Being an Adult is not a simple task in life but it is definitely something you cannot avoid. Responsibilities pile on as you gain exposure to the outside world and start leading your choice of life. Managing financial responsibilities and understanding the implication of financial decisions are termed as the most difficult life lessons.
But why wait for a tragedy to strike, when you can prepare for it in advance? Here are some important money terms you must know so as to make informed financial decisions in your life.
APR is an acronym that stands for “Annual Percentage Rate”. It represents the annual cost of borrowing money. Do not confuse APR for the interest rate. Interest rates are just the interest charged on your borrowed amount. It does not include or indicate any extra costs or fees that you may incur during the loan application process.
APR can be best explained as the actual cost incurred when you borrow or apply for a loan. Fees and Interest Rate together give you the APR, which in turn gives you the actual cost of your Loan. APR is a better determinant and comparison tool when you want to see which bank loan is a better choice. The interest rates offered by banks may be similar but their APRs may differ and the lower the APR the better the deal is for you to take.
2. Compound Interest
Compound interest can be best defined as the interest you earn on the principal amount + the interest that gets accumulated. Compound interest helps you increase your investment and savings.
Whether it’s a loan or an investment – Compound interest is calculated in the same way for both instances. For example: If you deposited PKR 100 in an account in 2016 and there is a 5% Annual Compound Rate at the end of the year you would have earned PKR 105. If the compound interest remains the same, you would earn another 5% at the end of 2017 on PKR 105 and not just the principal amount of PKR 100. This means you will have PKR 110.25 by the end of two years. Similarly, compound interest on borrowed money would mean your debt could grow faster.
3. Fixed and Variable Rate
Fixed Rates are always preferred over variable interest rates for various reasons. But the foremost is the predictability of Fixed Rates over Variable Rates. A fixed rate loan means you know the amount you owe and have to pay. This can help you budget accordingly. However, in case of a variable interest rate, the rate may change over the loan repayment period making it difficult to forecast, predict or plan for. Always check on your loans and evaluate if they have fixed and/or variable components.
4. Savings Account vs Current Account
A Savings account is a bank account that helps you save money for short term or even long-term investment purposes. Sometimes a Savings account may have some limitations as to how and when you can draw your money from the account. Savings Account have some interest rates decided that give some returns on the amount available in the account.
Current Accounts however are bank accounts where you may store your money for short term like salary accounts. There are no long-term investments benefits associated with these accounts and are usually in use by the owners for immediate needs.
Risk is not just the opportunity cost or loss experienced because of investment in the stock market. In the wider sense, Risk is any loss of income you may experience because of death or disability, because of loss in investments made in business or securities and perhaps risk because of tax rate increases because of revised budgets.
Sometimes even when you invest in low risk or safe investments, the inflation rate may increase more than expected because of macro-micro economic factors and may cause you loss in purchasing power. So “risk” has to viewed, at all times with a wider lens and not just the risk pertaining to the stock market.
Bonds are often referred to as Debt Investments. When you invest in a bond, you are essentially loaning an amount of money to an organization or maybe the government for a fixed term with a fixed interest rate. This means you are entitled to receive either a periodic interest based income or the complete principal amount you loaned at the end of the fixed term.
7. Stocks (Equity)
Stocks are referred to as ownership rights or equity within a company. You become a shareholder in a company and have rights on the company’s earning and assets.
Stocks can be common or preferred and that also determines the kind of equity rights you can exercise over a company’s earnings and assets. Common stocks give you the ability to attend shareholders meeting and vote. You also have the right to receive dividends. However in case of bankruptcy, you would be the last to receive any payback. As a preferred stockholder you do not have any voting rights but you will be the first ones to receive dividends and payoffs if incase there is liquidation of the company. You can sign up with a brokerage house to invest in stocks yourself or invest in mutual funds to have a more structured way to invest in stocks.
Premium is the amount or fee you pay to an insurance company for any financial loss coverage that you may be insured for. Premiums can be paid annually, bi-annually, quarterly or even monthly.
9. Capital Gains or Losses
Any increase or decrease in the financial value of your investments or assets are often termed as Capital Gains or Capital Losses, respectively. A Capital gain is often not realized unless the property, asset or investment is liquidated. In case, there’s been a capital gain in your assets short-term or long-term then tax needs to be paid on when the asset/investment is sold. Similarly, in case of capital losses, you receive tax rebates.
10. Net Worth
Net worth gives you an overview of your financial health. It refers to the financial difference that you can calculate between your assets and liabilities. Add all your investments, financial incomes (rentals, savings accounts, bonds, stock etc.) and money available. Then add all your deductions, which may include tax, debt owed to bank on behalf of loans or credit cards etc. Subtract these deductibles from your total income and it will give you your Net Worth.
Hope this blog was helpful and we wish you good luck in journey towards financial freedom! To compare which financial products are best for you, click here!