Common Finance Terms

Finance

There are some common financial terms that everyone needs to be aware of.  In order to be on top of your financial game and to keep ahead it is crucial that you know and understand these following terms.  It is also important that you keep these in mind as you continue to grow and proceed on your financial journey.  The key is to understand and maintain a good working knowledge of these terms and keep them in mind when going through your life.

The first is the concept of net worth.  If you think about this one, it is clear this is important for you to know and understand.  A person’s net worth is the value of all their assets and then the deduction of their liabilities.  The difference is your net worth.  If it is positive, that is what everyone strives for in the end.  A negative net worth is where you owe more than you own.  This situation is not good and will require some serious work on your part.

Inflation is the rate at which our money can buy things at a future date.  Let’s face it, that 20 years ago we made less, and most things cost less in comparison to today.  The average rate at which we need to make more and in turn we spend more has been about 3% a year in growth of the inflation rate.  This means that the money we save today needs to grow at a rate higher than inflation so we will have purchasing power in the future.  If we do not do, this our money will not be enough for us to have the buying power we will need.

Another term that is important to people is liquidity.  As a former bank examiner liquidity is not only something that is important to businesses but also individuals.  Liquidity for individuals is how easily you can get at your money.  Cash is considered the most liquid of assets and keeps in a savings or checking account.  Real estate would be an asset that is considered non-liquid as it may take a long time for you to sell and get your money out of the asset.  Equities can be regarded as both liquid and non-liquid as they are easy to sell, but you may not sell at a profit every time.  If you have an emergency fund, which everyone should, that needs to be held in a very liquid asset such as cash.

Some additional terms that many people interested in financial markets need to know and understand are bull and bear markets.  These terms refer to how the United States stock markets are trending.  If the markets are going up, economic trends are positive, and unemployment is low we are in a bull market.  Today we are experiencing a bull market but how long it will last is anyone’s guess.  That is the nature of the markets they go up then at some point they reverse and go down.  If the markets are not doing well, economic trends are negative, and unemployment is rising we are in a bear market.

Risk tolerance is very intertwined with the markets.  How risky do you want to be in your investments?  That is a crucial term for anyone who invests their hard earned money.  Younger people tend to have a higher risk tolerance as they are younger and if someone has time on their side they can afford to take more risks.  The reason is simply that the longer you have to invest the longer you have to make back any losses.  There are several websites that offer free risk analysis so to find one you like simply do a Google search for one that fits your needs.

A final term that is linked to the stock markets and can be used for any investing is diversification.  This is not just limited to stocks, and you do need to be diversified in that area as it is never good to be heavily investing in one company or sector of the market.  But you also need to diversify asset classes and own such things as equities, bonds, real estate, cash, and commodities.  By doing this, you limit your exposure to any one asset class taking a down turn and by not exposing all your investments to one asset class.  Also, by diversifying you will reduce your risk that is taken in your overall portfolio.

The final two terms we will look at are related, and they are interest and compound interest.  Both of these concepts can work for and against you depending on how you use them or how they are used against you.  Interest is what you are paid for loaning someone your money or what you will pay for someone to lend you money.  It is the cost of money to you or the cost of using your money from the bank you use.  Compound interest is what makes interest a powerful alley or enemy.  If you are saving money, the compounding of interest means you will earn a set amount of money on a set basis.  Then you will make money from not only your original money invested but the previous interest paid to you.  It is the same with what you owe, and that is what makes loans, especially credit cards, dangerous.  It is better to be on the receiving end of compound interest any time.

Those are some of the key financial terms everyone needs to know.  While not terribly in depth this does give you an excellent overview.  If you require more information or have any questions, please feel free to contact me.

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