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Basic Financial Terms Everyone Should Know

Are you interested in investing? Taking advantage of compound interest? Making your money work for you? Investing can help you reach your financial goals, but many are intimidated by the terms and complexities of what this entails. Today we’ll look at some of the most important terms, what they mean, and how understanding them helps you grow your money.
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Image by Firmbee from Pixabay

First of all, don’t think that financial jargon is beyond you. These are simply terms used to describe various aspects of budgeting, investing, and finance. Chances are you’ve heard these terms before; a deeper dive into what they mean will have you more financially savvy in no time! Ready? Let’s get started.

Net Worth

Net worth is the result of your assets minus your liabilities. Your net worth will either be a positive or negative number. To calculate your net worth, add up all your assets. This includes cash, your home’s value, investments, your vehicle’s value, trust funds, etc. For things like your mortgage, the number to use is the equity you have in the home and the market value – not the price you paid for the home. For your vehicle, use the price you could sell it for today, not the price you paid for it. You must account for the depreciation.

Now, add up your liabilities. This is money you owe to any source. Include the outstanding balance on your mortgage; loans from the bank, family, or friends; vehicle loans; credit cards; student loans; etc.

Subtract the sum of your assets from the sum of your liabilities. The answer is your net worth.

Rebalancing

Rebalancing means returning the allocation in your portfolio to a certain level.

Whether you are investing on your own or through a broker, you must do a risk assessment. This determines if you should invest in high yield, volatile options, or invest in stocks or bonds that have slow growth but more predictable outcomes. There is no right or wrong answer; it all depends on your appetite for risk.

Investments change over time. One stock may become volatile or your asset mix may organically change as the corporate structure of the companies you have invested in changes.

Rebalancing is assessing your current situation (usually done on an annual basis) and making the changes necessary to ensure you are in line with your risk tolerance, and continue to hold the desired percentage of stocks, bonds, and other investments in your portfolio.

Bonds

When you invest in stocks, you are investing in the equity held in an asset. When you purchase bonds, you are investing in the debt of an asset. Since the bond is an obligation that must be repaid, bonds are typically steady, predictable, if not slowly growing investments. Lots of people like bonds because debt has a pay back, aka maturity date. When that date arrives, full payment is required. This is what makes it such a safe investment.

You can invest in both corporate and/or government bonds. Since this is a slower growing investment, buying bonds is a long game. It’s best to hold onto them with the expectation that you will be doing so for a number of years.

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Compound Interest

When we say, “your money makes money,” this is compound interest. But be careful. This also refers to debt!

Here’s how it works. Let’s say you have an investment that is making money. The money, or interest, that you made on your initial deposit becomes part of the money that accrues even more interest. This is exactly why another term, time horizon, is so important. The longer the time horizon, the less money you have to invest upfront to get your money to grow. Your money makes money for you.

It works the same with debt – to your detriment. If you owe $100, and you incur an interest penalty on that debt, next month you owe the $100, plus the interest, plus another interest charge on the $100 and the last month’s interest. This is why high interest debt can be so difficult to escape.

Capital Gains

Capital gains are calculated after you have sold an asset. It is simply the value difference between what you paid, and what you sold it for. Capital gains are income, and that means they are taxable.

Let’s look at an example. You buy a cabin for weekend retreats. As the years go on your cabin turns out to be in a really desirable location for other weekend retreaters. More and more people buy up land in the area and soon it’s a haven for city folk escaping to the lakeside for the weekend. Now your cabin is worth three times what you paid for it, so you have a capital gain. When you sell the cabin, you are taxed on that gain.

The flip side is a capital loss. While it’s never fun to lose money on an asset, a capital loss can lower your tax burden.

To remain compliant with CRA, it is very important to keep your capital gains and losses top of mind when selling an asset.

Learn more

See? Financial jargon isn’t all that bad. Once you learn a few terms, you can invest with even more knowledge and confidence. Today’s sponsor is invested – in you! They want you to reach your financial goals and are happy to help you learn more about how, when, where, and why to invest your money. Visit our sponsor online or call today to learn more.

CPC-logoThis story was made possible by Loans Canada through our Community Partners Program. To expand your knowledge and learn more about financial terms , please check out Loan's Canada's: Make Sure You Understand These Financial Terms Before Getting a Loan. Thank you to Loans Canada for helping to expand local news coverage in Alberta. Learn more.