The Basics of Finance Everyone Must Know

basics of finance

Students during their teenage or young adult phase, barely know anything about managing their personal finances. Poor financial planning can lead to a financial crisis like debt, bankruptcy in the future. We don’t understand that our financial behavior will affect our personal well-being. Hence, every individual should have an idea about the basics of finance.

As the term suggests, finance is the activity associated with capital markets, money, investments, credit, leverage, and banking. It is the core of everything today and helps an individual/organization make better decisions with their hard-earned money. 

Since childhood, we’re always taught to score well in exams for increasing our chances of landing up a high paying job. The issue here is that we’re never taught how to manage our finances. Financial management helps the individual/organization figure out how much to spend, when to spend and where to spend. It basically means taking control of your cash flow. Personal financing includes managing your money, investing, budgeting, mortgages, insurances, etc. It includes everything from having enough money for paying your electricity bills to plan for your retirement.

basics of finance
Image/Graphic: Gourishankar / ManipalBlog

 Here are some basics of finance, along with some reasons as to why you need to manage your cash.

Time Value of money/Inflation 

A rupee in the present is worth more than a rupee in the future because of the economic realities of interest rates and inflation. Inflation is the general increase in the price of products and services. This means that the same amount of money can buy fewer goods in the future. And the later the fund is received, the less value it holds.

Insurance

This is something we all have been watching advertisements and are advised quite often to do. Insurance, in simple terms, can be understood as paying small premiums to an insurance company. The company, in turn, pays for any untoward happening. It softens the blow of financial damage. It is not an unnecessary expense and is an inevitable part of financial planning.

The most common type of insurances are:

  • Life insurance
  • Health insurance 
  • Property or Business Insurance

Liquidity 

It refers to your ability to buy and sell or the amount of money you have with you for investments and expenditure. It includes cash, bonds, liquid funds, commodities, or any other assets sold immediately.

Emergency Fund 

It is a financial safety net for unexpected events that can be expensive. It can be an unforeseen medical expense or temporary loss of income, etc. It is designed to cover substantial financial shortfalls. 

Interest 

It is a fee or cost of borrowing someone else’s money, which the borrower pays the lender. It works both ways for you, and there are a few things you need to keep in mind. 

When you lend your assets (be it Cash, Property, Equity), you get the returns. In cases where your interests get added to the principal amount, you will witness the power of compounding. Those return % might not look much different in figures, but with time they make a huge difference. Therefore, one needs to choose wisely when they’re planning to invest.                      

One should compare the interest rates and prepayment policies for loans. Meanwhile, there must be a plan to settle loans with higher interest rates as soon as possible. It is always inadvisable to be on the other side of compounding.

Net worth and retirement planning 

Networth is the value of assets one owns minus the amount they owe. Your financial condition is good if your net worth is into positives. The best time to start your retirement planning is in your twenties because you have time on your side. As you have more time for investing money and doubling or tripling your savings.

Asset class and allocation 

An asset class is the category of investment with specific return and risk characteristics. And the technique of allocating money across asset classes is called asset allocation. 

For instance,

  • Fixed income instrument – At maturity, the capital is returned to the investor. E.g., Fixed deposits, Bonds issued by the Government of Bharat, Corporates, or Government related agencies. (Good option if you would like to guard your principal amount) 
  • Equity – It refers to buying shares of publicly listed organizations/companies. There’s no capital guarantee, but the returns of the investment can be incredibly rewarding (higher the risk, higher the returns). The shares are traded on both the Bombay stock Exchange(Bombay) and the National stock exchange (Bombay).
  • Real Estate – It includes buying and selling non-commercial and commercial land (apartments, buildings). Sources of income from real estate include renting apartments too. Liquidity becomes an issue here because you can’t buy or sell whenever you want. It requires a lot of paperwork, as well.
  • Commodities (precious metals) – It includes investing in precious metals like gold and silver. One can invest in jewelry or exchange-traded funds.

Bull and Bear market

When the price of shares in the market is increasing, it is called a bull market. It means unemployment is low, and the odds are economy is in a good state (Though it is not a fact. Stock market can perform well when the economy is low and vice versa). A bear market is an exact inverse of a bull. The unemployment levels rise, share prices increase. The usual causes of the bear market are investor fear and uncertainty.

Risk tolerance 

 It is the number of market ups and downs an investor can tolerate or the measure of how much of a loss they are willing to withstand. When it comes to investing, reward and risk go hand in hand. An aggressive investor accepts market drops to pursue long-term profits and is always willing to risk losing money to get better results. A conservative investor has relatively low-risk tolerance. A few factors like your age, your future earning potential, the assets you have, your family status, job, etc., determine your risk tolerance. The older you are, the lesser you’d be interested in taking financial risks.

 

About the Author: Ishita Jha is a second-year media and communications student at MIC, Manipal. She wants to pursue journalism as a career.

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