Handling your own finances is a skill that is supposed to be known by any functioning adult. However, there is a surprising number of people, especially those who are market participants, that still don’t understand basic financial concepts. This is alarming because as soon as people have their own money that they earn to pay necessities with, they must already have a grip of the basic financial concepts. Knowing these are essential in understanding not only your assets but also in managing your money and growing your wealth. That is why it’s not too late to learn the basics.
In financial terms, interest is the amount or percentage charged for using borrowed money. Interest is commonly quoted using the annual percentage rate.
Interest can become an ally or an enemy depending on which side you are. If you let your money be loaned either by the bank or other investments then interest is on your side. Saving up and allocating your money somewhere it will accumulate interest over time is making money work for you. On the other hand, if you borrow money, you would typically be paying interest for the cost of borrowing money. A prime example is by using credit cards. Although there are many discounts and freebies, most credit cards will add interest on your next bill for using the bank’s money in place of your future earnings.
Asset Allocation and Diversification
Asset allocation is an investment strategy whose purpose is to balance risk and reward through the calculated allocation of the assets of a portfolio according to the preferences (goals, risk tolerance, and investment horizon) of the owner. It is where you decide to allot your assets to be used for investment.
Diversification, meanwhile, is a risk management technique that reduces risk through investment in a wide mix of assets. The thought is that by collecting a basket of investment from different asset classes will yield better returns and give lower risk compared to a portfolio with only one kind of investment.
Both financial concepts are crucial to the wellbeing of your asset. Simply distributing assets at random investments will not do. You must research and understand where you are putting your money.
One financial concept that is crucial to anyone who deals with money is inflation. Inflation is the rate of price increase in goods and services while the purchasing power of currency falls. This means that because inflation causes the increase in prices, you will be able to afford less and less. This is why products from your parents time that are still available today are priced significantly higher.
Inflation occurs due several factors. One of them is the increase in aggregate demand or the decrease in aggregate supply for goods and services. It also occurs because of decrease in demand or increase in supply for monetary currency.
Experts see an average inflation rate of 3% per year.
Another concept that is relevant to the basic financial knowledge is liquidity. Financial books define liquidity as the availability of liquid assets to a market or company. In other words, it is the accessibility of your money.
The most liquid of all your assets is cash because it is the most accessible to you. And usually, the less liquid an asset is, the more it gains value over time. However, it is inevitable that cash be used in our daily lives. The least liquid asset is real estate as it takes at least weeks or months to sell.
In taking into account your assets, you must be wary of their liquidity. Be cautious. Always have an emergency fund that is highly liquid. We recommend a cash account. Meanwhile, be ready to keep your money invested in other assets for them to grow.
One of the most basic financial concepts is the net worth. Academically, net worth is the amount that is left when assets exceed liabilities. In general, it is the overall measure of an individual’s financial health. It is known in several other names depending on the field of context. Ib business, net worth is synonymous book value or shareholder’s equity.
Naturally, an increasing net worth signifies a growing net worth. Subsequently, net worth can drastically go down because of several factors such as annual operating losses or asset value depreciation due to liabilities.
Your goal as a financially stable adult is to keep your net worth high and growing.
There are a number of financial concepts out there that is crucial to the proper education of market participants everywhere. You do not have to learn everything but at least be aware of the basics. Everyone must remember that researching and understanding these terms is essential to your financial health.