, it’s important you have a solid understanding of your finances and how your choices impact your life.  

How can I learn financial literacy? 

Not understanding your finances can be dangerous, as it can lead to poor decision-making and missed opportunities, which could mean you lose out on money or even lose value on your savings.   

While building your financial literacy may seem daunting, it doesn’t have to be.  

There are five basic principles of financial literacy that offer a solid foundation to empower you to make confident, informed decisions about your money and help achieve your financial goals.   

The five principles of financial literacy 

Let's take a look at the five principles and how you can put them into practice:  

1. Earn 

2. Save and invest 

3. Protect 

4. Spend  

5. Borrow and manage debt 

1. Earn

Your income is a vital foundation of your finances. It’s important to understand your earnings, manage your income, and recognise how much you lose to taxes.

Understanding how earnings and taxes work is a vital consideration when developing financial literacy.

If you’re an adult, critical aspects of this principle include:  

• Opening a pension: Making sure you’re auto-enrolled in a workplace pension is vital, as not only can you contribute, but your employer does too, plus you benefit from tax relief (you can claim more tax relief if you’re a higher earner). While there are minimum contribution levels, your employer may exceed these if you contribute more.

• Managing your tax liability: There are ways to manage your tax liability, so you don’t pay more than you need to. For example, you could use a salary sacrifice scheme or annual allowances for an individual savings account (ISA) or capital gains tax (CGT).

2. Save and invest 

Creating a budget and planning for the future is one of the most important ways to achieve your long-term financial goals. It allows you to build wealth and make your money work harder.  

Here are some of the most important aspects when it comes to saving and investing:  

• Create a budget: Have a plan for your money and follow it as best you can by monitoring your income and expected monthly expenses.  You can amend your budget as your income and circumstances change.

• Open a savings account or pots: It’s a good idea to start small, by putting money into an easy-access savings account with a decent interest rate or create savings pots for major life goals such as buying a home, getting married, or retirement. You could deposit a little bit each week or month, depending on when your paycheck comes through, so it builds into a bigger pot.

• Start investing: Investing can be an effective way to build your wealth, but you must invest wisely to protect your money while generating returns on investments. You should also ensure you minimise tax via a stocks and shares ISA and your CGT and dividend allowances.

3. Spend  

Understanding your cash flow and how you spend is crucial to meeting your financial goals and improving your financial literacy.

So, it’s worth asking whether you’re spending wisely or if you’re struggling to make ends meet by the end of the month.

Here are essential things to remember regarding spending:  

• Track your spending: Using a budget or other tracking tools can help monitor what you’re spending money on. This can help identify areas for improvement and reduce any unnecessary spending.

• Needs vs wants: It’s important to understand what you must spend money on (‘needs’), such as groceries, vs ‘wants’, which come under non-essential spending.

• Spend mindfully: Being mindful of your spending can lead to financial freedom, where you have enough money to cover your expenses and live the lifestyle you and your family want without worrying about financial constraints.   

4. Protect 

Life is full of curveballs, such as losing your job, significant home repairs, or a surprise bill. So, it’s essential to protect your finances and take steps to safeguard your financial future.  

The best way to do this is to create an emergency fund where you aim to have at least three months’ worth of expenses.

This way, should the worst happen, you are prepared.  

When protecting your finances, you should also prioritise: 

• Getting insurance: Insurance, such as health, critical illness, and life insurance, gives you and your family peace of mind, providing a financial safety net if the unexpected happens.

• Retirement planning: Protecting your pension is vital to ensure you grow your nest egg enough to sustain you throughout retirement.

• Estate planning: This involves sorting your financial affairs and deciding how you want your assets to be distributed.  

5. Borrowing and managing debt 

Whether you’re getting a mortgage or covering a big one-off purchase, for many of us, borrowing is a part of our lives.  

However, borrowing wisely is essential to building your credit and avoiding unnecessary debt.

To do this, you should include the following in your financial planning: 

• Be strategic with your debt: When borrowing money, ensure you borrow within your means and have a clear and achievable repayment plan.

• Make repayments on time or early: When making repayments, you must not fall behind. Always make your repayments on time to avoid damaging your credit score, which could impact your borrowing in the future, including for a mortgage.

• Monitor your credit score: Outstanding debt can impact your credit score, so it’s vital you keep an eye on how it’s performing and intervene when necessary.  

When is Financial Literacy Month? 

In the UK, Financial Literacy Month is every April, as this is usually the end of the financial year for many businesses. It aims to help people feel more confident when making financial decisions and boost their financial knowledge.

Financial Literacy Month originally started in the US, but is now recognised in the UK.

There’s also Financial Awareness Day in the UK on 14 August, which aims to promote financial literacy and encourage people to make informed decisions to support their long-term goals.

Get expert financial advice  

Improving financial literacy is essential for making confident and informed decisions. If you want to improve your financial literacy, consulting with a qualified adviser is worth considering.

With Unbiased, you can get matched with an FCA-regulated and qualified financial adviser who can provide expert guidance when it comes to making life’s big financial decisions.