18 Oct Financial concepts every adult should know.
If you are an adult, you handle and make decisions about money on a regular basis. You should therefore know and be comfortable with a few financial terms:
- Interest and Compound interest
Einstein once said “Those who understand interest earn it, those who don’t, pay it!” Interest is the cost of using somebody else’s money. When you borrow money, you pay interest. When you lend money, you earn interest. Every time you do not pay for your goods/services in cash, you probably will pay interest.
With Compound interest, Einstein also said ” It is the eighth world wonder of the world”. I can’t remember what I was watching last week and I thought that person’s description of compound interest was not only hilarious, but spot on! They said, imagine compound interest to be a lie that one tells, it keeps on building up and you have to keep telling more lies. It compounds and snowballs.
Compound interest therefore is interest earned on interest.
2. Net worth
This is probably one of my favourite calculations because it tells you if you are getting richer, poorer or just staying the same. I like the calculation also because it reminds you that it’s not about how much you earn, but how much you keep (and make work for you).
Net worth = Assets – Liabilities. Your assets are anything that brings or has the potential to bring you either income, capital appreciation or interest, i.e. an investment property, shares in a company etc. Liabilities on the other hand are all the things that take away your money: outstanding bond, car loan, personal loans etc.
I always encourage that you do this calculation once a year and set goals to increase your net worth.
If you had bought a burger for R25 in 2007, you would pay R47.04 for that same burger today due to inflation. Inflation is the rate at which prices of goods and services keep on rising continually. Inflation therefore erodes your purchasing power.
That is you should be investing. Investing in the right investment allows you to beat inflation and get a good return on your money.
4. Bear market & Bull market
On Monday 16th October, the JSE all share index closed at a record 58,300 points, which is indicative of a bull market. A bull market is when the price of stocks/shares keep on rising, it means investors are buying and trading on the stock exchange because they are optimistic and confident that companies will yield good results.
A bear market is characterised by pessimism and lack of confidence that investors will have good returns. Investors don’t think there is any value on the stock exchange.
is how quickly you can turn your asset into hard cash without losing it’s value. A property is not very liquid as you cannot sell it overnight. Cash in your bank account is highly liquid. That is why I always encourage that your emergency fund be in a highly liquid and accessible account.
Diversification is saying: I will not put all my eggs in one basket. It is a technique in which you reduce your risk. If you are investing on the stock exchange for example, you have access to four different asset classes i.e. Equity, Property, Bonds and Cash. It is advisable to invest across all these classes to reduce your risk. Remember, each type of class carries its own inherent risk.
There are many more financial concepts we can talk of and I will write further about them. Remember that your financial journey is not a sprint but a marathon. Learn and apply as much as you can, no matter how slow; as long as there is progress.
Tribe, what terms or concepts have you learned and found useful?