Navigating today’s complex financial landscape requires sound knowledge of key financial literacy terms. These terms are the building blocks for understanding and managing your finances.
From interest rates and compound growth to concepts like diversification and inflation, this article covers the essential financial literacy words and terms you should know. Dive in and decode the language of money.
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What is financial literacy?
Financial literacy means having the skills and knowledge to manage your money effectively. It helps you make smart decisions about saving, spending, investing, and avoiding unnecessary debt.
When you understand basic financial terms like budget, interest rate, and investments, you can take control of your finances and avoid costly mistakes and scams. This leads to greater financial stability and freedom. With financial literacy, you can make informed choices that support your money goals and create a better financial future for yourself.
20 financial literacy terms to know
Becoming financially literate requires you to understand basic terms. Here are 20 financial literacy terms to know:
1. Budget
A budget is a financial plan that spells out how much you earn or can earn and how much you should spend within a given period. It involves tracking your sources of income and allocating funds for spending under categories such as housing, food, transportation, and savings.
For instance, setting a weekly budget of $150 for groceries ensures you set aside a specific amount for this expense and helps you avoid overspending.
2. Credit score
A credit score is a numerical representation of a person’s creditworthiness based on credit history. It indicates the likelihood of borrowers repaying debts on time, making it a valuable tool for lenders to assess the risk of lending money and determine loan eligibility and interest rates. A more favorable credit history, gives you a higher credit score, leading to optimal borrowing terms.
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3. Interest rate
Interest rate is the percentage of the principal a lender charges a borrower for borrowing money or earned by an investor on an investment. It’s essentially the cost of borrowing money or the return on invested funds.
4. Compound interest
Compound interest is the interest calculated not only on the initial principal amount but also on the accumulated interest from previous periods. It has a considerable impact on long-term savings or debt.
Say you have $100,000 in a savings account with an annual interest rate of 2%, compounded yearly. After the first year, you would earn $2,000 in interest (2% of $100,000), resulting in a total balance of $102,000. In the second year, rather than earning interest only on the initial $100,000, you earn interest on the new balance of $102,000.
5. Assets
Assets are anything of value that can be owned by an individual or entity. They come in various forms: cash, stocks, bonds, real estate properties, vehicles, and other possessions. Assets contribute to your net worth and can be used to generate income or measure financial stability.
6. Liabilities
Liabilities are debts or financial obligations an individual or entity owes to others. They cover loans, taxes owed, mortgages, and other outstanding payments.
7. Net worth
Net worth describes the sum of your assets less your liabilities. It’s a measure of financial health and represents the amount of money you’ll be left with if you pay all your debts and sell all your assets. A positive net worth indicates that your assets exceed your liabilities, while a negative net worth suggests the opposite.
8. Inflation
Inflation is the rate at which prices of essential goods and services rise over time. It reduces the purchasing power of money as the same amount buys fewer goods and services.
9. Investment
Investing involves allocating money with the expectation of earning income. It typically entails buying financial assets, such as stocks, bonds, real estate, or mutual funds, to generate returns over time through dividends, interest, or capital appreciation.
You may opt to create a stand-alone investment account where you pick and choose the different financial assets to include. However, making an educated decision often requires a ton of research and even years of experience. Instead, many investors will opt for a managed account.
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10. Diversification
Diversification is the strategy of spreading investments across different asset classes or sectors to reduce risk. By diversifying a portfolio, you minimize the potential negative impact of a single investment — gains in others may offset losses in one investment.
11. Risk tolerance
Risk tolerance refers to the degree of willingness and ability to tolerate potential losses when making investment decisions. It measures how much risk a person is comfortable accepting in the quest for profit. Risk tolerance depends on age, financial goals, time horizon, and personal circumstances.
12. Dividends
Dividends are payments companies make to shareholders as their share of profits. Shareholders can choose to receive dividends as additional shares or cash.
13. Capital gains
Capital gains are the profits gained from selling a security or asset at a higher price than the purchase price. For example, if you purchased the stock of Company XYZ for $1,000 and later sold it for $1,500, the $500 difference would be a capital gain.
14. Mutual fund
A mutual fund is an investment option where several investors pool their money to purchase a diversified portfolio of stocks, bonds, or other assets. Professional fund managers oversee the fund’s investments and make decisions on behalf of the investors, seeking to maximize returns while minimizing risk.
15. 401(k) or retirement plan
A 401(k) or retirement plan is a tax-advantaged savings account employers provide to help employees save for retirement. Employees contribute a portion of their pre-tax income, often with employers matching their contributions. The funds are invested for potential growth in stocks, bonds, mutual funds, and other investments until retirement.
16. Roth IRA
A Roth IRA is a retirement savings account that allows individuals to contribute after-tax income. Qualified withdrawals from a Roth IRA, including earnings, are tax-free. It provides potential tax advantages by allowing tax-free growth and tax-free withdrawals in retirement, making it an attractive option for long-term retirement savings.
17. Stock market
The stock market is where publicly traded company shares are bought and sold. It provides a platform for investors to participate in the ownership of companies by purchasing stocks, which represent ownership in a portion of the company’s assets and earnings.
18. Risk management
Risk management involves identifying, evaluating, and mitigating potential risks to protect one’s financial well-being. It involves implementing strategies such as insurance coverage, emergency funds, diversification, and other risk-reducing measures to minimize the impact of unforeseen events or losses.
19. Debt-to-income ratio
Debt-to-income ratio is a financial metric that compares your monthly debt payments to monthly income. Lenders use it to appraise your ability to manage additional debt. For example, with a monthly income of $10,000 and total monthly debt payments are $2,000, your debt-to-income ratio would be 20% ($2,000 / $10,000).
20. Emergency fund
An emergency fund is a reserved amount specifically designated to cover unexpected expenses or financial emergencies. It’s a safety net, providing a financial cushion to avoid relying on credit or accumulating debt when faced with unforeseen circumstances such as job loss, medical emergencies, or significant repairs.
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4 tips for learning new financial literacy terms
Learning is a life-long endeavor, and new concepts and terms appear as the financial landscape evolves. Here are tips to keep abreast of new financial literacy terms.
1. Use online resources
Websites, blogs, and educational platforms offer articles, tutorials, and videos that explain financial terms in a user-friendly manner, often for free. Explore these resources to supplement your understanding and gain practical insights.
2. Enroll in a financial education course
Many educational institutions, community organizations, and online platforms offer courses designed to improve financial literacy. These courses provide structured learning, interactive activities, and expert guidance to help you grasp complex financial concepts and terminologies.
3. Read financial news and books
Stay on top of financial matters by regularly reading news articles and books. Financial news sources report on current events, market trends, and economic concepts, exposing you to various financial terms in their real-life context. Similarly, books written by financial experts can offer in-depth explanations and case studies that deepen your understanding.
4. Consult with a financial adviser
Consider consulting an adviser if you have specific questions or need personalized guidance. A professional adviser can explain financial terms relevant to your situation and offer tailored advice.
Financial literacy: decoding the jargon
Understanding the personal finance terms listed here will help you progress toward your financial goal. To further expand your financial knowledge, you can leverage online resources, enroll in relevant courses, and seek guidance from financial advisers. Decoding the jargon of the finance world can empower you to seize control of your financial well-being.
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FAQ
What are some common financial literacy terms?
Common financial literacy terms include budget, credit score, interest rate, assets, and liabilities.
Why is financial literacy important?
Financial literacy is important because it gives you the knowledge and skills to make intelligent decisions, plan for the future, and avoid common financial pitfalls.
How can I improve my financial literacy?
To improve your financial literacy, you can use online resources, enroll in financial education courses, read financial news and books, consult with a financial adviser, and actively engage in discussions and learning communities focused on personal finance.
