If you are new to personal finance, you will hear so many terms that seem strange at the beginning. By learning these basic monetary terms, you will be able to make better financial decisions.
From saving money to budgeting, from investing to getting out of debt, the understanding of the language of money is step one!
In this guide, we review the key monetary terms every rookie needs to know. All the terms are described with simple and practical examples.
At the end of this piece, you will feel more assured reading financial articles, patronizing banking services or organizing your finances for the future.
The Importance of Familiarizing Yourself with Monetary Terms
For some, the financial language used makes managing money feel complicated and this is part of the reason why many people do not.
The truth is that no money term is difficult to understand when simplified.
Knowing these terms helps you:
- Make better financial decisions
- Understand bank products
- Avoid costly mistakes
- Build confidence with investing
- Improve your financial literacy
And these keys, as basic as they may seem today, will serve you for years down the line.
ALSO READ: How to Make a Budget That Actually Works?
All the important monetary terms are explained below number by number.
1. Income
Income is the regular money coming to you. It is typically earned from a job, but can also come from business, investments or rental property.
There are two types of income which are common.
Active Income
Active income comes from work. You trade your time and skill for some currency.
Examples include:
- Salary
- Hourly wages
- Freelance work
Passive Income
This is passive income in that after the initial effort, it continues with minimal daily effort on your behalf.
Examples include:
- Dividend payments
- Rental income
- Royalties
- Interest from savings
Multiple streams of income can help you security financially.
2. Expenses
Expenses are those money which you spend on goods and services.
Typical expenses will generally be categorized into two main groups.
Fixed Expenses
These expenses are fairly steady from month to month.
Examples include:
- Rent
- Mortgage
- Insurance
- Internet bill
Variable Expenses
These expenses vary from one month to the next.
Examples include:
- Groceries
- Entertainment
- Fuel
- Dining out
Analysing your expenses allows you to set an adequate budget.
3. Budget
A budget is a spending plan. It directs where your money goes before you spend it.
A good budget includes:
- Income
- Essential expenses
- Savings
- Debt payments
- Fun spending
Budgets also help you prevent overspending and maintain long term financial goals.
4. Savings
Savings are funds that you put away instead of utilizing right now.
It can help pay for:
- Emergencies
- Vacations
- Education
- Large purchases
Every little bit has an impact over time, even low savings every month.
5. Emergency Fund
An emergency fund is a money that you saved for unexpected situations.
Examples include:
- Medical bills
- Car repairs
- Job loss
- Home repairs
Most finance experts suggest saving the equivalent of three to six months worth of expenses.
6. Interest
Interest it the cost of borrowing money or the reward for saving money.
When you borrow, you pay interest. If you keep money in a savings account, the bank pays you interest.
Interest is one of the most powerful forces in personal finance.
7. Compound Interest
With compound interest, you earn a return not just on your original amount but on any interest you have already earned.
It helps investments to compound over time.
You start saving or investing sooner and the better compounding works in your favour.
8. Debt
Debt is the money that you borrow from another person or an institution, and pay it back.
Common types include:
- Credit card debt
- Student loans
- Personal loans
- Car loans
- Mortgages
Debt itself is not always a bad thing, and if done correctly it can even be a good thing.
9. Credit Score
A credit score is a representation of how responsibly you borrow and re-pays money.
A higher score can help you:
- Get approved for loans
- Ability to secure better interest rates
- Rent a home more easily
- Access better financial products
If you pay your bills on time, it will help build up your credit score.
10. Assets
Assets are items owned that hold an economic value.
Examples include:
- Cash
- Savings
- Investments
- Real estate
- Vehicles
Assets increase your net worth.
11. Liabilities
Liabilities are what you owe.
Examples include:
- Loans
- Credit card balances
- Mortgages
- Outstanding bills
The less liabilities you have the healthier your finances will be.
12. Net Worth
Net worth (or net assets) is the asset minus liabilities.
The formula is simple.
Net Worth = Assets – Liabilities
Positive net worth is when you have more than you owe.
13. Inflation
Well, inflation is an increase in price as time goes on.
When inflation increases, it indicates that with your money you can purchase less goods and services.
Saving, on the other hand, may not be sufficient to counter inflation. Long-term buy can protect your purchasing power.
14. Investment
An investment is the putting of money with the expectation of earning a return.
Popular investments include:
- Stocks
- Bonds
- Mutual funds
- Exchange traded funds
- Real estate
As with all investments, risk can not be avoided.
15. Return on Investment
ROI or Returns on Investment measures the profit made from an investment.
If your return on investment is positive, it means that you earned money on your investment. A negative ROI is you lost money.
ROI shows how well the investment performs while it compares with other opportunities.
16. Diversification
Diversification means investing in different assets.
You invest in multiple not just one.
Diversification reduces overall investment risk.
17. Risk
Risk is that something can go wrong and you can lose money.
Every investment involves some risk.
Higher potential return also comes with higher risk.
Understanding the capacity of risk is crucial for selecting investments that go well with you.
18. Liquidity
As we saw above, liquidity is an asset that can be converted into cash.
Cash is considered the most liquid of all assets.
Because selling a property takes time, real estate is far less liquid.
Media sources say that liquidity is important while planning for emergencies.
19. Cash Flow
Cash flow refers to the transfer of money into and out of your business.
Positive cash flow = you make more than you spend.
In cash flow negative means your income is not sufficient to cover your expenses.
With a healthy flow of money in and out, expectations can be set both for how much to save and invest.
20. Financial Goal
A financial goal is what you want to do with your money.
Examples include:
- Buying a home
- Paying off debt
- Building retirement savings
- Starting a business
Setting clear objectives can lead to more effective financial planning.
21. Diversified Portfolio
Portfolio: A portfolio is the range of investments you have invested in.
A diversified portfolio incorporates a variety of investment types to help offset risk.
Many investors mix stocks, bonds and other assets.
22. Dividend
Some companies pay money to shareholders, this is called a dividend.
Dividends are typically paid to shareholders by corporations, based on their earnings.
The passive income grows through dividend investing.
23. Capital Gain
You have a capital gain when you buy an investment for less than you paid.
So if you purchase shares for a hundred dollars and sell them for one hundred fifty dollars, your capital gain is fifty dollars.
One way investors make money is through capital gains.
24. Principal
The principal is the amount of money that you invest or borrow initially.
Interest is calculated on principal amount.
Whatever the status or idea this is significant with regards to comparing a loan or savings account.
25. Financial Literacy
Financial literacy is an understanding of how money works.
It includes skills such as:
- Budgeting
- Saving
- Investing
- Managing debt
- Planning for retirement
Good financial literacy supports people in making better financial decisions.
How to learn more about your money?
This is just the basic to learn finance terminology.
Ways to Maximize Your Money Knowledge:
- Reading personal finance books
- Following trusted financial websites
- Practicing budgeting
- Tracking your expenses
- Starting small investments
This can also involve asking questions if something does not make sense. It is much easier to develop positive money habits through ongoing education.
Common Mistakes Beginners Make
Know the common financial mistakes people make and how to avoid them.
Some of these include:
- Costing more than what they make
- Ignoring savings
- Carrying high interest debt
- Investing without research
- Not creating a budget
- Not starting to invest sooner
This means that you are less likely to make those mistakes, which can derail your making a sound financial future.
ALSO READ: How to invest on a small budget?
Final Thoughts
One of the best self investment I think You could make, is to have at least basic understanding of money terms!
These words are everywhere: bank accounts, loan applications, investment platforms, budgeting tools.
Once you know what they mean, it makes managing your money a whole lot easier.
You don’t have to become an expert – financially – overnight. Take it one concept at a time and use it in your own daily life.
The more you know the more confident you will be. The small improvements you start making today, can lead to smarter financial decisions and more financial freedom in the future.