Financial literacy is the possession of skills, knowledge, behavior, and attitude that allow an individual to make informed decisions regarding money. Financial literacy, financial education, and financial knowledge are used interchangeably. Financially unsophisticated individuals cannot plan for their future 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.Lusardi, A., & Mitchell, O. S. (2017). How ordinary consumers make complex economic decisions: Financial literacy and retirement readiness. Quarterly Journal of Finance, 7(03), 1750008.
Raising interest in personal finance is now a focus of state-run programs in Australia, Canada, Japan, the United Kingdom, and the United States. Understanding basic financial concepts allows people to know how to navigate the financial system. People with appropriate financial literacy training make better financial decisions and manage money than those without such training.
The Organization for Economic Co-operation and Development (OECD) started an inter-governmental project in 2003 to provide ways to improve financial education and literacy standards through the development of common financial literacy principles. In March 2008, the OECD launched the International Gateway for Financial Education, which aims to serve as a clearinghouse for financial education programs, information, and research worldwide. In the UK, the alternative term "financial capability" is used by the state and its agencies: the Financial Services Authority (FSA) in the UK started a national strategy on financial capability in 2003. The US government established its Financial Literacy and Education Commission in 2003.
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.Noctor, M., Stoney, S., & Stradling, R. (1992). Financial literacy: a discussion of concepts and competences of financial literacy and opportunities for its introduction into young people's learning. National Foundation for Educational Research. To survive in modern society individuals need to have knowledge about financial literacy.Kim, J. (2001). Financial Knowledge and Subjective and Objective Financial Well-being. Con sumer Interests Annual, 47: 1-3. Ability to use financial concepts in daily life and make optimal financial decisions is called financial literacy.Servon, L. J., & Kaestner, R. (2008). Consumer financial literacy and the impact of online banking on the financial behavior of lower‐income bank customers. Journal of consumer affairs, 42(2), 271-305. Financial literacy is an ability to effectively manage the economic well-being of individuals with knowledge and financial skills.Literacy, U. F. Education Commission 2007,'Taking Ownership of the Future: The National Strategy for Financial Literacy'. 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." The Financial Literacy and Education Commission (2020) includes a notion of personal capability in its definition as "the skills, knowledge and tools that equip people to make individual financial decisions and actions to attain their goals; this may also be known as financial capability, especially when paired with access to financial products and services." The National Financial Educators Council adds a psychological component defining financial literacy as "possessing the skills and knowledge on financial matters to confidently take effective action that best fulfills an individual's personal, family and global community goals." The OECD's Programme for International Student Assessment (PISA) in 2018 published a definition in two parts. The first part refers to kinds of thinking and behaviour, while the second part refers to the purposes for developing the particular literacy. "Financial literacy is the knowledge and understanding of financial concepts and risks, and the skills, motivation and confidence to apply such knowledge and understanding in order to make effective decisions across a range of financial contexts, to improve the financial well-being of individuals and society, and to enable participation in economic life" Financial literacy encompasses not only knowledge and skills but also the ability to apply them effectively in real-world situations, making informed financial decisions that align with one's goals and values.
Academic research
Measurement
Financial literacy in personal financial planning can be defined as objectively measured financial literacy or as subjectively measured financial literacy.Lusardi, A., & Mitchell, O. S. (2014). The economic importance of financial literacy: Theory and evidence. American Economic Journal: Journal of Economic Literature, 52(1), 5-44.
Objectively measured literacy is mainly about the numerical understanding of concepts such as compound interest, portfolio investment, diversification benefits, and the impact of inflation on financial decisions. Objective financial literacy has been measured with five 5-item tests, which include questions related to interest rates, saving accounts, and inflation. Out of five questions, people who tend to answer three questions correctly counted as low financial literacy.Allgood, S., & Walstad, W. B. (2016). The effects of perceived and actual financial literacy on financial behaviors. Economic inquiry, 54(1), 675-697.Hastings, J. S., Madrian, B. C., & Skimmyhorn, W. L. (2013). Financial literacy, financial education, and economic outcomes. Annu. Rev. Econ., 5(1), 347-373.Tang, N., & Baker, A. (2016). Self-esteem, financial knowledge and financial behavior. Journal of Economic Psychology, 54, 164-176.
Subjective financial literacy can be defined as the self-perception of individuals about their financial literacy. Lusardi and Mitchell (2014) identified that people rate their subjective financial literacy higher than objective financial literacy because of their behavioral biases when judging their financial knowledge subjectively. People often misestimate their financial knowledge.Lusardi, A., & Mitchell, O. S. (2011). Financial literacy around the world: an overview. Journal of pension economics & finance, 10(4), 497-508.
Critical financial literacy
Some financial literacy researchers have raised political questions about the character of financial literacy education, arguing that it justifies the return of greater financial risk (e.g. tuition fees, pensions, health care costs, etc.) from corporations and governments back to individuals. Many of these researchers argue for a financial literacy education that is more critically oriented and broader in focus: an education that helps individuals better understand systemic injustice and social exclusion, rather than one that understands financial failure as an individual problem and the character of financial risk as apolitical. Many researchers work within social justice, critical pedagogy, feminist and critical race theory paradigms.
Journal of Financial Literacy and Wellbeing The Journal of Financial Literacy and Wellbeing, published by Cambridge University Press, is an open-access academic journal established in April 2023. It publishes rigorous research on financial literacy and financial well-being. It aims to inform public policies as public, private and civil society strategies and activities, with the ultimate objective of improving the financial literacy, resilience, and well-being of individuals and micro and small entrepreneurs. This journal covers the topics including financial knowledge, financial attitudes and skills. This journal also includes research on related fields like financial well-being.
Accounting literacy Accounting literacy refers to the ability to read and analyse the financial statements of a company or individuals and understand the impact of financial decisions. This can be helpful for investors, managers, and individuals. Accounting literacy can be combined with financial planning, tax planning and understanding the financial health of the company.YATBAZ, A., & ÇATIKKAŞ, O. (2019). Accounting and finance literacy: A comparative study. Muhasebe ve Finansman Dergisi, Ağustos 2019 Özel Sayı, 161-170.
Academic researchers have explored the relationship between financial literacy and accounting literacy. Roman L. Weil defines financial literacy as "the ability to understand the important accounting judgments management makes, why management makes them, and how management can use those judgments to manipulate financial statements".
The 1999 Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees recommended that publicly traded companies have at least three members with "a certain basic 'financial literacy'. Such 'literacy' signifies the ability to read and understand fundamental financial statements, including a company's balance sheet, income statement and cash flow statement."
Digital financial literacy Digital financial literacy is all about the combination of Fintech and financial literacy. Digital Financial Literacy combines objective financial knowledge with four dimensions of digital literacy including digital knowledge, awareness of digital financial services, tacit knowledge of using digital financial services, and the ability to avoid digital fraud.Choung, Y., Chatterjee, S., & Pak, T. Y. (2023). Digital financial literacy and financial well-being. Finance Research Letters, 58, 104438.https://doi.org/10.1016/j.frl.2023.104438. Digital Financial Literacy is the ability of individuals to use digital devices to make financial decisions. There is a need for digital financial literacy across all consumers because of increasing fraud victimization due to digitalization, which prone individuals to misinformed financial decisions.OECD. (2018). G20/OECD INFE policy guidance on digitalisation and financial literacy. Paris, France: OECD Publishing.
International findings More recent OECD research has provided updated international measurements of financial literacy. The OECD/INFE 2023 International Survey of Adult Financial Literacy, covering 39 countries and economies, found an average financial literacy score of 60 out of 100 across participating countries and economies, compared with 63 out of 100 across participating OECD countries.
An international OECD study was published in late 2005 analysing financial literacy surveys in OECD countries. A selection of findings included: In Australia, 67 percent of respondents indicated that they understood the concept of compound interest, yet when asked to solve a problem using the concept, only 28% had a good understanding. A British survey found that consumers do not actively seek out financial information. The information they receive is acquired by chance, for example, by picking up a pamphlet at a bank or having a chance talk with a bank employee. A Canadian survey found that respondents considered choosing the right investments more stressful than going to the dentist.