Understanding personal finances is a crucial to any person and the earlier we learn the better. Being fully aware of finances and how to deal with them by the age of thirty can save many years of financial hurt. To help, we’ve put together five of the most important money concepts to understand before reaching your 30s:
1. NET WORTH
Net worth provides and indication of a persons current economic position. It is a way to measure financial health by calculating the assets a person owns minus their liabilities. A positive Net Worth is the aim and shows that more is owned than owed. A negative Net Worth would mean that more is owed than owned, but is not necessarily a bad thing. For example, money may have been borrowed to fund an investment such as a business or property. This investment could then be expected to grow in value thus overturning a persons negative Net Worth into a positive Net Worth.
In our list of important money concepts, Inflation is next. Inflation is the measure of the change in the price of goods and services over a period of time. Inflation can be positive or negative. Positive inflation (prices rising) will result in an increase in expenditure. If income levels remains the same less money will be leftover to spend. Negative inflation or deflation (prices falling) sounds like a good thing but isn’t necessarily. If prices fall, companies selling products and services may receive less income and in turn be unable to pay their staff as much.
Liquidity is how convenient a persons money is to access. Cash is the most liquid form of money. Property or retirement accounts are less liquid because it is more difficult to release the value from them.
Liquidity must be carefully managed so that when there is a need for money, it can be accessed. If a large expense is expected and the cash is not readily available there are 2 options. Either a loan would need to be arranged or an asset would need to be accessed. For example, some savings accounts requires 60 days notice to access the funds. If an expense was expected, the notice should be given to the account to access the funds in time.
Interest is one of the most important money concepts. By general definition, is the cost of borrowing money or the income of lending money. It is usually expressed as a percentage annual rate of which the lender party must pay at a previously agreed cycle (monthly or yearly). Interest is normally calculated in 2 main ways, simple interest and compound interest.
Simple interest is not a common form of interest, however there are some who use this practice, typically short-term lenders. Simple interest is calculated based on the original amount lent and does not take into consideration compounding interest paid on the original loan.
If £10,000 was borrowed with a simple annual interest rate of 10%, the interest over a year would be £1,000. This would result in a total of £11,000 to be repaid after 1 year had elapsed.
5. COMPOUND INTEREST
Compound interest is a more commonly used form of interest. With compound interest the interest paid is taken into consideration when calculating the total interest at the end of each paying cycle.
This results in the total cumulative interest to build up significantly faster resulting in a higher general interest amount at the end of the loaning contract.
If £10,000 was placed into a savings account with an annual compound interest rate of 10% (if you find this account, let us know!), the results would be as follows:
In the 1st year received interest would be £1,000 (10% of £10,000).
Year 2 would result in interest of £1,100 (10% of £10,000 + £1,000).
In the 3rd year, interest of £1,210 (10% of £10,000 + £1,000 + £1,100) would be received.
There are many other important money concepts that should be understood. These are just a few of the most important. What other concepts do you think should be known by the age of 30? Let us know in the comments below.