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Why financial literacy is imperative

Posted on 25 May 2021,    
 5244    Share  Report

It helps you to make the most of the financial resources available


Author : Madhu Sinha/DNA

Content :
Financial literacy is the process by which investors improve their understanding of financial markets, products, concepts and risks. Through information and objective advice, they develop the skills and confidence to become more aware of financial risks and opportunities and make informed choices to improve their financial position.
Financial education primarily relates to personal finance, which enables individuals to take effective action to improve overall well-being and avoid distress in financial matters.
Financial literacy goes beyond the provision of financial information and advice. It is the ability to know, monitor, and effectively use financial resources to enhance the well-being and economic security of oneself, one’s family, and one’s business.
Why do we need financial literacy?
India is among the world’s most efficient financial markets in terms of technology, regulation and systems. It also has one of the highest savings rate in the world - our gross household savings rate, which averaged 19% of gross domestic product (GDP) between 1996-97 and 1999-2000, increased to about 23% in 2003-04 and has been growing ever since.
While savings are more in India, where the savings are invested is a cause for concern. Investments by households have been more into either bank fixed deposits, risk-free government-backed securities and low-yielding instruments, or in non-financial assets.
A majority of our households do not use modern financial markets. As per an RBI report, only 1.4% of household savings was invested in equity, mutual funds and debentures in 2003-04. Though this went up to about 4% in 2005-06, it is still very small.
Unless the common person becomes a wiser investor and is protected from wrongdoings, wealth creation for the investor and the economy will remain a distant dream. We need to convert a country of savers into a nation of investors.
Participation in modern finance throws up a number of questions and choices for households like:
* Do you make household budgets?
* How much do you need to save every month to meet all your financial goals?
* How should you allocate your savings into various asset classes and among asset classes to various products?
* How should you change your asset allocation pattern with age and circumstances?
* What should be the basis of selecting a mutual fund house, insurance company, bank or lender?
* Do you know there is a need for diversification of your investments to diversify risk?
* What are the channels through which financial services are provided?
Which one should you use?
Such questions and choices appear tough to even urban population not to talk of those in rural areas, where most of India’s population is. When it comes to financial solutions, investors tend to use thumb rules or seek advice from friends and relatives, which are often poor approximations compared to those that follow from a systematic process. If they get bad advice, their outcomes will be poor, and they will start to lose faith in the financial sector. A big improvement of financial knowledge of households is necessary so that they participate continuously in financial markets.
Financial literacy plays a significant role in the efficient allocation of household savings and the ability of individuals to meet their financial goals. It also means the ability to seek sound financial advice
Financial literacy has assumed greater importance in recent years as financial markets have become increasingly complex and the common man finds it very difficult to make informed decisions. Financial literacy is considered an important adjunct for promoting financial inclusion and ultimately financial stability. Both developed and developing countries, therefore, are focusing on programmes for financial literacy/education. In India, the need for financial literacy is even greater considering the low levels of literacy and the large section of the population, which still remains out of the formal financial set-up.
To understand financial planning, a person should be financially literate to understand the importance of preparing household budgets, cash-flow management and asset allocation to meet financial goals.
Everyone saves money for future needs but the approach is to save surplus money without preparing household budgets, without prioritising personal financial goals, without properly allocating investments in different asset classes and without understanding the real rate of return (after adjusting for inflation).
Individuals make a wide array of financial decisions through their lifetime. Examples of such decisions include providing for children’s higher education, saving for retirement, managing credit wisely, budgeting, tax and estate planning, insurance, etc. Each of these decisions is prompted by the emergence of a need. To help consumers make informed decisions, financial education is very important.
“The writer is a certified financial planner & full member of FPSB India, and is currently working as academic & regional head (western region) with International College of Financial Planning, Mumbai. FPSB India relies on its members’ prudence, competence, and ethical standards to have submitted this write up in good faith in their personal respective capacity. The article and the views are those of the writer and do not represent that of FPSB India. Readers are advised to consult their professional financial planners for advice. Feedback to this article may be mailed to


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