Following my previous blog on basic concepts of financial literacy followed by a YouTube video to explain it; the next step is advanced financial literacy. I have simplified it below to help you get started.
According to study done by Annamaria Lusardi on “Financial literacy: Do people know the ABCs of Finance?”; in order to make sound savings and investment decision, we need knowledge beyond the previous financial concepts I discussed in the earlier blog and video (Numeracy, Compound Interest, Inflation, Risk diversification). We need to understand the relationship between risk and return; how bonds, stocks, and mutual funds work; as well asset basic asset pricing. These are part of Advanced Financial literacy. Here I will discuss in simple terms for initial comprehension.
In its simplest form, stock is a share in the ownership of a company. It represents a claim on the company’s assets and earnings. Stocks are a way to build wealth. They can also go by the name of “equities” or “shares”. Buying a company’s stock comes with some rights which may include receiving a dividend as well as voting rights at shareholder meetings.
As you acquire more stock, your ownership stake in the company becomes greater.
Owning stock means that, no matter what, the maximum value you can lose is the value of your investment. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.
Bonds are a good way to get income and stability. Bonds represents a loan from you (the buyer) to the seller of the bond which is usually companies or governments; and generally they pay a stated interest rate made under an agreed-upon time period
There are many different types of bonds. They vary according to who issues them, length until maturity, interest rate, and risk.
The best time to take out a loan is when bond rates are low, since bond and loan rates go up and down together.
Mutual funds are investments that pool your money together with other investors to purchase shares of a collection of stocks, bonds, or other securities, referred to as a portfolio, that might be difficult to recreate on your own. Mutual funds are typically managed by a portfolio manager. This helps to mitigate the risk of choosing individual securities.
Mutual funds are extremely popular because they allow you to pick one fund, which contains different stocks, and not worry about putting too many eggs in one basket (as you likely would if you bought individual stocks).
BASIC ASSET PRICING:
We need to understand the behaviour of asset prices to make many important decisions in our day to day lives. The choice between saving in the form of cash, bank deposits or stocks, or perhaps a single-family house, depends on what we think of the risks and returns associated with these different forms of savings.
Now that you have a bit of understanding of what is needed for advanced concepts of financial literacy, those who are more financially knowledgeable are much more likely to have planned for retirement.
The study also mentioned that In terms of economic importance, knowledge of risk diversification is the strongest predictor of planning. Financial literacy is not simply a proxy for low educational attainment, race, or gender. (As has been noted in studies, women, minorities, and those with low levels of education are disproportionately less likely to be financially literate.) Even after accounting for many demographic characteristics, financial literacy continues to be an important determinant of planning.
I will be putting together another video soon to explain the concepts and checklist to check your understanding.