Knowledge Is Power: Making Sense Of These 8 Financial Concepts Is Crucial

Knowledge Is Power: Making Sense Of These 8 Financial Concepts Is Crucial

We could sit here right now and reel off about three hundred cliches about money being the be all and end all. We could tell you it isn’t a salary that makes your rich, but your spending habits. We could remind you that a lack of money is the root of all evil. And we could enlighten you to the fact that, while money probably won’t make you happy, it is far more comfortable to cry in an Audi R8 than on a rusty bicycle. Basically, it is all about money, which is why we find it so bizarre that financial understanding is not taught in schools or colleges. In fact, there is not a single form of educational system that focuses on money management.

Yes, having money isn’t everything, but not having it is, and that is what we need to be most wary of. That is why you need to understand how money works. When you are the person in charge of your finances, it is absolutely essential to have at least a basic understanding of financial concepts. But this tends to be easier said than done.

In fact, most people get into money problems because they don’t understand the jargon their financial advisors or banking managers use, which makes them feel insecure, unprepared, inadequate and out of their depth, and so they bury their heads. This may even describe your relationship with financial know-how. You’ve probably been to a meeting and come out feeling more scared than ever, maybe even motivating you to go and swat up a bit on “money talk.” But where do you start?

Knowledge Is Power: Making Sense Of These 8 Financial Concepts Is Crucial

Well, to help you face your biggest fear, we have come up with a list of terms everyone should know about because, armed with this knowledge, you will be able to increase the value of your money.

So, without further ado, here is our list of the most important financial concepts to wrap your head around:

Concept #1: Net Worth

This is arguably the most important calculations you can make when it comes to your personal finances. What’s more, it is actually quite simple to understand. All you have to do is add up the value of all the things you own and then subtract the total value of all your debts from this sum. It’s the sum of your total assets minus your debts. Your assets could be the value of your home, your car, your prized artwork, savings accounts, retirement funds and investments, while your debts will be things like credit cards, mortgage, and student loans. To put it bluntly, you want your net worth to be as positive as possible. That is the dream. If your net worth is dangling anywhere the negatives then you’ll want to put some work in on this front. Don’t be scared by what you find, just use it as a means of measuring and a tool to motivate.

Concept #2: Inflation

Inflation is a hugely important concept to understand because it has a huge effect on your personal finances and what you can afford. In fact, inflation is the main reason why people start investing; they want their finances to grow at a faster than inflation. What inflation refers to is the cost of living. It is the amount of money it costs to buy fuel, groceries, goods, and services, and the average rate at which this rises is 3% a year. So, as prices rise, you’ll be able to afford less. The dream here is to have a salary that increases at the same rate as inflation or more. If it isn’t, well, a few years down the road and you’ll be struggling to live the same lifestyle. So make sure your savings pot is working for you, or your income keeps up and, if it isn’t, then find alternative ways to bring in money.

Concept #3: Infinite Banking

This is a modern concept that was championed by Nelson Nash, which is why your best bet at understanding infinite banking is to read his book, “Becoming Your Own Banker”. That is what this concept alludes to. It is all about leveraging the power of life insurance to be able to build your own banking system, one that will not only allow you to use your money more efficiently but also pass your wealth on more efficiently too. The major benefit of this concept is that it allows your money to be saved in a stable and tax-free growth environment, but with the added bonus of being accessible at any time. So, if you ever hear these words being muttered by a financial advisor, ask them to clarify in more detail.

Concept #4: Interest

The thing you need to know first and foremost is that interest can work for you and it can work against you, making it friend or foe depending on the context. If the context is saving money, then interest is going to be your friend because the more interest you are garnering the more your money is working for you. In layman’s terms, if you have a savings account, what you are doing is letting the bank borrow your money at a rate of interest. If, however, the context is you borrowing money, then interest is the foe you need to be aware of because you will be paying the issuer a rate interest to borrow their money. What’s more, you’ll keep paying interest until you have paid off the amount you borrowed. This is where the most stinging blow from being in debt comes from, and is why you should do all you can do to avoid getting into debt or to pay off your debts as soon as possible.

Concept #5: Compound Interest

This is different from interest in the sense that the interest isn’t based on the initial sum, but works off a rolling balance. So, let’s say you have put $100 into an account that offers 8% interest annually. At the end of that first year, you are going to have $108. The next year, however, instead of the interest being 8% of $100, it is going to be 8% of $108, meaning your interest by the end of year two will be $8.64. Sure, this may not sound much, but let’s say you have put $10,000 into a savings account that offers compound interest. That will be $10,800 by the end of year one and $11,664 by the end of year two. Now that is a difference worth realizing, especially if you are saving for retirement over a 40 year period. It is one of the most effective ways to get your wealth to snowball and snowball fast.

Concept #6: Liquidity

In short, this is all about how accessible your money is. That’s all. So, instead of freaking out whenever you hear this word dropped into a conversation, just realize it simply refers to how easily you can get your hands on your money. Cash, for example, is about as liquid as your money can possibly be, which is because you can get your hands on with immediate effect. The money in your retirement account, however, is rather inaccessible. The same goes for the money tied in your house, or stocks, or anything else that falls under that bell curve. Yes, these vehicles tend to gain value over time, but there are some cases where cash is Queen. A great example of this is an emergency fund. That is something you will want to be made up of cash for the simple fact you will want to access it as quickly as you possibly can.

Concept #7: Bull Markets

Anything to do with markets always makes us want to curl up into a ball and ignore the world because we have no idea what they mean. Well, a bull market is simply a market that is on the up and up; which is a great thing. It means the price of your house is on the rise, your stocks and shares, your classic car, and all that sort of stuff, which is exactly what you want to hear as an investor of any kind. The other thing a bull market tends to be synonymous with is a strong economy, meaning the chance of it coming crashing down is low. To give you a real world example, it is safe to say that good old America is enjoying a bull market at the moment. Unfortunately, there is an opposite to this market too…

Concept #8: Bear Market

This a term that the majority of investors never wants to hear because it signals a market that is in decline. House prices will be falling, shares will be tumbling, the value of the dollar will be dropping, the economy is spiraling downward and employment levels are on the rise. Basically, it is not a very pretty picture and not a good time to have money tied up in investments. However, the most important thing to remember is that, while a bear market sounds hellish, every market is a roller coaster and that means it will always go back up. So don’t just panic when things start to look like they are taking a turn for the worst. Ride it out. Depending on your age, you probably have time on your side, and if there is one thing time is great for, it is making your money blossom, so don’t just sell everything because you’re scared.