Money Basics
Financial Literacy: Why It Matters
What financial literacy means, how surveys measure it, and evidence on how understanding money affects people's financial wellbeing.
Financial literacy means understanding basic money concepts well enough to make good financial decisions: budgeting, saving, borrowing, investing and avoiding scams.
Measuring it
Economists Annamaria Lusardi and Olivia Mitchell developed three simple questions, often called the Big Three, used in surveys around the world:
- Interest: if you have 100 in a savings account at 2 percent interest per year, how much will you have after five years if you leave it to grow: more than 102, exactly 102, or less than 102?
- Inflation: if the interest rate on your savings is 1 percent and inflation is 2 percent, after one year could you buy more, the same or less with the money?
- Risk: is buying a single company’s stock usually safer than buying a mutual fund?
The answers are more than 102, less, and false. Many people get at least one wrong.
What surveys show
A global survey by Standard & Poor’s in 2014 found that only about a third of adults worldwide were financially literate by its measure. In India, the share was lower than the global average. Financial literacy tends to be lower among women, younger and older adults, and people with less education.
Why it matters
Research has linked higher financial literacy to:
- Planning and saving for retirement.
- Avoiding high-cost debt.
- Investing in diversified assets.
- Being less vulnerable to scams.
Financial education
Does teaching financial literacy help? Evidence is mixed but encouraging. A 2020 review of dozens of randomised trials by Tim Kaiser and colleagues found financial education programmes, on average, improved financial knowledge and behaviour, especially when well designed and timed close to real decisions.
In India, the RBI, SEBI and other regulators run financial literacy programmes, and the National Strategy for Financial Education sets goals for spreading financial knowledge.
Someone keeps savings in an account paying 3 percent while inflation runs at 6 percent. Without understanding inflation, they believe their savings are growing safely. In reality, their purchasing power shrinks each year. Knowing this basic concept could lead them to consider options that better protect their savings.
People with limited incomes often face the hardest financial choices, where mistakes are most costly. Basic financial knowledge can help anyone avoid high-cost debt, scams and lost savings.
- Financial literacy means understanding money concepts well enough to make good decisions.
- The Big Three questions test understanding of interest, inflation and risk.
- Surveys find many adults worldwide, and in India, lack basic financial literacy.
- Financial education, especially when timely, improves knowledge and behaviour on average.
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