My friends at Wikipedia define financial literacy as the ability to understand finance. How vague, but fairly accurate, allow me to elaborate; given that the word literacy pertains to the ability to read and write, from this we can understand that financial literacy in this context will be the ability to read, interpret and moreover; understand information of a financial nature.
Compound interest is by far the most important concept in all things finance. If you cannot get your head around this idea, then you will struggle financially for the rest of your life. An OECD study showed that 67% of Australians said they understood the concept of compound interest, but when asked to solve a problem using the concept only 28% passed.
Of those 28%, maybe half of them will actually have the actual discipline to save. I suppose discipline is the wrong word. I have only met one generation Y'er who has the discipline needed to save. I think the correct phrase is courage to save because you don't need to be disciplined to save; but you do need the courage to first acknowledge you don't have the discipline, then you need the courage to set up a savings strategy that doesn't require discipline.
Understanding the psychology behind money is another core competency behind financial literacy. Having the emotional intelligence to realise, "hey if I don't spend this money now, but instead put it away for my retirement it will eventually have grown significantly is size." What I am getting at is that you need to realise that there is short term pleasure in buying nice things right now; therefore not buying them must mean short term pain. Conversely, saving for your retirement will result in long term pleasure, and not saving will mean long term pain. All humans are geared toward whatever will give them immediate pleasure; in this instance spending money. Those strong enough to re frame the situation and find pleasure in saving, will be financially successful.
The implications of poor financial literacy for the individual can be as minor as excessive bank fees from non bank ATM withdrawals, to the extreme of bad credit ratings or bankruptcy. On a social scale, if financial literacy is consistently poor the the number of bankruptcies and defaults would be alarmingly high. No body wins in Bankruptcy, the borrower loses their house and credit rating, the bank may also lose money if it's forced to sell the house at a loss. If you amplify that impact across a broad demographic the end result is what was called a GFC, or Global Financial Crisis. Now I am sure I am not the first to make a statement along the lines of, "The primary cause of the GFC was poor financial literacy," but if I am, well you heard it here first.
Those that are financially literate will be the wealthy ones. Everyone else will get left behind, working till their 65, living from paycheque to paycheque and relying on the equity in their home and their modest superannuation balance to finance their retirement. Don't let this be you!
Recommended Reading:
The Secrets of Money: A Guide for Everyone on Practical Financial Literacy
Financial Literacy for Teens
Economic Literacy: What Everyone Needs to Know About Money and Markets
