FINANCE MADE EASY TO UNDERSTAND
- JWB Post
- February 1, 2014
Not all aspects of finance will ever apply to you but personal finance is something you have to deal with everyday. It’s important that you know some personal finance basics so you understand what’s going on with your money. Becoming familiar with these few financial terms may help make your financial picture clearer.
Your personal net worth is the difference between your assets and debt. A positive net worth means you have more cash flow from your resources than liabilities. A negative net worth means you owe more than you bring in.
An asset is a resource that has economic value. Assets increase your net worth by generating cash flow. Your business is an asset because it brings in cash.
A liability is a debt or monetary obligation you have. While owning property is an asset, a mortgage is a liability because you must pay it every month.
Five C’s of Credit
The Five C’s of Credit is an evaluation method lenders use to determine whether to extend you credit. They are as follows:
1. character: your reputation
2. capacity: your ability to repay the debt in a timely manner
3. capital: any financial resources you may have, such as income
4. collateral: any large assets (property for example) that you’re willing to put as a guarantee in case you default on the loan
5. conditions: the terms of the loan, such as interest rate
Inflation is the rate at which the cost of goods and services is increasing in inverse relation to the purchasing power of each rupee.
Interest is the charge paid for borrowing money. If you were to take out a line of credit, you would pay a certain percentage of it as interest. When you put your money in the bank, it would pay you an interest percentage on your money for borrowing it.
Debt to income ratio
Debt to income ratio (sometimes just called “debt ratio) is a comparison of the amount of debt you carry in relation to the amount of income you receive. Divide your total debt by your total income to determine your debt to income ratio.
Time value of money
The time value of money is the concept that money on hand today is worth more than the same amount of money in the future because the money today can be invested to earn interest. Why is it important? Understanding that money today is worth more than the same amount in the future can help you evaluate and compare investments that offer returns at different times.
Market volatility measures the rate at which the price of a security moves up and down. If the price of a security historically changes rapidly over a short period of time, its volatility is high. Conversely, if the price of a security rarely changes, its volatility is low. Why is it important? Understanding volatility can help you evaluate whether a particular investment is suited to your investing style and risk tolerance.
This strategy means spreading investments over a variety of asset categories, such as equities, cash, bonds, etc. Why is it important? How you allocate your assets depends on a number of factors, including your risk tolerance and your desired return. Diversifying your investments over asset classes can potentially help you manage risk and volatility.
An annuity is a contract where you pay money to an insurance company in return for the insurer’s promise to pay it back, with interest, in the future. Why is it important? You can supplement other retirement savings with tax-deferred annuity funds, and you can add to your retirement income with payments from your annuity for a fixed period of time or for the rest of your life.
Buying a bond is essentially when you lend money to a government or business, and they pay you back with interest. Bonds can be bought at all levels: national, state, county, municipal, and even from private businesses. It’s like you are the bank!
When a company decides to go public, they sell some percentage of their company as shares of stock. The public is allowed to purchase shares of this company, and when you buy a stock, you become a partial owner of the company. In some cases, you can even vote on company rules. You can buy stock in any company that is publicly traded on exchanges
APR is the three-letter-acronym meaning annual percentage rate. You’ll hear this at the end of car commercials. It’s the interest rate and expenses for the whole year, representing — in a single number — the fees associated with with paying back a loan. Pay attention to this number because regardless of how it breaks down, you can consider it as the interest you’re paying. In general, the lower the number, the better.