16 Basic Financial Terms for Managing Money
- August 4, 2020
- by Ashley
Getting good at managing your finances and budget requires knowing a few key concepts. We set up the following list of introductory money related concepts to help you get started on your financial journey.
Personal Finance Terms
Before you begin looking at saving or investing, it is important to understand some personal finance concepts.
- Credit Score – Your credit score is a number that reflects how much of a financial risk you are if you decide to take out a loan. The highest credit score you can get is 850, but a good credit score is considered anything over 650. The higher the credit score the better loan terms you can get. Here are some ideas for improving your credit.
- Net Worth – Net worth is the value of all the assets a person has. To figure out your net worth, you can add up everything you own, then subtract what you owe in loans. For example, if you own a $200,000 home but owe $150,000 on it and have $5,000 in savings, your net worth is $55,000 ((200,000-150,000) +5,000).
- Job Benefits – If you are employed, your employer might offer benefits. Benefits include things in addition to your salary such as discounted or free health insurance, life insurance, disability insurance, stock in the company.
- Insurance – Insurance is a contract between a company and a consumer that helps protect the consumer from financial loss. Consumers pay the insurance companies each month (this is called a premium) and in exchange, the insurance company will financially cover the item or person that the contract is designed to protect.
- Life Insurance – If insurance is designed to financially cover the loss or damage of an item, life insurance pays out in the event of a person’s death. These insurance policies are designed to help the families of deceased people financially recover from their loss. Here are some tips on buying life insurance from an author of ours who tragically lost her husband.
- Capital Gains – When you purchase an asset and sell it for a higher price, this is called capital gains. For example, let’s say you purchase a home for $150,000. If you sell it for $175,000, your capital gains are $25,000. An asset might refer to a stock, bond, or even a home.
- Taxes – Taxes are a fee that someone who earns money, spends money, or invests money pays to the government. Many people’s first experience with taxes is when they see that income tax is taken out of their paycheck.
Now that you understand some of the fundamental financial words, let’s talk about saving. Saving is important because we can’t predict the future. If you have money set aside to make a large purchase or get yourself out of a sticky situation, it can help you prevent going into debt.
- Assets – An asset is something of value that you own. For example, the money in your checking or savings fund is an asset. When you earn money, it is an asset until you spend it. If you own a home, car, or another item that has a resale value, they are also considered assets. Additionally, if you have money in an investment account or retirement fund, that money is also considered an asset.
- Liabilities – A liability is a financial responsibility to something, typically a debt. For example, if you have a car or mortgage payment, that is considered a liability. Liability is typically an amount owed for something that you already have possession of.
- Cash Flow – Most people earn and spend money continually. This consistent earning and spending of money is called cash flow. For example, you might earn a paycheck then make a mortgage payment and earn another paycheck and spend money on food and other expenses.
- Emergency fund – Financial advisors and other experts recommend always having an emergency fund in savings. This is typically up to six months of expenses that stay in your savings account and is not used to purchase day-to-day items unless necessary. An emergency fund is meant to help you cover sudden, large costs, or help you pay for your lifestyle in case you lose your income.
Once you have a little bit of money saved up, you might want to start investing. Investing is an allocation of money that is not easily accessible. Typically, people invest their money with the expectation that they will not touch it for several years.
- Stocks – A stock is a small portion of a company that you can purchase. When the company’s value increases, so do the value of your stocks. Stocks represent ownership in a company and some pay regular dividends. You can also sell your stock if you need the money back.
- Bonds – Bonds are a loan that companies or governments take from individuals. Rather than owning a portion of the company, bondholders have given a loan to the company and are paid back in interest over time, then the full value of the bond at the end of the term.
- Mutual Funds – Mutual funds are groups of investments pooled into one collection. Mutual funds typically have a mix of stocks, bonds, and other securities. They typically hold a wide range of assets which would ordinarily be out of reach for the average investor. This diversification helps to decrease the overall risk to the individual.
- Retirement Fund – A retirement fund or retirement plan is money that individuals invest over time intending to live off the money after they stop working. The money invested in a retirement fund is typically not able to be accessed by the individual who owns it before they turn 59 ½ without paying a penalty.
- Compound Interest – Compound interest in investing is when your money earns money. When you invest your money, it earns interest. Then, that interest is added to the total balance of the account. After that, the total balance of your account earns interest. This cycle repeats, and your account continues to grow. The interest that earns interest is called compound interest.
The Bottom Line
Now that you understand some of the basic terms involved in personal finance, you can start to plan where you put your money. You can start to save money or invest it and increase your net worth. However, if you are just getting started, it is wise to have an expert guide you to ensure that you start on the right foot.