Financial Illiteracy Is the Reason Most Americans Fail Financially

October 10, 2014

Millions of people go through life without understanding money and finances. They try to make ends meet, pay their bills, fill their families' needs, buy homes and cars, save and invest even though they have little or no knowledge about what they're doing.

Would you sit down at a high-stakes poker table in Las Vegas if you didn’t know how the game was played? Of course not! If you did, you would be throwing your money away. In the beginning, you might be lucky and win a few hands, but in no time flat, your ignorance would catch up with you and you would lose your shirt.

Well, everyday, millions of people do something just as inconceivable. They go through life without understanding money and finances. They try to make ends meet, pay their bills, fill their families’ needs, buy homes and cars, save and invest even though they have little or no knowledge about what they’re doing. So many of them fail … unnecessarily.

Most of Americans have never been taught how to manage their personal finances so most of are are financially illiterate.

At school, they teach us about all sorts of subjects, many of which we may never use. We learn about ancient civilizations and mythology, but not about the basics of managing our money. Although managing our money is an essential skill that we constantly must use, it’s not a part of most school curriculums. So when it comes to money, most of us don’t know what to do.

To complicate matters, the subject of money and finance is made to seem complex, confusing and beyond our grasp. When we first learn about it, most of us find it intimidating so we’re not drawn to it. Many of us hope that others will manage money for us or think that we can always learn about it at a later time, but few ever do.

Lack of financial literacy is the reason why most people don’t accumulate wealth. It’s also why they make financial mistakes, fall into debt, can’t provide for their loved ones and jeopardize their futures. Getting into financial trouble is easy; people have lost all their money because they made just one financial blunder. The most common mistakes include speculating, putting too much money into one asset class, overpaying, spending frivolously and taking bad advice.

The most prominent symptom of financial illiteracy is buying what you can’t afford. People routinely purchase items that are more than they need and cost more than they can afford. To do so, most take on debt. In many cases, they don’t understand debt and how it can quickly spiral. Before long, the amounts they owe mount and exceed what they can afford to repay.

When it comes to their finances, most folks don’t know what they’re doing, they don’t know how to figure out what they can afford, the best ways to buy, save, and invest. Much of the present financial crisis occurred because people took out mortgages that they didn’t understand and subsequently couldn’t repay. When it came to mortgages, they were illiterate and didn’t know what they were getting into. They couldn’t tell when they were being “sold,” being put into no-win situations, or given poor advice.

Nearly half of all Americans live from paycheck to paycheck because they don’t understand how to manage their personal finances. They are only one or 2 paychecks away from being broke. They have no wiggle room for the emergencies and unexpected expenses that always pop up.

Lots of people get into financial trouble because they try to keep up with their friends and neighbors. They see them living extravagant, luxurious lives and want to follow suit. However, it's hard to tell what lies beneath those lavish facades. The people who seem to have so much may earn more than we do or be subsidized by their wealthy families. They may be putting on a grand front when everything inside is falling apart. Get more education. Learn about basic economics. If you asked 10 people what the GDP (gross domestic product) is, only one or 2 would know. Learn about the items below, which I’ll discuss in detail in the chapters that follow. They are:

Investing: I regularly see people who have hundreds of thousands of dollars at risk and do not understand where that money is and how that investment works. So my first job is to educate them and encourage them to learn on their own. Learn the basics. If you don’t, you can’t take an active role in managing your own investments. You can’t help make decisions on how to invest your own money and will be forced to rely on others.

At the least, every investor should know the basics about stocks, bonds, mutual funds, and annuities. Specifically, they must understand the advantages, disadvantages and costs involved for each such as commissions, penalties and surrender fees. Finally, they must know how to measure the risks involved.

Credit and debt: When used properly, credit is great because other people’s money can help you get rich. An example of good credit is low-interest, fixed-rate mortgages that are used to acquire property that increase in value. For example, if you can put down 20%, borrow 80%, and the value of the property increases, that is an excellent use of credit. Unfortunately, as the value of their properties has gone up, too many people have refinanced them and used the equity to fund consumer purchases.

The best example of bad debt is credit cards. Credit card debt is cancer to the financial body. Most credit cards charge high rates of interest, but despite that fact, many people use them to support themselves or buy items that they cannot afford, really do not need, and should not buy.

Insurance: Although insurance accounts for 10% to 15% of most people’s expenses, most know little or nothing about it. You don’t have to become an expert, but learn the basics about insurance. Most people I see have either too much or too little insurance, they don’t understand it and how it should be used. Few shop around to find the best values. As a result, they have too much, too little, or the wrong type of insurance. They also tend to have the wrong deductibles and pay the wrong premiums for the wrong types of life insurance.

Taxes: Most people are so fearful of the IRS and so ignorant about taxes that they pay others to do work that they easily could do themselves. Many could have prepared their own tax filings while others might have noticed costly mistakes that their tax preparers made. Since taxes take a portion of our wealth, we should all manage our money in the most tax-efficient way. To do so, we must understand deductions, tax-free investments, tax-deferred investments and other strategies that enable us to keep more of our money. The more money we can keep, the more we can invest for our futures.

Estate planning: Many people die without a will or having done any estate planning. They have made no provisions or left no instructions on what should be done when they die. Estate planning can ensure that your money will go where you wish and it can decrease taxes and red tape for your survivors. Most people are not prepared to die and leave their families with time-consuming and costly messes that easily could have been avoided.

Goal setting: Few people have a plan. They live their lives on the fly. If they can save some money, they do — but usually, they can’t and they don’t. You can’t succeed if you don’t know where you want to go. Determine how much money you want for the future. It could be money for the down payment on a home, for your kids’ education, for investments, an emergency fund, for your lifestyle or your retirement nest eggs.

  • Set specific financial goals
  • Write your goals down
  • Live with discipline to achieve your goals.

Goal setting helps us lead more financially disciplined lives. When we know that we have firm objectives, we will be more inclined to work to achieve them. Realistically, most goals won’t be fully achieved, but if you achieve some of them, or better yet, most of them, you will be well ahead of the game. You will be saving or investing some, rather than saving or investing nothing and then trying to scramble when it may be harder or too late.

Most people don’t say, “I’ll save $300 every month and put it into a mutual fund portfolio that will pay for my retirement.” Nor do they set aside specific sums for each of their children so that they will have the money they need to pay for their college educations when they need it. They don’t put money aside to pay for vacations. Instead, they charge them on high-interest credit cards.

Keep current: Stay up to date on finances and the economy. Pay attention to the economic developments that are reported in the media. News and information affects your investments and impacts your financial planning. Follow the news about subjects such as finance legislation, unemployment, inflation, and housing starts.

Things change. And when they change, they can provide money-making opportunities for those who see them coming and are prepared to act. Follow the news and developments about subjects such as finance, tax legislation, unemployment, inflation, housing starts, politics and market performance. Learn what’s going on in your locale and in your areas of interest. Form alliances with people who can be your investment partners.

Become more disciplined: Don’t spend money unless you have it. It’s old advice that is seldom followed. People keep spending when they can’t afford to. Since most don’t plan for the future, they just live for today. Unfortunately, the future comes very quickly and catches them off guard. When it does, they may be well past their peak earning years and may be unable to acquire what they need. Starting early in life really helps.


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