Understanding basic money terms should be your first step towards financial literacy. It would be very difficult to start learning financial literacy, much more overhaul your financial life without understanding the basics. Just like reading for example, you won’t be able to learn how to read without knowing the alphabet.
The financial world is complicated. It is full of many terms and concepts that are alien or even boring for most people. However, whether you like it or not, you need to learn and understand some concepts in order for you to make good personal financial decisions.
Learning and understanding some basic personal finance vocabulary is the first step towards financial freedom.
To make it easier, we have narrowed down the list to ten terms that will help you understand the basics of personal finance.
Here are 10 basic terms that you should know about personal finance:
Assets are any resources with economic value. However, Robert Kiyosaki, author of the Rich Dad, Poor Dad redefined assets as economic sources that you own that generate income for you. Sample assets include certificates of deposits, bonds, funds, stocks, real estate or business. In this modern definition, a real estate property can only be considered an asset if you have it rented out or you sell it and receive capital gains from the sale. Cars are not considered as assets unless you use them in income generation activity such as Grab for example.
Credit is an agreement where the borrower receives something usually money or any other product or service with value with a promise to pay in the future within a specific time frame, usually with interest. In short, credit pertains to agreement between borrower and lender. Examples of credits are home loans, car loans, consumer and personal loans and credit cards.
3. Compound Interest
Compound interest is the addition of interest on the principal amount of your loan, savings or investments. In short, it is interest on interest. Thus, it has the capability to grow at an increasing amount. Use this concept to your advantage and your wealth will increase. However, this concept can also work against you especially if you have credit card debts. This is how credit card companies earn. Protect yourself and understand this concept so as not to end up a victim of enormous credit card debt.
Depreciation is the lowering of the value of an asset over time, usually because of wear and tear. Depreciable assets in your home include your cars, cellphone, appliances and furnitures. For example, if you bought a car worth million a year ago, you can no longer sell that car for the same price today because the value of the car already went down. That is depreciation. Buying depreciable assets on credit is not recommended.
Inflation is a finance concept that everyone should know because it affects everybody. When the value of your money declines, that is inflation. It simply means that the same amount of money that you are holding now can purchase less goods compared to last year. So, if you have money placed in a regular savings or current account, you are loosing money every year even if you are not actually withdrawing money from your account because of inflation.
6. Financial Freedom
Financial Freedom is the state wherein you are already living your ideal lifestyle without having to work for money. You can be enjoying yourself somewhere in the Bahamas and yet continue to receive money regularly.
Financial Freedom is achieved when your passive income is greater than your monthly expenses.
Liabilities are amount that you owe somebody, a company or the bank. They are your debts and financial obligations. Your liabilities include your bills, home loan, car loan, credit card debts and other consumer and personal loans.
A mortgage is a loan in which a property or real estate is used as collateral. A collateral serves as security for the loan. Ownership of the real estate is conditional until all obligations and monthly payments are met. This is your typical housing loan.
You are not the owner of your real estate until you have fully paid your mortgage.
9. Net Worth
Your net worth is the monetary equivalent of all your assets added together minus all your liabilities. In short, your net worth is the value of everything you own minus your debts. It is a gauge to measure your financial well-being or how wealthy you are.
NET WORTH = ASSETS – LIABILITIES
High income does not necessarily mean high net worth. A janitor without debt can be considered more wealthy than a company president whose liabilities are greater than his assets.
10. Passive Income
Passive income is money that you receive on a regular basis with minimal work requirement or without you having to work. This income is generated through your investments or assets.
Examples of passive income are:
- rental payments from your real estate properties
- dividends and capital appreciation from stocks and funds
- interests payments on bonds
- income from investments
- retirement income
This is the opposite of earned income wherein you need to work or exchange your time, skills and expertise to earn income. Example of earned income is your salary.