The urge for financial literacy has never been more tremendous. We make financial decisions every day. So many individuals struggle with managing their finances, paying interest, or investing in the stock market. They find it challenging to develop a retirement plan or fulfill any other financial goal. The problem here is a lack of understanding of financial literacy concepts, leading to unwise investments, poor loans, and wasteful spending. It can put people at the risk of falling into a debt trap and an unstable financial life. People are unprepared for a financial disaster, such as the coronavirus pandemic or a recession. This issue can be attributed to a lack of financial literacy. Rather than focusing only on the return we get, we need to improve our awareness of the topics to understand their logic.
What is financial literacy?
Financial literacy is a comprehensive approach to economic, credit, and debt management. Financial literacy concepts cover how credit works, monitoring account balances, and staying out of debt. A person with good financial literacy can understand complex financial events happening in the market.
It’s important to realize that this understanding influences people’s personal and professional lives. The right financial decisions can make our aspirations a reality. Consumers can handle financial risks more successfully if they have a firm grasp of financial literacy concepts.
Why is financial literacy important?
Being financially smart can make your life so much easier. A financially savvy person can make effective decisions. Even if you believe you are good at finance, you need to keep your knowledge base growing. Learning financial concepts every day can keep you abreast. This is the differentiating factor between the wealthy and ordinary people. Nobody could have more financial knowledge than you if you devote your heart and mind to increasing your savings. It extends beyond whatever academic education you may have received. You must learn to teach and make an investment in yourself. In this manner, you educate yourself on how to increase your money.
Basic financial concepts that everyone must know
This article will cover the basic financial literacy concepts you need to know.
- Inflation- Inflation, in simple terms, refers to the price increase of all goods and the decrease of our purchasing power. Rising inflation can increase the cost of living. Inflation happens when the supply does not match the high demand or when the cost of labor or materials goes up. It can also occur when a currency is devalued. An inflation rate of 2% is considered normal. It indicates an economy that is growing and healthy. Anything beyond that is not suitable for the country.
- Liquidity- It refers to how simple or difficult it is to convert an asset or security into cash. A more liquid asset can be swiftly converted into money for a more significant portion of its value. When making investing decisions, it’s critical to consider liquidity to ensure that you’ve covered both long-term and short-term demands. No matter how much you invest in illiquid assets, you must set aside a part of your funds for quick access. This helps to ensure that the value of your money does not change as a result of any conversions.
- Networth- The sum of your assets and loans at any given time is your net worth. When calculating your net worth, you consider all of your help, less any debts you may have. Positive net worth shows that your assets exceed your liabilities, indicating that you’re well on your way to accumulating riches. A negative net worth suggests that you need to improve some aspects of your financial life. A person’s objective should be to see it improve and evolve.
- Risk tolerance- It is an investor’s capacity to bear losses comfortably, and it varies significantly from person to person. You must pick where you put your funds based on your risk tolerance. Debt instruments and government bonds are low-risk investments. Investing in ownership of the company (Equity) has a high level of risk. Determining your financial objectives will assist you in deciding how much time you have to build your money. Based on that, you can choose how much risk you can accept with the assets you select. It would be best to consider what you’re saving for when you plan to take part or all of the funds and how long you’ll use them.
- Asset allocation- Asset allocation is the process of distributing your money amongst various assets such as stocks, bonds, and cash. The decision to allocate assets is subjective. The optimum asset allocation changes over time, based on how long you have to invest and the risk you are willing to bear. Investors can protect themselves against severe losses by adding various asset categories to their portfolio. Market changes that lead one asset type to perform well may result in bad returns for another asset type. You may decrease the danger of losing money by investing in many asset types. Your portfolio’s overall investment returns will be average. Suppose the investment return on one asset type reduces. In that case, you can offset your losses in that asset type with higher investment returns on another asset type.
- Diversification- Diversification is a technique for reducing the risk of an investment. It is based on the principle of “Don’t put all your eggs in the same basket.” In this method, the investment is made in various asset classes that are not related. Diversification goes beyond the usual asset types seen in most investment accounts. Because investment accounts are exposed to market fluctuations, returns cannot be guaranteed. Pensions, annuities, and insurance products, on the other hand, can provide assured income streams and returns. Investors frequently diversify their portfolios to lessen the risk by investing in a variety of products. Investing in unrelated asset classes can reduce the portfolio’s risk and volatility.