Understanding basic money terms and concepts that affect your financial health is the first step toward financial literacy. Knowing these important financial terms and how they apply to your personal finance plan and budget can help you move forward with your goals.
Savings Terms to Know
Compound interest: You’ll essentially be earning interest on interest. When you deposit money into your financial account, such as a savings accountor a retirement account, the bank will pay you interest on your initial deposit and any interest it earned. Here’s how it works: Say you start with a deposit of $10,000 in your savings account, which has an annual interest rate of 0.2 percent. That means you’ll make $20 every year. Now, that extra $20 in your account will earn also interest. The first year, you’ll have $10,020, the second you’ll earn $20.04 in compound interest for a principal balance of $10,020.04. And it continues to grow year after year as long as you keep the money in your account.
Short-term savings: Whether you’re saving for a vacation or new appliances, a short-term savings plan will help you make those purchases without accruing nonessential debt.
Long-term savings: This type of plan focuses on saving money for your long-range goals, such as a down payment on a house, a college education or an advanced degree, a new car, or a wedding. Planning ahead of time and setting aside money each month may help minimize debt incurred from these larger expenses.
Emergency savings: This type of savings should be set aside for any unforeseen life event that could be a risk to your finances. Cecilia Bailey, Community Education Administrator with Regions Bank, recommends you have enough money in your savings account to cover living costs for six to nine months. But starting your savings with $1,000 will offset some of the more common emergencies such as car or home repair, unexpected travel, or medical expense. “An emergency is not really an emergency if you have the funds to pay for it,” says Bailey.
Retirement savings: While it can be difficult to save for something that you won’t benefit from in the near future, planning for your golden years is an important part of your long-term financial health and security. The earlier you start saving for retirement, the more value you’ll get out of every dollar you save, due to compound interest.
Credit Terms to Know
Credit: Credit is money that a bank or business allows you to use now and pay back in the future. Credit is available in many forms, including credit cards, lines of credit, personal loans, and more.
Credit score: Your credit scorecan impact your ability to get credit, the interest rate you will receive, and the credit limits you will be given. This numerical score, based on several factors, can help lenders identify certain risks based on your credit history. Your score ranges from 300 to 800+, with scores above 700 considered good credit and above 750 considered excellent credit. “You may be able to help build a good credit score by paying all of your bills on time and keeping balances on credit cards at or below 30 percent of your credit limit,” Bailey says.
Lending Terms to Know
Debt-to-income ratio: This is the sum of your monthly debt payments divided by your gross monthly income. When you’re applying for credit, this ratio gives lenders a chance to determine whether you’ll be able to manage the payments every month.
Collateral: When you apply for a loan, you may offer your lender property or money as collateral, which the lender can use to recoup its costs if you default on the loan. This type of loan is considered a secured loan, which is commonly used in home mortgages and auto loans.
Equity: Your equity in an asset is the amount of money you owe on a mortgage or loan subtracted from the value of your owned property. Most commonly, you’ll have home equity in real estate, but you may also have equity in other financial assets. You can use the equity in your house or condo as collateral for a home equity loanor line of credit.
By understanding these basic personal finance terms, you can work to build your credit score, and pay off or minimize your debt and store enough savings for a secure future.
FAQs
Liabilities = Amount a person owes, such as unpaid bills, credit card charges, personal loans, and taxes. Liquidity = The ease with which an asset can be converted to cash without serious loss. Loan sharks = Unlicensed lenders who charge illegally high interest rates.
What is the 50 30 20 rule for financial literacy? ›
Do not subtract other amounts that may be withheld or automatically deducted, like health insurance or retirement contributions. Those will become part of your budget. The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings.
What are the 3 keys to financial literacy? ›
A strong foundation of financial literacy can help support various life goals, such as saving for education or retirement, using debt responsibly, and running a business. Key aspects of financial literacy include knowing how to create a budget, plan for retirement, manage debt, and track personal spending.
What is the first rule of financial literacy? ›
1. Budget your money. In general, there are four main uses for money: spending, saving, investing and giving away. Finding the right balance among these four categories is essential, and a budget can be a very useful tool to help you accomplish this.
What is the golden rule of financial literacy? ›
Spend less than you earn
This is when 50% percent of your after-tax income goes toward needs; 30% toward wants; and 20% toward savings or debt repayment. This is a simple, excellent way to budget your money. To be clear, though, needs are bills you must pay such as mortgage/rent, car payments, and groceries.
What is the rule of 72 in financial literacy? ›
It's an easy way to calculate just how long it's going to take for your money to double. Just take the number 72 and divide it by the interest rate you hope to earn. That number gives you the approximate number of years it will take for your investment to double.
What is the 20 rule for money? ›
Budget 20% for savings
In the 50/30/20 rule, the remaining 20% of your after-tax income should go toward your savings, which is used for heftier long-term goals. You can save for things you want or need, and you might use more than one savings account.
What does the rule of 72 tell you? ›
The Rule of 72 is a calculation that estimates the number of years it takes to double your money at a specified rate of return. If, for example, your account earns 4 percent, divide 72 by 4 to get the number of years it will take for your money to double. In this case, 18 years.
What is the big three big five? ›
According to the first, there are three main factors: Extraversion, Neuroticism and Psychoticism, whereas the Big Five theory claims that five factors are needed to account for most of the variance in the field of personality: Extraversion, Neuroticism, Agreeableness, Conscientiousness and Openness to Experience.
Do 90% of millionaires make over $100,000 a year? ›
“Only 31% averaged $100,000 a year over the course of their career,” the study found, “and one-third never made six figures in any single working year of their career.” Just look at the story of former custodian Ronald Read for a perfect example.
Pay Yourself First means putting a portion of your money into a savings account before allocating the rest to your expenses. This is a crucial principle to successfully saving your money, and it can be done by including saving as an expense item in your spending plan.
What are three ways banks make money? ›
They earn interest on the securities they hold. They earn fees for customer services, such as checking accounts, financial counseling, loan servicing and the sales of other financial products (e.g., insurance and mutual funds).
What are the four main types of financial literacy? ›
Financial literacy is having a basic grasp of money matters and its four fundamental pillars: debt, budgeting, saving, and investing. It's understanding how to build wealth throughout one's life by leveraging the power of these pillars.
What are the 4 steps to financial literacy? ›
Key steps to attaining financial literacy include learning how to create a budget, track spending, pay off debt, and plan for retirement.
How do I teach basic financial literacy? ›
Start by teaching them about budgeting and managing expenses. Explain how credit works, why it's important, and how to use credit cards responsibly. Stress the importance of saving, and introduce the basic ways to invest money.
