5 Financing Terms You Should Know
Financial terminology can get confusing when you’re not well-versed in the industry. You might be aware of the more common terms like interest, profit, and expenses. However, when it comes to the more complex terminology, it’s easy to get overwhelmed.
There’s a reason that accountants and financial advisors need to study for years to qualify and work in the field! They need to properly understand what the hundreds of different terms mean and why they are important.
There are lots of great online resources that you can use as part of your research. You don’t need to learn every single term out there (which would be pretty much impossible)! Getting your head around a small selection of keywords and phrases is a great start.
Whether you’re considering a career in the finance industry or you just want to learn more about money and finance, this article will help you!
Below, we’ve got five important financial terms to learn when you first begin your research.
- Asset Allocation
- Capital Gains
- Compound Interest
- Net Worth
These terms are commonly used in the world of banking and finance, so it will be helpful to know exactly what they mean.
1. Asset Allocation
Asset allocation describes how your money is tied into different asset classes. The main asset classes are cash, stocks (equities), and bonds (fixed income). Investing in each asset category comes with its own risks and rewards.
Generally, having a high stock asset allocation can yield great returns as stocks have a higher growth potential than bonds. However, stocks are also more volatile and can fluctuate based on the market. Some stocks can lose value over time.
Determining where to allocate your assets is important when you’re an investor. You must determine which risks you’re willing to take in order to gain profits on your stocks and maintain your current assets.
2. Capital Gains
When you make investments, the aim is for them to rise in value over time. The term capital gains refer to the money that you have make on your investments. You can calculate your capital gains by subtracting the amount you paid for an investment from the amount you sold it for.
If you’ve sold your investment for a profit, you will need to pay taxes on the profits that you’ve made from your capital gains. The tax rate depends on your location and your income.
Selling your investment for profit within the first year is known as a short-term capital gain. If you sell your investment after a year, it’s a long-term capital gain.
If you lose money on your investment, it’s referred to as a capital loss. In this case, your losses would be deducted from your tax return so that you don’t pay taxes on this amount.
3. Compound Interest
The money you earn on investments or savings is called compound interest. The initial amount of money that you originally save, invest, or borrow is known as the principal sum of a loan. Therefore, adding the amount you’ll earn or repay is the principal plus compound interest.
You can also gather compound interest on money that you have borrowed for things like mortgages or car loans. When you repay your loan, you will need to pay the amount you borrowed, plus any compound interest that has accumulated over the loan period.
Diversifying your income is key to a successful investment portfolio. Diversification means investing in multiple areas to counteract the volatility of the market.
This means balancing your asset allocation by spreading your assets across all three asset classes. The practice of spreading your assets across multiple areas minimizes risks while boosting your investment returns.
There are several different types of cash, growth, and defensive investments to consider when you want to diversify your portfolio. The most common aspects of each type of investment are shares or equities (growth), savings (cash), fixed interest or bonds (defensive), and property investments (growth).
5. Net Worth
Net worth is a term used to describe the total value of everything that a person or business owns (including monetary and physical assets) after deducting the value of the things that they owe to lenders or other businesses or individuals (known as liabilities).
Knowing your net worth is important because it provides an insight into how well you or your business is doing financially. A higher net worth is more desirable as it shows that you have a positive amount of assets, even after accounting for all of your loan repayments and deposits.
You can calculate your net worth by subtracting what you owe from what you own. Consider your home, car, savings, and investments when adding up your assets. Your liabilities include things like loans, mortgages, credit card balances, and contracts.