Financial Literacy Background

The Cost of Financial Illiteracy Financial illiteracy is a huge problem in the United States, affecting both individuals and businesses. Recent statistics show that 43% of American families spend more than they earn each year, and the average household credit card debt is more than $8,000. In 2003, 1.6 million Americans filed for bankruptcy – the highest amount in history and twice the number since 1993. In a 2004 national survey of financial knowledge, high school seniors scored an average of 52% -- a failing grade. Many college graduates leave academia with a diploma and $20,000 in combined student loan and credit card debt. Four out of 5 business start-ups fail within 5 years.

The truth about financial illiteracy is that it keeps people from living their dreams. Two out of three Americans will probably fail to realize one or more of their major life goals because they have not developed a comprehensive financial plan. That means millions of Americans will not be able to own a home or pay for their children’s college education. Many seniors will have to hold part-time jobs well into their retirement years.

The cumulative effect of millions of financially illiterate individuals and small businesses unable to effectively manage their finances has the potential for dire consequences on the national economy. An example is tremendous consumer-spending rate that Americans maintained even during a slow economy. Although economic indicators suggested lower spending, Americans continued to borrow more as interest rates on car loans and home mortgages remained historically low—below 6% for 30-year loans. Many consumers failed to consider the financial implications of higher debt balances.

So what is Financial Literacy? Financial literacy can be defined as the ability to effectively evaluate and manage one’s finances in order to make prudent decisions toward reaching life goals and achieve financial well-being.

Financial Literacy Background

1

Being financially literate helps to protect individuals from being exploited through identity fraud or questionable investments and allows them to meet basic, everyday needs.

How Financial Literacy Affects Your Daily Life There are five basic areas of personal finance that people need to understand to become financially literate. Grasping these basic areas is important for managing many aspects of day-to-day life. They include:

• Money and income o Career choices, education and job skills affect income. o There is always a trade off between time and effort, money and rewards. Time equals money. If you work for a living—and most of us do—you earn a salary. It’s important to look at that salary not only as a yearly total, but also as hourly earnings. For example, according to the U.S. Department of Labor, in 2000, the median annual earnings of executive secretaries and administrative assistants was $31,090. It would take a person earning this salary almost an hour and a half to earn enough money to buy a $20 CD. o Some things to remember: ƒ Know your sources of income – both earned and unearned. ƒ Understand gross versus after-tax, or net, earnings – something always goes to Uncle Sam. ƒ Remember inflation reduces the purchasing power of income.

• Money management o What we need and what we want are two different things. The truth is that few of us will ever have the money to purchase everything we desire. For this reason, we need to think about our priorities before we spend. o Financial responsibility means that we are all accountable for our financial future. o Money likes a bit of control. A budget is a spending plan to help forecast and control expenses. By watching what you spend and carefully

Financial Literacy Background

2

allocating your money, you can monitor your cash flow and save for the bigger items you’d like to purchase. A financial plan helps you plan for your future.

• Spending and debt o Whether you spend now or later, whenever you purchase an item, you take from your income (earned or unearned) to pay for it. Careful consumers compare the benefits and costs of spending alternatives. o If you spend more than you have, you will end up in debt. o Credit is a basic financial tool, and it does not equal free money.

• Saving and investing o Saving means not spending money. Saving doesn’t take brainpower, it takes willpower. o Investing means that you earn a return on the money you put into it. o Savings accounts are investments, though they earn a low rate of return. o Saving is the first step. Save for a while and then invest when you feel ready. o Delayed gratification is the key to financial maturity. Investments grow over time and help you achieve long-term goals. o Understanding the financial markets is becoming increasingly important as more and more Americans take charge of their investing.

• Risk management o There are always risks associated with both spending and saving money but there are ways to mitigate these risks (risk avoidance, risk control and risk transfer through insurance). o Insurance protects against major losses incurred through disaster or unexpected life crises such as death or medical emergency. o You can never be too careful-- protect yourself from identity theft and privacy infringement.

Financial Literacy Background

3

Planning for Life’s Milestones Financial literacy comes not only from knowing what you have and what your options are, but also from planning for life’s milestones. Each milestone requires a unique set of financial management skills.

Some of life’s milestones and the financial skills that should be mastered include:

• Creating your first comprehensive long-term financial plan o Determining what is important to you and defining your goals. o Assessing your current financial situation. o Evaluating the alternatives to meet your goals. o Developing and implementing a sound financial plan. o Monitoring and updating your plan as necessary.

• Buying your first home o Saving for the down-payment. o Establishing good credit. o Planning for home expenses and repaying mortgages. o Understanding financing and refinancing alternatives. o Evaluating risks of home ownership and insurance policies.

• Getting married o Understanding the “financial partnership”. o Establishing separate and joint credit. o Creating wills and trusts. o Naming beneficiaries and owners of title on assets.

• Financing a family o Saving for children’s education.

Financial Literacy Background

4

o Paying for health care and child care costs. o Assessing life insurance needs. o Creating wills and trusts to establish guardianships and financial support in the event you die. o Assessing your cash flows and debt management decisions. o Instilling financial literacy in your children from the start.

• Starting a business o Understanding financing and start-up considerations. o Identifying cash flow needs and expense timing. o Managing income and expenses. o Knowing where to find capital for major expenditures and growth. o Building and maintaining the value of your business.

• Planning for Retirement o The first step in planning for your retirement is to determine how much money you will need. A ballpark figure is that in order to retire with financial security, you typically need 70% to 100% of your pre-retirement income. o Determine where your retirment income will come from, such as Social Security, employer pension plans, personal retirement savings accounts, personal investments, part-time work or consulting. o Planning for retirement requires setting concrete goals. Devise a budget and investment strategy to help you meet those goals.

• Preparing a will and protecting your assets for your heirs o Properly designating beneficiaries. o Determining the distribution of assets upon your death. o Identifying insurance needs to cover funeral costs and family needs. o Naming a guardian for your minor children. o Creating medical and other powers of attorney in the event of your incapacity.

Financial Literacy Background

5

o Preparing letters of instruction to identify wishes upon your death.

• Dealing with loss o Preparing financially for the unexpected is often overlooked. Whether it’s something as life altering as a natural disaster, or less catastrophic, like the loss of a job, being financially prepared in a time of emergency is crucial. o Remember to pay yourself first each month. Financial experts often recommend that households maintain a liquid emergency fund equivalent to three to six months of income.

• Sandwich generation o Many adults today are caring for their young children and their elderly parents at the same time—a group experts now call the “sandwich” generation. This can be emotionally stressful and a drain on finances.

• Divorce o Nearly two-thirds of marriages end in divorce. It isn’t something you want to plan for, but if it happens to you, it will affect your finances.

Educate Yourself on Financial Literacy

There are many sources available to you for learning about financial literacy, such as: • Classes. Take a money management class or enroll in life-long learning programs at your local community college or university. • Financial Media. Read the financial or business sections of various newspapers and financial periodicals and watch and listen to financial programs. Remember to utilize various financial sources to get many points of view. • The Internet. A new Web site provides comprehensive financial education for every stage of life. Visit www.360financialliteracy.org to find the information you need when you need it. You also can visit the Web sites of government, not for profit and financial organizations, such as the U.S. Department of Treasury’s

Financial Literacy Background

6

Office of Financial Education, the American Savings Education Council (ASEC), Jump$tart Coalition for Personal Financial Literacy, the AICPA or the Small Business Administration. • CPAs or other financial advisors. Seek out an advisor who can be your partner in financial success. A CPA will gain an intimate knowledge of your finances and can provide many services to individuals and small businesses beyond tax preparation. Examples of these services range from financial planning and eldercare guidance to cash management, business valuation, software evaluation and design, and succession planning.

The Professions Initiatives on Financial Literacy The CPA profession is committed to improving financial literacy in America.

The SPEAKER’S STATE SOCIETY creates numerous programs and tools that you can use to become more financially literate.

Some include: Speaker can talk about state society’s initiatives.

Financial Literacy Background

7

At the national level, the CPA profession has implemented numerous initiatives designed to prevent financial illiteracy and offer assistance to those in financial distress. Recently, the American Institute of Certified Public Accountants, with the support of the state CPA societies, launched 360 Degrees of Financial Literacy. This multi-faceted effort encourages CPAs to take a broad leadership role in volunteering to educate the American public, from school children to retirees, on financial topics that apply specifically to their particular stage of life. Some of the program’s components include:

• 360 Degrees of Financial Literacy Web site: This new Web site provides financial literacy education tailored to the 360 Degrees of Financial Literacy life stage approach. Consumers can find information to support sound financial decision making at every stage of their lives. Go to www.360financialliteracy.org.

• CPA Financial Literacy Resource Center: This new site for CPAs and the state CPA societies contains resources to use in educating and supporting consumers in making significant financial choices. CPA Mobilization Kits, created by the AICPA and the California Society of CPAs, are focused in the life stages and provide a PowerPoint presentation and fact sheets of key issues. Also available for CPAs is a free continuing professional education course, background information and links to state financial literacy activities.

• Disaster Recovery Handbook: To help Americans regain financial balance following the devastation of disaster, the AICPA and the National Endowment for Financial Education (NEFE), with support from the AICPA Foundation, jointly developed a recovery guide. More than 100,000 copies have been distributed free of charge through local Red Cross chapters and state CPA societies, and more than 600,000 hits have been made to the Web page. Available online at: www.redcross.org/services/disaster/beprepared/FinRecovery/acknowledgements .html.

• Project for Financial Independence: The AICPA is one of six organizations sponsoring the Project for Financial Independence, the nation's first multi- organizational pro bono financial planning effort. The project offers free financial guidance to individuals who cannot afford a financial advisor, or who are facing an immediate or unusual financial need. For more information, visit www.consultaplanner.org.

• Start Here. Go Places: The Money Means Business game lets students of all ages practice new financial skills. Visit www.startheregoplaces.com.

• TV Shows: Two television programs funded by the AICPA Foundation aired on PBS YOU in summer 2003. Penny Wise and Business Building Blocks focused on teaching middle and high school students, respectively, about personal

Financial Literacy Background

8

finance, basic money management and the accounting profession. They can be watched on the AICPA Web site at www.aicpa.org/financialliteracy.

• Annual AICPA and USA Today Tax Hotline: Each year, AICPA members volunteer as tax experts to answer questions received on USA Today's Web site. Questions from online tax chats are used to develop a feature story about hot tax topics that runs in the newspaper’s money section, read by more than two million Americans every day.

For more information, visit www.aicpa.org/financialliteracy.

Financial Literacy Background

9