Increase Your Financial Knowledge

Below is a list of basic financial concepts to help you advance your financial understanding.

Net worth
How much are you actually worth? This can be determined by calculating the total value of all the assets you own e.g. property, cash, shares, jewellery etc and the subtracting the amount of money you owe (liabilities) e.g. personal loans, mortgages, credit card debt etc. Your net worth may be positive or negative, however a positive net worth indicates that you are in good financial health.

Liquidity
Liquidity refers to how easy it would be for you to convert your assets into cash. Shares can easily be sold, but it may take time to sell property. Things like jewellery and personal items can be sold fairly easily, but you may get back far less than they are worth, depending upon your circumstances and the means by which you are selling them. Cash itself is the most liquid of all assets.

Simple Interest
Sometimes you may enter an arrangement where you agree to pay a fixed amount of interest on the original amount of money borrowed (only), for the time of the loan.

For example, when buying a car for $30,000 you may choose to obtain a loan which you agree to pay back in full in five years. As the reward for lending you this money, the lender e.g. bank or credit union, may charge you a flat interest rate of 5% per year i.e. $1,500. This means that by the end of the five years you will have paid a total amount of $7,500 ($1500 x 5) simple interest on top of the $30,000 you originally borrowed.

Compound Interest
Compound interest is calculated on the original amount of a loan plus any accumulated interest. It is also known as interest on interest.

Using this method,  the accrued interest for a specific period is added to the original loan amount to calculate the interest for the subsequent period. You can choose to compound the interest monthly, quarterly, or annually, depending on the agreement. 

For example, if you have $1000 in a savings account with a financial institution and as a reward for having access to your money they agree to pay you 5% in interest each year, then assuming you don’t withdraw any of the funds, at the end of the first year your balance will be $1,050 ($1,000 + $50 = $1,050), at the end of the second year $1,102.50 ($1,050 + $52.50 = $1,102.50) and at the end of the third year $1,157.25 ($1,102.5 + $55.13 = $1,157.63). 

Superannuation accounts attract compound interest as do most housing loans.

Credit
Credit refers to the ability to purchase goods and services or borrow money and to pay now, generally with interest e.g. loans, mortgages and lines of credit e.g. credit cards.

Inflation
Inflation is a very important concept to understand as it is talked about a lot in the media and by politicians and can have a big impact on your ability to meet your financial goals. Basically, as the cost of goods and services rises (due to inflation), your ability to afford the same item decreases. Without an increase in your wages (or welfare benefits) equivalent to the rate of inflation, you are literally going back financially. In a nutshell, you can no longer buy the same amount of goods for the same amount money!

A more comprehensive glossary of financial concepts and terms can be found at: https://moneysmart.gov.au/glossary