Knowledge is power, especially when it comes to finances. Understanding basic financial concepts can help your overall financial well-being. While Americans have improved their financial literacy over the past few years, many Americans could still use a financial term refresher. In fact, respondents of the 2020 TIAA Institute-Global Financial Literacy Excellence Center (GFLEC) Personal Finance Index answered 52% of questions correctly. This survey asks respondents basic questions about debt management, investment risk, savings accounts, and other money-related topics.
Although the 52% accuracy is an improvement from the 49% accuracy in 2017, consumers still need more education around financial topics. So, to help you get started, here are some financial terms and what you need to know about each one.
WHAT FINANCIAL TERMS SHOULD EVERY ADULT KNOW?
Loan. When you borrow money from a lender, the sum of money is known as a loan. Essentially, you request financing for a certain expense like a car and agree to pay back the amount of money following the terms the lender outlines. Examples of loans are personal loans, mortgages, and auto loans.
Interest. When you borrow money, you pay the lender a certain percentage to use the money. This percentage is known as the interest rate. You could also earn interest on investments or your bank account because you’re essentially lending the money in your account to the bank.
Compound interest. Albert Einstein referred to compound interest as the eighth wonder of the world. It was given this nickname because of its unquestionable power to grow your investments. Essentially, it’s interest on interest. For an example of its magical powers, you can use the compound interest calculator to see how investments can grow over time.
Credit score. Your credit score is a three-digit number that informs lenders how creditworthy you are. The more favorable your credit score, the better terms and lower interest rate you will receive because you are deemed less risky than folks with a higher credit score. A very good credit score can range from 740 to 799, while a poor credit score may range from 580 to 669. Making on-time payments, using a minimal amount of your credit, and paying off debt are several ways you can boost your credit score.
Investment. When you buy an asset with the expectation of growth and value accumulation, this is known as an investment. In other words, you buy an investment hoping it will generate income now or in the future.
Stocks. Buying a stock gives you a portion of ownership of a certain public company. So, when you buy a share of Amazon or Walmart, you then own a very small percentage of the company.
Bonds. To find funding, the government or a corporation issues bonds. Then, investors can buy the bonds and receive interest for lending the government or a corporation money to finance a new project. Usually, bonds are considered fixed-income securities, since they provide interest, regardless of where interest rates are during the life of the bond.
Asset allocation. To balance risk and reward, investors allocate their assets among several investments. This way, investors avoid putting all of their eggs into one basket, which could be very risky and result in loss. Spreading your money across different types of investments like stocks, bonds, and mutual funds can help reduce your risk exposure. For example, if you invested all of your money into one stock and the company went bankrupt, you may lose your total investment. But, if you spread out your money on different investments, you can reduce your loss.
Net worth. The total value of your assets (investments, property, etc.) minus debt. So, if you own a $400,000 home, have $50,000 in investments, and have a $10,000 car loan, your net worth is $440,000.
HOW TO INCREASE YOUR FINANCIAL LITERACY
The list of financial terms above is just a start. It’s up to you to increase your financial literacy so you can better manage your money. Here are a few extra tips to enhance your financial education.
- Check out free resources. If you’re curious about a certain topic, you can simply Google it for a myriad of free financial resources. The Internet is full of educational sources. But make sure you select reputable resources, such as the websites of banks, insurance companies, or lenders.
- Speak with your employer. Some employers offer financial resources, like free access to financial advisors, as a part of your benefits package. So, reach out to your employer or HR department to see if there are some resources available to you.
- Brush up on your reading. There are plenty of financial education books available for purchase. Reading financial education content can enhance your understanding of the topic.