Test Your Financial IQ: Your Guide to Financial Literacy
A recent global financial literacy study by Standard and Poor’s reveals that only 57 percent of US adults are financially literate. Since April is Financial Literacy Month, we put together a word list to help you become more familiar with common financial terms and test your financial IQ. Having a better understanding of the jargon from the financial world is a step towards greater financial literacy.
Financial Literacy Glossary
Diversification — A strategy to minimize the risk of loss. Diversification spreads investments over various assets with varied risk potential.
Dividend — Cash payments from equities owned; cash earned by a company paid out to shareholders.
Some stocks will pay out high dividends because they have a lot of cash flow and they return a portion of that cash to shareholders. Other companies will use their cash flow to fund the business’s operations and don’t pay a dividend to shareholders. A company’s dividend policy is based on the cash flow needs of the business and how much cash that they earn.
Emergency fund — Money set aside for unexpected expenses like large medical bills or job loss. An emergency fund can act as is a buffer tohat protects against accruing debt.
Equity — A type of investment, another term for stocks or ownership. Owning stock gives a person equity, which makes them a part-owner of that business. Returns from this investment vehicle are unpredictable.
Financial planning — The study of putting all aspects of someone’s financial life together and coming up with a concrete direction or goal. This covers everything from asset allocation to how much is being saved to reach specific financial milestones: i.e., retirement, college education.
Fixed income — A type of investment that comes from lending rather than ownership, where a stated return or interest rate is received for a certain period of time. The returns from this type of investment are designed to be relatively stable.
A balance of equity and fixed income in a portfolio is important. The key differentiator for anyone is how much of their assets should be in either equity or fixed income, which varies based on individual goals and risk tolerance.
Interest — The percentage of a loan that lenders charge borrowers. Interest is broadly divided into compound and simple interest. Compound interest is based on the loan principal and accumulated interest over a certain time period. Simple interest is calculated solely by using the initial borrowed amount.
Liquidity — Refers to how quickly the money an investment represents can be turned into cash. Having a certain amount of liquidity is necessary because emergencies happen, and having a fund or cash cushion to pay for those things is important. All assets have varying degrees of liquidity.
The most liquid asset is cash, or what is in a checking and savings account. Equities are also fairly liquid; selling a stock is typically easy. Although it might not be the most appropriate time, if you need the money, you can usually get it. Fixed income tends to be less liquid because they aren’t as easy to sell.
Net worth — The total value of assets owned, less any outstanding liabilities; what is owed subtracted from what is owned. It’s a measuring tool to determine if you’re on track with financial objectives.
If you have any liabilities (a car loan, mortgage, credit card debt), you subtract that from any real assets owned (money in the bank, investments, house, car), which equals net worth. If you plan to retire at a certain age, you need your net worth to be high enough so you can draw upon the assets during retirement.
Pay yourself first (PYF) — A strategy prioritizing saving, making it an essential budget item. An amount of income is deposited into a savings account monthly. Saving is treated as an essential monthly cost, like rent and food. Once needed expenses are covered, leisure purchases can occur.
Principal —The original amount invested or the current value of a portfolio.
People, mostly in retirement, want to ensure principal stays where it is and doesn’t change. They then want to live off the earnings of their portfolio. If principal goes down, then they have less assets to draw from. For people that are not yet retired, their goal is to keep adding money to their portfolio to see the principal increase.
Risk tolerance — How much portfolio volatility someone can withstand; how much of a loss someone can accept in their portfolio.
People withstand more fluctuations within their portfolio. If someone has a low risk tolerance, they want a more stable portfolio with less price volatility. The key is trying to determine someone’s risk tolerance and matching that with a portfolio that will guide them to their goal.
Time value of money — A dollar today is worth more than a dollar tomorrow, or a year from now. The key here is keeping up with inflation. Inflation has caused prices to go up over time.
If you want a dollar to be worth as much a year from now as it is today, you need to get some sort of return on that dollar. If you get a return, then that dollar will be worth more in the future. If you get no return, it will be worth less in the future. That’s why we recommend being invested in equities. They are the only asset class that has historically demonstrated success in keeping pace with inflation.
Total return — The amount an investment increases in cash received in both price appreciation and any interest or dividends from an investment.
Some investors look for high dividend-paying stocks to get cash. Some are less concerned with that, so total return becomes important. Investors unlock the return of equities that don’t pay a dividend by selling shares to get a return from price appreciation. If someone invests $10,000 and $1,000 is earned in dividends, and the value goes from $10,000 to $12,000, the total return on investment would be $3,000, or 30 percent.
How Financial IQ Is Important in Our Life
Your financial IQ impacts essential decisions you make about money. It affects how you invest, save, earn, and spend. By investing time in understanding financial terms, you can achieve your money goals at every life stage.
Financial intelligence is vital to your success. It helps you:
- Manage wealth: Your financial IQ teaches you to track money and cash flow. You can identify patterns and know where to cut, modify or lessen spending, increasing wealth.
- Control money: Successful people control money effectively by growing their financial intelligence. Your relationship with money relates to your success.
- Grow knowledge: As your financial IQ grows, so do your knowledge and willingness to learn.
Learn About Fort Pitt’s Financial Advisory Services
Most people need access to sound financial advice. Fort Pitt Capital Group has solutions to help you reach your financial goals. We keep things straightforward — no charts, industry terms or complicated documents. Get reliable information and financial advice to achieve your goals and increase your knowledge.
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