You’ll need some basic financial knowledge as you grow up and start managing your own finances.
When you master these concepts, you can start making better financial decisions for yourself and your family.
It’s a good start, isn’t it?
You’ll need to learn and address any financial issues as soon as possible if you want to manage your finances well, live without stress and build wealth.
You can get a great start by learning these basic financial concepts. Are you ready to start?
What are the basic financial concepts?
The ideal basic financial concepts would cover banking, credit cards and understanding them, saving money, investing, and earning more money. You should be able to grasp these concepts before you turn 30, but a late start is fine.
The examples below will show you how to manage your finances as an adult.
Net Worth
Compound Interest
Inflation
Liquidity
Money Mindset
Bull & Bear Markets
Appreciating Assets
Diversification
You Must Pay Yourself Before Anyone Else
Risk Tolerance
Multi-Streams of Income
- Net Worth
Net worth is a way to measure your financial status. It’s calculated by subtracting your total assets from the total amount owed. A positive net worth means that you are debt-free and your assets have some value.
You should also understand your liquid networth. It is different than net worth because your liquid net value is the number assets that you can sell at any time and convert into cash.
Stocks and bonds, for example, are considered liquid whereas real estate would be non-liquid.
Tip: Looking for a way to track your net worth and see charts and data? Personal Capital may be the platform for you.
- Compound Interest
“Compound Interest is the eighth Wonder of the World.” – Albert Einstein Albert Einstein: “He who understands compound interest earns it… and he who does not, pays it.”
Compound interest is essential to understanding how to increase your net worth so that you can retire comfortably. Compound interest is what happens when you invest money, and that money earns interest. Then you allow the interest to also grow.
As you continue to add money, and let the interest work, eventually, your money will start to compound, and grow in a big curve.
Two examples:
You invest $10,000, and you never add more to it. If you invested $10,000 and received a return of 7% in the stock markets, your money could compound to over $70,000 in 30 years.
Contribute $10,000 per year to your retirement fund. If you had a 7% rate of return in the stock markets, your money could compound to over $900,000.
Compound interest is the key to investing and saving money.
- Inflation
Inflation is the constant increase in prices of goods and services. Inflation increases the cost of goods and services, so you can afford less. When inflation increases, your money loses its purchasing power.
It is not a very fun concept, but is important to grasp because it is part of all economies around the world.
Statista has some additional data that will help you dig deeper. It shows the annual rate of inflation in the U.S. between 2010 and 2019 as well as projections for 2021.
This graph shows the percentages of inflation over the past 11 years.
Inflation in the U.S.
- Liquidity
In the section on net worth, I alluded to a concept called liquidity. Let’s dig a little deeper. Liquidity is simply how easily your money would be available if you were to need it.
Cash in your savings account, for example, is liquid. You can get cash from your bank quickly.
Your home or retirement investment is not liquid because it takes time to gain value. Selling these investments can be time-consuming and, in the case retirement accounts, may incur penalties for early withdrawal.
- Money Mindset
How you feel and think about money, or about people who are wealthy, is an important concept that will influence the way you approach your finances. Money can be viewed as a frustrating or evil concept by many people.
We as a culture are too often controlled by money instead of taking control. It’s important to improve your money mindset, and it is probably one of the most useful financial concepts in this list.
You can change your attitude towards money by working on your mentality. It can also help you learn to master delayed gratification and impulse spending. You can also practice gratitude for your possessions, evaluate what’s important to you and more.
- Bull & Bear Markets
At first, investing can seem intimidating and overwhelming. You can teach yourself to invest and manage your money without spending much time.
I like Vanguard Index Funds, and use a simple portfolio such as the three-fund approach.
You’ll need to know what bear and bull markets are, and how they affect your investment.
Bull Market: The markets are on the rise. Share prices continue to rise and you can expect high returns, like those seen by many in 2020. This is usually a sign of a relatively healthy economy, but there are many factors involved.
Bear Market: Stock prices are continuing to drop and the market is in decline. It can be frightening, but it is also a great opportunity to invest when the shares are cheaper. You can invest with time and take some losses in a bear market. Only when you decide to sell will you lose money.
- Appreciating Assets
Understanding appreciating assets is important to building wealth and improving your finances.
Assets that are likely to appreciate in value over time are intended to diversify your portfolio and increase your networth. There is no guarantee of price appreciation, and there may be times when assets lose their value. Overall, the assets will recover and grow in value.
Some examples of assets that appreciate include:
Real estate
Stocks
Bonds
Private Equity
Savings Accounts
Commodities
Collectibles
Start A Business
- Diversification
How many millionaires have you met who became wealthy through savings accounts? I rest my case.” – Robert G. Allen
Diversification is a simple concept that will benefit you in times of economic recession. It is risky to put all of your money in one asset, one category or one stock.
By investing in different categories, you can balance your portfolio out if a particular area is hit. This ensures that your capital is not destroyed, but rather takes a more moderate downturn.
You might be tempted to invest heavily in stocks but it is a good idea to mix up your investments. For instance, you could put some of your money in savings or bonds, buy some real estate or start a small business. All assets have some risk, but you can have other assets with a low correlation if the first one suffers.
Diversification is key! Diversification is the key!
- You Must Pay Yourself Before Anyone Else
Paying yourself first is the most important financial principle that many people fail to implement.
This means that you should put your money towards your financial goals before any other expenses, such as paying your monthly bills or debts. You will want to pay off your debts and obligations, but put this money to use for yourself first.
Many people pay their bills and debts, spend on certain items, then invest or save the remaining money (if any). You will be less likely to overspend when you reverse the process.
- Risk Tolerance
Diversification, as we discussed earlier, is an excellent way to reduce your risk and minimize exposure to a single asset. We need to discuss risk tolerance in more detail, as this is something that you should always be aware of when it comes to your personal finances.
How comfortable you are with economic fluctuations will determine your risk tolerance. What will you do when you know how the markets and economy work? How much you invest and how aggressively you do so will depend on your risk tolerance.
Your personal circumstances are not relevant to determining your risk tolerance. You should only consider the market’s nature. Your income, how long you will have to invest, your assets, and risk vs. rewards are all factors.
- Multi-Streams of Income
You need to understand how to achieve wealth accumulation if it is a goal that you have. Wealth can be created from a 9-5, but not everyone can achieve 6-figures or 7-figures.
Everyone has the opportunity to generate multiple income streams that can be used over time to increase their wealth.
Tom Corley, an author and researcher from the University of California at Berkeley, conducted a five-year study in which he surveyed individuals with high incomes about their daily habits and then compared these individuals to those who earned less.
He found that the majority of self-made millionaires earned their money from a variety of sources. There were up to seven streams. The breakdown was:
Three-fifths of the respondents had multiple streams of income
Four-fifths of the respondents had multiple streams of income
29% of respondents had more than five sources of income
You can work a 9-5 job, invest in dividends, buy rental property, start a business, freelance or consult on the side, participate in the gig-economy, etc. Multiple streams of income can help you increase your income and build wealth. They also allow you to diversify your income in the event that one stream is lost.
You can make money in many ways and improve your finances. You may be surprised to learn that you can earn more than you thought!
