5 financial terms every successful investor must know
What's the story
Navigating the world of finance can be a bit overwhelming, what with the thousands of terms that sound complex to the ears. However, understanding key financial jargon is important for making informed decisions about one's personal finances and investments. Here's a look at five key terms that every adult should know, and which will help you manage your money better.
Compound interest
Understanding compound interest
Compound interest is when interest is added to the principal amount, and future interest calculations are done on this total. In simple terms, you earn interest on both your money and the interest earned in earlier periods. It can tremendously increase savings over time, making it an incredible tool for wealth generation. Understanding how compound interest works helps you assess savings accounts, loans, and investment opportunities.
Credit score
The importance of credit score
A credit score is a number that reflects your creditworthiness based on your credit history. It falls between 300 and 850, with a higher score reflecting better credit health. This can result in better loan terms or lower insurance premiums. Factors affecting your credit score include payment history, amounts owed, length of credit history, new credit inquiries, and types of credit used. Monitoring your score regularly keeps your finances healthy.
Diversification
Diversification in investments
Diversification is about spreading your investments across different asset classes to minimize risk. When you don't put all your eggs in one basket, you're less likely to incur heavy losses if one of your investments doesn't do well while others may do. Typical diversification strategies involve investing in stocks, bonds, real estate or mutual funds across various sectors or geographies. Knowing diversification helps create a balanced portfolio per your risk appetite.
Inflation
Inflation's impact on purchasing power
To put it simply, inflation is basically the rate at which the prices for goods and services rise, which in turn decreases how much a currency can buy. This erodes purchasing power, adversely affecting savings (if not offset by investments with returns above inflation rates). Equities or real estate can provide such returns, making them vital to stay financially stable in an inflationary environment when budgeting or planning retirement goals.
Liquidity
Liquidity: Accessing cash quickly
Liquidity denotes how fast an asset can be converted into cash without substantially impacting its market price. High liquidity means easy access, while low liquidity could indicate difficulty in selling out assets quickly. Cash is highly liquid compared to real estate which takes longer due diligence. Knowing liquidity enables you to manage your emergency funds well, ensuring they're available in unforeseen situations without heavy losses.