Last Updated on January 22, 2025
Overview – Investing and Financial Literacy: An Interesting Dynamic
Financial literacy is a topic that’s discussed year-round, and understandably so. Many people are concerned about how to best manage their monetary resources, so taking the time to understand, or at least familiarize themselves, with the relevant skills and knowledge is a sensible thing to do.
As people continue to learn about different financial terms and related concepts, it’s only a matter of time before they inevitably come across investing. After all, the idea of putting your money to work is certainly alluring and is an important aspect of managing your finances.
If financial literacy and investing are indeed related, what exactly does that relationship look like? Does one precede the other, does skill/knowledge in one transfer to the other, or is it something else entirely? Let’s take a look.
What is Financial Literacy, Anyways?
Before we continue this discussion, let’s first define what “financial literacy” is.
There are hundreds, if not thousands, of definitions for financial literacy. These definitions range from very simple to very complex, and each has its nuances to help people understand it in their way.
For our purposes, the definition we will use will be:
“The skills, knowledge, and ways of thinking needed to help individuals make prudent financial decisions today and for the rest of their lives.”
Just as there are countless definitions of financial literacy, there are also countless variables that contribute to a person’s level of financial literacy.
Responsible use of credit, buying a car, buying a house, taking out a loan, the importance of saving, paying taxes, investing: the list goes on almost endlessly. There already exists mountains of material regarding financial literacy and goes well beyond the scope of this article.
Because the financial landscape changes almost every day, it’s no surprise that definitions of financial literacy are subject to frequent change. No matter how many times the definition of “financial literacy” is modified, the underlying definition will always stay the same – understanding the relationship between people and finances.
So, this brings us back to our main question: how are investing and financial literacy related to one another?
What Comes First: Financial Know-How or Investing Skill?
You’re probably familiar with the famous “chicken or the egg” paradox. If an egg came first, this implies that a chicken had to first lay the egg. If a chicken comes first, this means that it first hatched from an egg.
A similar observation can be made when trying to discern the relationship between financial literacy and investing: do you learn how to invest by first becoming more financially literate, or is financial know-how a by-product of someone’s investment activities?
As we will soon discuss, both scenarios are equally possible, but with important caveats to keep in mind.
High Financial Literacy Does Not Guarantee Investment Skill
Many people first hear about investing after having explored other, related financial topics, such as budgeting and saving. After having gained a firm understanding of these fundamental concepts, knowing what investing entails is a natural next step.
Having an excellent grasp of finance fundamentals such as budgeting, saving, and long-term planning can be greatly beneficial for investors-to-be.
Before people can even hope to start investing, they must have adequate capital on hand to deploy, which can only be obtained if they know how to adequately budget their money and save it. Any intelligent investor knows how to think about the ramifications of their decisions, which financial literacy teaches when it comes to planning how to best allocate your limited money.
Establishing a strong knowledge base in general financial topics before moving on to investing is, for many people, a common path, and understandably so.
While strong financial literacy can be advantageous for those who want to start investing, it’s important to note that the skills needed for day-to-day finances may not be adequate for investing, especially if you plan to manage your portfolio.
Investors need a multitude of skills if they want to succeed such as critical reading, data analysis, numeracy, and knowing how to keep their emotions under control, among many others. People who try to become more financially literate may already have some of the necessary skills, but chances are, not all of them.
Being financially literate is important, no doubt, but it by no means guarantees that those looking to make the jump to investing will immediately have all the necessary skills and competencies needed to thrive.
Investment Skill Can Improve Financial Literacy, to a Certain Degree
Though arguably less common, the relationship between financial literacy and investing can also be reversed: people can become investors first and improve their day-to-day financial know-how as a “side effect” of their investing activities.
As we mentioned in the preceding section, succeeding as an investor requires multiple skills and competencies. Fortunately, some of these skills are highly transferable when it comes to managing day-to-day financial affairs.
Investors use their know-how to understand how to best allocate their capital, find investment opportunities that can advance their goals, and manage risk, along with many other tasks. The skills that investors use to perform these jobs can also be applied to general financial tasks like knowing how to best spend your money, finding the opportunities that best advance personal financial goals, and the importance of keeping a close eye on spending.
If successful investors possess the right skills and knowledge needed to safeguard and grow their capital, then there’s nothing stopping them from applying those same skills and knowledge in a general financial context.
Although many investment skills can be applied in a general financial setting, this doesn’t mean there’s nothing else for investors to learn. Investing and financial literacy, though related, seek to achieve two different objectives.
Investing seeks to grow a set amount of capital while simultaneously making sure the original amount is largely kept intact, while financial literacy is more concerned about having a broad range of skills needed to address a variety of financial tasks and decisions.
Therefore, just because an investor is highly skilled at what they do doesn’t mean they know everything under the general financial umbrella.
Investing and Financial Literacy Have a Complementary Relationship, to an Extent
After having gone through the previous two sections, we see that investing and financial literacy share a complementary relationship, but only to a certain extent.
Establishing a strong foundation in financial literacy before moving on to investing is an excellent start, but there are still many skills and competencies that must be learned if you wish to succeed as an investor. Conversely, although successful investors possess a multitude of valuable skills, not all of them will apply in a general, non-specialized setting.
One can serve as an excellent starting point for the other, but both “routes” will always require the acquisition of additional skills and competencies.
Wrapping Up
At a glance, it’s clear that investing and financial literacy are related in some way, but what exactly does that relationship look like? Does one precede the other?
For many people, the relationship between the two is that as they become more financially literate, they inevitably come across investing, and possess some of the skills needed to succeed at it due to what they’ve learned in a general financial context.
On the other hand, though arguably less common, some people become more financially literate due to the skills and competencies they’ve acquired to carry out their investment work.
Therefore, financial literacy and investing share a complementary relationship that goes both ways, but strength in one area does not immediately guarantee strength in the other.
