People who have very little understanding of financial literacy are susceptible to making poor financial decisions. And poor financial decisions may lead to a lack of savings, poor investments, and in worse cases, bankruptcy. This is because financial literacy helps people make sound financial decisions and better manage their wealth. To read more about the importance of financial literacy, click here.
Financial planning is long term. Even if one day you happen to win a lottery, with poor financial literacy, you may find it difficult to retain and grow your wealth. To help you improve your financial literacy, here are some financial terms that you must know and understand.
1) Asset allocation
Asset allocation is an investment portfolio strategy that is used to balance risks. This is done by dividing assets across different categories that offer different levels of returns such as stocks, real estate, bonds, and cash. In an investment, one category may increase in value while the other does not. To protect yourself against a major financial loss, you should never put all your eggs in one basket.
2) Annuity
An annuity is a financial instrument that is typically offered through an insurance company. Annuities help to save your money until you are ready to receive retirement income by guaranteeing a certain payout, either in increments or a lump sum payment.
3) Internal Rate of Returns (IRR)
IRR is used to estimate the profitability of certain investments. The higher the internal rate of return, the more attractive the investment will be. IRR can be used to rank multiple investment options using similar characteristics to determine the best investment option.
4) Capital gain
Capital gain is an increase in the capital asset’s value. It is generally associated with stocks and funds, but it can also be realised when an asset is sold for a price higher than the purchase price.
5) Cash flow
Cash flow is the movement of money coming in as income and going out as expenses. A cash flow statement (CFS) is a financial statement that summarises the total amount of cash entering and leaving the company—it is a measure of true inflows and outflows, therefore, it cannot be manipulated. Cash flow is also used to measure how well a company manages its finances.
6) Portfolio rebalancing
Portfolio rebalancing is a process used by investors to restore their portfolio to its target allocation. This is usually done when investors want to establish better risk control over their investment portfolio and want to ensure that their portfolio is not too dependent on a single investment option. Rebalancing can be done by buying and selling assets to ensure the proportion of assets are in line with the preferred amount of risk or by divesting in underperforming assets and investing in the assets that have the potential to grow.
7) Total Debt Servicing Ratio (TDSR)
TSDR was introduced in Singapore in 2013 to ensure that individuals stay out of debt by borrowing responsibly. It refers to the portion of a borrower’s gross monthly income that goes into repaying their debt and loans. A borrower’s TDSR should be less than or equal to 60% of the total amount. This is commonly used to assess housing loans, refinancing, and loans secured by the property.
8) Diversification
Diversification is a process of investing in multiple investment vehicles and asset classes. Similar to the idea of not putting all your eggs in one basket, diversification is less risky as it means your portfolio will not go downhill if one investment option loses its value. This technique is used to maximise returns by investing in different areas offering different returns.
9) Equity
Equity is defined as your ownership of an asset after you have accounted for the debt you owe on it. An example would be when you bought a house with a mortgage, your equity is the home’s value minus your outstanding loan balance.
10) Decentralised Finance (DeFi)
DeFi is used to define several financial applications in cryptocurrency or blockchain. It is an anonymous system that completes traditional financial transactions without any interference from an intermediary or governing body. DeFi uses an application through blockchain technology to connect users directly.
While you may not be familiar with all of the financial terms mentioned above, it is highly beneficial for you to understand them. Equipping yourself with knowledge of finances and money management can greatly help you make sound financial decisions, reach your financial goals, and grow your wealth. If you need a more detailed explanation of these terms or would love to get started with financial planning, get in touch with our team at KWO now!