Is financial literacy common sense? Is there nothing else to learn?

Financial literacy, in the easiest terms, means being literate about finance.

The real question here is: What is finance?

If you look it up on Investopedia, the definition says “the system or study of creating, circulating, and managing money."

If we break this definition down, we find ourselves with three aspects.

1. creating money- through financial instruments

2. Circulating: banking and economics

3. managing them—financial investments.

Knowledge about economics, banking, financial instruments, and investments makes you financially literate, as per definition. That is a lot of subject areas to cover only with common sense. Common sense only helps you understand when to invest, or even how much to invest. But where to invest, when to exit, and how to leverage your investments can only be answered by being financially literate.

Finance can further be divided into

i) Public finance- creating, circulating and managing money with the public as the focal point.

E.g.: Government Budgets, Taxation policies, monetary policies from RBI.

ii) Corporate Finance- creating, circulating and managing money with the ‘business/corporate body’ as the focal point.

E.g.: IPOs, Debentures etc.

iii) Personal Finance- creating, circulating and managing money with the ‘person’ as the focal point.

If you are not a finance professional the first two divisions are mostly irrelevant to you. But, personal finance is not to be treated similarly. Its important to understand the definition around which personal finance revolves around the ‘person’. It is the responsibility of every individual to manage their personal finances with utmost care and safety.

This leads me to explain why financial literacy is important for individuals and how financial literacy is more than just common sense.

Most people view their financial investments with one view: the money received is more than the money invested.

As correct as it seems, it is not that simple. Usually, money is invested with a goal, risk profile, and time frame in mind.

The same individual may have many goals; his or her risk profile might also change with changes in income, changes in health, etc. during that time frame. The time frame for every goal of the investor is different as well.

Eg: lets apply the definition of personal finance.

i) Creation of money- depends on the income generating activity of the individual- it might be a business in a booming industry, it could be a business in a dying industry, it might be a secure job with a well established company or might be a job in a struggling company. These are factors to know and consider.

ii) Circulating the money- Expenses of the individual, dependents, health etc. insurance premiums and EMIs if any and finally investments.

iii) Managing the money- Cutting out unnecessary expenses, investing, diversification, rebalancing investment portfolio.

To prepare and perform all of the above-mentioned processes using common sense is impossible.

If we notice that circulating and managing the money involves knowledge of money, i.e., financial literacy, the idea of managing the money through diversification and rebalancing investments may be born out of common sense, but to follow through and create outcomes where the worst-case scenario is minimal is what financial literacy is capable of.

That is the reason why a lot of people choose to work with financial advisors and planners. It is not a wrong choice; when you have money, it makes sense to leverage the knowledge and experience of financial advisors and planners, but it is always advised to still understand the basics of it, i.e., the basics of how the financial instrument works and the risks associated with it.

Nowadays, with new, stricter regulations, planners and advisors are mandated to bring to the attention of investors the facts relating to the risks, regulations, and rewards associated with financial investments, and to understand the same, investors require a basic understanding of financial literacy.

Its not too late if you are not financially literate; you can still be financially literate with a few consistent efforts daily. There is a lot of content out there on the internet that helps you begin your journey toward financial literacy.

Today, money powers the world, and finance reflects all the changes, good or bad, in the creation, circulation, and management of money.

Being financially literate is not a one-time thing; it requires you to continuously update yourself. Financial opportunities change with newer financial instruments, government, international relations, business cycles, taxation policies, economic cycles, and the list goes on.

Authored By

Sudarshan Seshadri Iyengar

(BCom ,ICWA Finalist)