Common personal finance terms (I)

IN the next two articles, we will try to explain some common personal finance terms using little or no technical jargon, so we can get a clearer understanding of them and be better positioned to learn from articles and discussions on wealth management.

Financial Planning — The process of deliberately controlling and channeling one’s financial resources to meet life’s events and goals and to improve one’s living standards. Financial planning gets one prepared for life’s events by creating options and pathways to adequately prepare for these events financially.

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Personal budget – also known as spending plan, is a financial plan that allocates portions of one’s income to various expenses. Usually prepared for monthly income since most people earn salaries every month. But it is advised that we have budgets for every income, if for instance you’re expecting an annual allowance, it is best to budget it before receiving it. Budgets help to guide our spending in line with our financial goals.

Financial goals – goals that have a financial element. In some cases, they are the financial considerations attached to life events like weddings or home ownership. Like all goals, they must be SMART (specific, measurable, achievable, realistic and time-bound) so that progress towards their achievement can be effectively monitored.

PFM App – A personal finance management application is a software that one installs on a cellphone or other compatibledevices. It helps you to manage your finances by assisting in the creation of budgets and goals, alerting you when bills are due, giving investment advice, monitoring your compliance with your budget and evaluating your progress towards achieving your financial goals.

Disposable Income – This is the part of your salary that is left for you to spend after you have paid personal income taxes, retirement savings contributions and other statutory deductions and commitments. This is what determines how much you have to spend for upkeep, housing, leisure and ultimately investments.

Asset – Something that has potential or actual economic/ commercial value, something that creates value. An income-generating property that creates investment income for an investor e.g. rental houses, taxis or company shares.

Liability – a property that creates expenses that one is obligated to pay; like credit card debt or utility bills.

NetWorth – the net monetary value of a person’s wealth after the addition of all assets and the deduction of all liabilities. This is what is the Forbes’ List of the World’s Richest measures in determining who goes in which position in the list.

Money Market – accessed mainly through banks, this is the market where debt instruments like fixed deposits, FGN treasury bills etc. are traded. They are called debt instruments because only cash is traded; there is no underlying asset like shares, real estate or commodities. We give our money to the bank, and the bank pays us for using the money. They ultimately return the money to us without converting it to another asset class. Examples include savings accounts fixed deposits, treasury bills, commercial papers and banker’s acceptances.

Equities – accessed through stockbrokers, equities are ownership units in companies. The total worth of each company is divided into small units (shares), these shares are then sold to individuals who become part owners (shareholders) of the company to the tune of the number of units they hold.

Investment Portfolio – This is the collection of all the investment assets belonging to an individual. A good portfolio is sufficiently diversified to include different classes of assets like money market, public and private equities, real estate, commodities etc. The diversification of each person’s portfolio varies depending on the investor’s age, time horizon, risk appetite and investment objectives. Diversification reduces concentration risk by reducing over exposure to any one asset class.

Compound Interest – This is interest earned on interest. If you put a sum in fixed deposit for a period and at the end of that period you do not collect your interest but ask the bank to roll it over, in the second period, interest would be paid both on the initial sum and the interest earned in period one. This is compound interest. It works in the same way for loans. If you take a loan and do not pay the interest monthly, you end up paying interest both on the principal loan and the accrued interest.