I’m sure that at least at some point in your life, you’ve been part of a conversation involving finance and found yourself drifting off into dreamland. I would face this quite often when I was much younger and my dad would turn on some financial news channel. This happens because of the seemingly complex terms people use. Today, I want to discuss ten such essential financial concepts with you.
These are terms that you absolutely must know because they’ll help you understand this magical world of numbers a whole lot better. I haven’t ranked them in any particular order, they’re all equally essential. So here goes.
1. Net Worth
What do we know Bill Gates for, apart from Microsoft, of course? For the longest time, Gates has been the richest man in the world. It was only in 2017 that Jeff Bezos overtook him. What is the measure of this richness? – Net Worth.In simple terms, net worth is the calculation of all your assets minus all your liabilities.
So let’s say you own a laptop, have some fixed deposits with a bank and you also have a student loan. The value of the laptop plus the value of the FDs gives you your total assets. When you subtract the outstanding amount of loan from this, you get your Net Worth. This concept is vital to understand in order to know how healthy your financial life is.
2. Inflation
Although this is a vast subject that’ll require a whole article to cover, let’s understand what it truly means.Inflation is the lowering of your currency’s spending power per unit. Simply put, ten years ago you could buy a dozen mangoes for ₹60, but today the same variety of mangoes will cost you ₹160.
Here’s a fun fact: Dangal is the highest grossing Indian movie off all time at ₹2397 crores. However, adjusted for inflation, the all time highest grossing Indian movie is Sholay at ₹3414 crores (source: IMDb).
3. Liquidity
In the broad sense, ‘Liquidity’ means having the financial ability to quickly pay for or buy commodities or assets. For instance, when you want to buy groceries, you will use cash or your card to pay for them and not barter your car for it. The best forms of liquid assets can be cash, savings account balance, liquid mutual funds, fixed deposits (to a certain extent) and sovereign gold bonds.
4. Bull Market & Bear Market
You might have come across this line in newspapers, “The markets are bullish today.” Or, “The market is having a bear day today.” It only pertains to whether the stock markets are up (bull) or down (bear).
An easy way to remember which is which is, think of what would happen if a bull came charging at you. He’d probably lift you up by the horns. And what would happen if a bear came charging at you? He’d probably pounce on you to take you down. Neither of these will likely happen, but I hope the visual makes it easier to recall. 🙂
The market crash in February this year is an example of what a bear market looks like. The net worth of individuals and organisations, inflation, growth, all rely on the markets staying happily green.
5. Risk Appetite
How far will you go to get what you want? How far will you push the envelope to win? Based on how you answer these questions you’d be able to measure your level of risk appetite. It’s a way to measure the kind of risks an individual or company would take in the financial market.
The various levels of risk appetite are divided as Averse, Minimal, Cautious, Open and Hungry. Cersie Lannister with her line, “When you play the Game of Thrones, you win or you die.”, tells you she must be the Hungry kind on the Risk Appetite scale. So what are you? Cautious or Hungry?
6. Asset Allocation and Diversification
Consider Asset Allocation as Level 1. And Diversification as Level 2.
Asset Allocation simply means investing your funds in different types or classes of assets. Asset classes include equity, debt, real estate and gold. Art is another asset class that people invest in.
Now, let’s take a look at diversification. If you’ve invested in Debt (Asset class), you could further divide your funds into say debt mutual funds and bank fixed deposits. This is called diversifying, when you take asset allocation one level further by spreading your money even more so as to get better gains as well as higher safety. As the saying goes, “Do not put all your eggs in one basket, unless you love your eggs scrambled.”
7. Simple Interest and Compound Interest
Welcome back to 6th Standard Mathematics Class. We’ve all learnt how to calculate both simple and compound interest in school but seem to have forgotten the practical uses of it along the way.
Today, we invest in numerous investment avenues, have credit cards and pay EMIs on various loans. All of these take interest calculations into account. It could be either simple or compound interest. I’ve put down the basic difference with an example here:
Simple Interest is interest on the principal amount only.
10% on ₹100 = ₹10. Every year you earn ₹10 as interest.
Compound Interest is interest on the principal as well as previous interest.
10% on ₹100 = ₹110. Next year you earn 10% on ₹110 = ₹11.
8. GDP
Gross Domestic Product or GDP is something we’ve heard thrown around in the news from time to time. To explain, add up all the money that the nation generates through goods, services and taxes derived from various sectors like agriculture, manufacturing, IT services, even restaurants and small businesses. All that money put together is the GDP of the country.
India is the fifth largest economy in the world, with a GDP $2.94 trillion and the fastest growing economy in the world as per Forbes. This puts us ahead of traditional superpowers like the United Kingdom and France, whose GDP is $2.83 trillion and $2.71 trillion respectively. The country at the top is the United States, with a whopping $21.44 trillion GDP, almost a quarter of the global economy. Google these numbers to check out the values in Rupees.
9. Credit Score
How does a financial institution trust itself to give you money? In the past it may have been goodwill or your status in society. As time went by, financial institutions felt the need for a better measurement of a person’s financial health. Enter the credit score.
Today, even the smallest personal loans require a credit check before you are given the go ahead. It is a number assigned to you ranging between 300 to 900, 900 being the best score. The higher the number, the better your chances of getting a loan.
There are four organisations licensed by the RBI to calculate credit scores. The most popular and widely used measure is the Credit Information Bureau (India) Limited (CIBIL) score. If you wish to check your credit score, click here.
10. Equity Shares
Equity shares are basically shares that make individuals fractional owners in any organisation they invest in. You possess voting rights on decisions made for the health of the company depending on how many shares you own. The higher the percentage of shares you own, the more voting rights you have.
I’ll speak of Bill Gates again. Microsoft earned him a lot of wealth. What we might not know is that he currently only owns only 3.6% shares in the company. He’s also an investor in many other companies as well, right from UPS to Coca Cola.
That’s all from me today. The bottom line (aka profit) is that these ten concepts are no longer alien to you. Go turn on any financial news channel and see how you feel now. 🙂
If there’s any particular term or concept I haven’t covered here that you’d like to know more about, just leave a comment here.
