Finance

Financial Concepts That Everyone Should Know

Schools don’t usually teach finance as part of the regular curriculum. But after we graduate, we will begin taking on economic responsibilities that can have life-long consequences, both positive and negative. Here are some of the most important concepts to know as early on as possible.

Inflation

Inflation is the devaluing of currency. It is caused when there is too much money in an economy, thus forcing the worth of each dollar downwards. Simply put: each year, our money usually becomes a little bit less valuable. That means the products we purchase usually get more expensive.

For example, you have probably noticed that a simple can of soda has increased in price over the years. Two decades ago it may have cost $1, but today it might be $1.25. That’s one instance of the effects of inflation.

However, note that inflation is not always negative. Many economists regard it as a sign of economic growth. Instead of stopping it altogether, they want to temper it. As such, policy makers like central banks will often aim to keep the annual rate of inflation at around 2% or 3%.

The opposite of inflation is deflation, where prices decline continually. That, too, can be destructive to an economy.

Investing

Investing is the practice of earning a financial return on money. It is especially important in light of the effects of inflation. If our currency depreciates by, say, 2% a year, that means we must earn an annual return on investment of 2% just to preserve our capital.

There are various forms of investments. The most common ones are stocks, mutual funds and real estate. Each asset class has its own pros and cons and can perform differently depending on the economy. Further, there are also sub-classes within each asset. For example, there are financial stocks (banks, insurance companies, etc.), energy stocks (oil, gas, solar companies, etc.), infrastructure stocks and dozens of others.

The Cost of Borrowing Money

People usually associate interest rates with loans. But there are additional fees that a lender can charge which can make the loan more expensive. Therefore, it is crucial to understand the cost of borrowing, which is the total amount you will pay for a loan. Alexis Assadi, an executive in Canada’s mortgage banking industry, has pointed out in various articles online expenses like origination fees, application fees, late fees, processing fees and legal fees that borrowers should consider.

Credit Scores

Credit scores are ratings of people’s abilities to repay their debts. They are used by most lenders as a method of determining whether they should give you a loan, how risky of a borrower you are and how much they should charge you for their capital. The higher your rating is, the better chance you will have of getting a low-interest loan. For most people, borrowing money is a fact of life. We use credit cards, mortgages, lines of credit and term loans. Therefore, it is important to strive to maintain a good credit score.

Credit scores are impacted by several factors. They include how much debt you have, how much debt you have in relation to how much you can qualify for and whether you ever default on your debts. A person’s credit score can plummet, for example, if they receive a court judgement for failing to repay their debts.

Insurance

Insurance is a product that is designed to help to offset the consequences of risks, like death, motor vehicle accidents, sickness, disability and more. In general, you pay the insurance company a monthly sum (known as a “premium”) in exchange for coverage in the event of the risk coming to fruition. For example, you might pay $50 a month in order for an insurance company to pay your child $500,000 in the event of your unexpected death. That way, your child will have a financial buffer in the event of your passing.

Ironically, you should consider insurance when you need it the least. That’s when you are likely to be of the lowest risk to an insurer. For instance, it will be more expensive to qualify for health insurance if you are already unhealthy. The insurance company will have a greater chance of paying a large sum, so it will probably charge you a higher monthly premium.

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