Updated: August 19, 2020
Money is an essential part of every functioning adult’s life, and learning how to manage it starts in understanding some of its vital concepts.
Here are ten financial terms that you should know if you’re hoping to achieve financial independence someday.
These are not necessarily your textbook definitions, but more of a practical guide in appreciating how money really works.
Assets are anything that you own.
It’s the clothes that you’re wearing now, the cash in your savings account, the investments that you have, and everything else that has your name on it.
All assets have an equivalent monetary value because, except for cash, these are practically things that you can sell.
If the value of an asset goes down over time, like your car, then it’s a depreciating asset.
If its value goes up over time, such as a prized painting; or it regularly puts money in your pocket, like a real estate rental property, then it’s classified as an income-generating asset.
It’s good to buy assets, but make sure you buy more income-generating ones.
Liabilities are anything that takes money out of your pocket.
These are mostly credit card debts, and that long-term loan that you took out to pay for that house or car, but it can also be the money that you borrowed from your friend.
When a liability needs to be paid within a year or less, then it can be considered a short-term liability. If the financial commitment is longer than that, then it can already be called a long-term liability.
Having liabilities is not necessarily bad, especially if it helps you achieve your financial goals faster without crippling your budget.
3. Net Worth
Take the total value of your assets, and subtract the sum of your liabilities, and you’ll get your net worth.
If the result is positive, then you are considered to be at least, financially stable.
If it’s negative, then that’s a sign that you’re in financial trouble. Work on increasing your income and decreasing your spending so you can pay off your debts and loans, and lower your liabilities.
Calculate your net worth at least once a year to check if you’re becoming poorer or richer over time.
Take the sum of your cash, and all your other assets that you can easily convert to cash within a few days; then subtract the short-term liabilities that you have.
If the result is positive, then it can be said that you’re liquid. If it’s negative, then you’re in a bit of financial trouble because it’s an early sign that you might not be able to pay your financial obligations in the near future.
Save more money, and pay your debts, to achieve liquidity.
When money is borrowed, debt occurs and the borrower is expected to pay back with a higher amount than what he initially got. The difference is called the interest.
Interests can work for, or against you; depending your role in the transaction.
If it’s you who borrowed the cash, then it can work against you, that’s why it’s bad to have a lot of debts. But if you’re the one who loaned out the money, then you’re on the good side of debt.
This is the reason why you earn interests in your savings account. The bank doesn’t really keep your cash in their vaults, they “borrow” it and use it for their business.
Inflation is the rate at which the price of basic commodities change.
For example, if a kilo of rice was P40 last year and it’s now P42 per kilo, then the inflation rate between last year and today is said to be 5%.
The price of everything increases over time because our planet is a limited resource, and the world population is growing. When there’s a finite supply for an increasing demand, then its price will certainly go up.
So the next time you complain about the rising costs of living, take time to appreciate the importance of investing your money because it’s really the only way to grow your money faster than the inflation rate.
7. Bear and Bull Markets
These terms are often used by business reporters, traders, investors, economists, and other financial people.
The origin of the terms is an interesting story, but for now, all you need to understand is that a bear market means the economy is going or slowing down. Meanwhile, the opposite is true for the bull market.
The best indicator to determine if it’s a bear or bull market is to look at the stock market index. If it’s been going down over a significant period of time, like a year or two, then you can say that the bears are in control. If it’s otherwise going up, then the bulls are said to be more dominant.
8. Timing the Market
The economy goes up and down over time – it’s a constant battle between the bears and the bulls.
Unless there’s a financial meltdown, a bear market will eventually lose its steam and reverse in direction to give way to the bull market. And of course, the opposite is also true. The bulls in due time, will get tired and the bears will start to take over and pull the market down.
Timing the market is the act of predicting the points when those changes will occur, and requires excellent analytical skills to become accurate in doing so.
For people like us who are busy with our own lives and may not have time to do technical and fundamental analysis, it may be better to simply read the news to know what’s happening, and then adapt our investment and money management strategies accordingly.
There are many ways to define risk with respect to personal finance. The most common is to describe the likelihood of losing money in an investment.
Consequently, this makes people avoid high-risk instruments because they are afraid to lose their hard-earned money in them, and would rather go for low-risk investments.
However, apart from looking at risk under this perspective, I encourage you to also see risk with respect to growth.
Low-risk investments offer slow, but steady growth for your money. A good choice if you plan to use your cash in the near-term.
Moderate-risk investments feature fluctuating growth, but eventually goes up over the medium-term. Invest here if you can afford to ride the ups and down of the market for the next 3-5 years.
Lastly, high-risk investments give volatile growth, but offer the best potential to make money if you can ride several cycles of bear and bull markets, which would be five years and more.
Last in our list is the concept of diversification, which is best described as NOT putting your eggs in just one basket.
To diversify your portfolio means investing your money in different types of instruments – from time deposits, to bonds; from mutual funds, to UITFs; from real estate, to the stock market; and many others.
As markets go up and down, each instrument will perform worse or better than others. For example, when the stock market is falling, bonds tend to go up, and vice versa. So if you’re invested in both, then you minimize your risk of losing money.
Remember that in the end, what’s financially important is that your net worth increases over time.
You will achieve this by accumulating assets and minimizing liabilities, being liquid enough to pay for your immediate needs, investing your money to beat inflation, and being patient as you ride through the bear and bull markets of our economy.