Like with tech speak, financial terminology can seem like a whole lot of alien-sounding terms and acronyms that can easily deter regular folks from learning more. But there are some essential terms that everyone should know when it comes to their money.
To help you be more savvy about your finances, this is a financial glossary that explains key concepts that you might have glossed over before.
1. Net worth
Net worth is the most important measurement of your wealth. It is basically the difference between what you own and what you owe, the difference between your assets (investments and savings) and your liabilities (debts).
To calculate your net worth, add up all the money, savings and investments you have (if you are a home- or car-owner, include also the current market value of your house and car).
Next, deduct all your debt, such as credit card and mortgage balances, as well as any other obligations or loans.
The resulting figure is how much you’re worth monetarily. By knowing your net worth, you will have a more realistic view of how much you actually own. It’s more accurate than just looking at your income, because if you have a lot of debt, you might still be in a poor financial situation even if you earn a six-figure income.
2. Compound interest
Compound interest is the interest earned from the money you have deposited, or the money you have borrowed. It is one of the most powerful forces in the financial world. It can cause your money to grow quickly, but can also bury you under debt quickly.
When you are saving or investing, you earn compound interest from the amount you deposited and any interest you have accumulated over time.
When you are borrowing, you are also charged compound interest based on the original amount you were loaned and the interest your outstanding balance has accumulated over time.
3. Asset allocation
Asset allocation basically means where you choose to put your money.
There are three major asset classes: bonds, stocks and cash or cash equivalents. Each of them have different reactions to conditions in the economy and the market.
You can decide how much you want to put in each class by choosing the ones that align best with your risk profile (i.e. your ability and willingness to take risks in investment) and financial goals, taking into consideration the time horizon. For instance, investing in stocks might give you robust growth over time, but they also tend to be pretty volatile.
One of the most common and prudent advice when it comes to investment is diversifying your portfolio, i.e. putting your money in several places to reduce your risk even as you achieve your financial goals.
The phrase “don’t put all your eggs in one basket” is exactly what diversification is about. When investing your hard-earned money, you want to place it in several different areas to lower your risk. For example, you don’t want to invest all your money in the property market or tech companies only to lose everything when the property bubble bursts again or if there’s another dot com crash. Diversifying your investments and allocating them in the right and most promising places can help strike a safe balance between your risk and rewards.
Simply put, a bond functions as an I.O.U. between lender (i.e. investors like you and me) and borrower (usually a corporation or government) that includes details of the loan (the maturity date at which the bond-owner can redeem the bond) and the terms of payments (variable or fixed interests made by the borrower). Bonds are typically used by governments and companies to fund projects and operations.
When you buy a bond, you (the creditor) are essentially lending money, with fixed interest. Interest can be paid every six or twelve months until they mature, usually after a 10 to 30-year term. Bonds are considered safe investments because of their lower risk, compared to stocks.
Think of a stock as a bite of the pie that is a private or public company. When you buy a stock, you hold a share of ownership in the company. Unlike exchange-traded funds (ETFs), stocks are tied to one specific company so when the company performs well, your stock investment reaps rewards. But when it performs poorly, so does your investment.
Like a stock, exchange-traded funds are traded on the stock exchange. Unlike a stock, however, an ETF tracks a basket of various commodities, bonds and other securities instead of one particular company. For this reason, ETFs are lower in risk as the investment is more diversified than a stock.
8. Capital gains and losses
A capital gain is what you earn when you sell something for more than what you spent to acquire it. Conversely, a capital loss is when you sell something for less than the original purchase price.
IRAS taxes capital gains but allows you to carry forward capital losses on your taxes. Such profits and losses are usually for investments such as bonds and stocks, but can also include property such as real estate, or even art and jewellery.
When you own a share of the company, this is what you can look forward to. A dividend is a portion of a company’s profits that the company pays out to its shareholders, usually every quarter. Dividends are considered regular income subject to taxation, but you can also reinvest the earnings by buying more shares. Different investments are taxed differently (for instance, income from rental property typically gets taxed at higher than ordinary rates), so it’s best to understand how different investments are taxed in order to retain more of your money.
10. Bull and bear market
Because a bull thrusts its horns upwards and a bear swipes its paws downwards, a bull market refers to the condition of the financial market where prices are rising or expected to rise, while the bear market is when prices are falling or are forecasted to fall.
The terms bull market and bear market are often used to describe the stock market but can also be applied to bonds, commodities, currencies, real estate, and anything else that is traded.
Both types of markets can last for months or years, so the terms are used to describe the trend over an extended period.