There are some basic financial concepts everyone needs to understand that can assist you in building a solid foundation for your financial future.
"Everyone will be in charge of their own money at some point," says Nolene Parboo, senior manager: Savings and Investments, Retail Banking at Standard Bank. "Knowing how the money matrix works is an important element of financial well-being."
Your net worth is an insightful measure of your financial health that can help you build and plan your financial future.
Basically, your net worth is the result of your total assets minus the total amount of money you owe. Your assets include cash and investments, your home (if you own it), cars or anything else of value. Liabilities are what you owe on those assets including car loans and bonds, plus loans and debt.
"Some people panic when they calculate their net worth and discover that it is very low or even in negative territory," says Parboo. "This can be as a result of having a lot of debt, which is often needed when you start out. As income increases and debt reduces, your net worth will improve."
Inflation refers to the sustained increase in the price of goods and services over time. As prices rise due to inflation, you'll be able to afford less and less if your income does not increase at the same rate each year.
"Inflation is particularly damaging when you apply it to savings. It is advised that you increase your savings each year to accommodate the effects. Depending on the rate, a good general rule is that the value of your money will halve every seven years; so a sustained annual increase in saving is essential," Parboo says.
Liquidity is how easily accessible your money is. Cash is the most liquid your money can be, because you can access it immediately.
A successful investment portfolio consists of cash and fixed assets (such as your home or retirement savings) that prevent you from accessing them until the age of 55.
Both types of assets are important. Many people are in a situation where they are 'asset rich, but cash poor', because they have invested all their money in their homes. While it is a good idea to pay off your bond as soon as possible to save interest, everyone needs cash reserves. Aim to have an emergency fund that is kept in a savings account.
"Money you have invested in the stock market, or other equity based products like unit trusts, are not as easy to access as cash, because you risk losing some of the value if you withdraw funds when the market is low," says Parboo.
A bull market refers to a stock market that is on the rise, so if you have invested in shares you will benefit. Usually, it also means the economy is in a good state, and the level of unemployment is low. However, South Africa is currently enjoying a robust stock market because many listed companies have interests overseas. In other words, it is possible to have a strong stock market, but high unemployment and a weak currency.
A bear market means that the stock market is declining and the economy is in a downward trend. It is important to realise that the market has ups and downs, but the long-term trend is up.
Your risk profile or tolerance refers to how comfortable you are with big upward or downward movements in the markets. If you have a low risk tolerance, you get uncomfortable if you see the value of your investments decrease. Generally speaking, the younger you are, the higher your risk tolerance should be, because you will not have to access your investments for a long time. If you are near retirement age you, will have a low risk tolerance, and it is best to be invested in a portfolio that does not fluctuate widely.
"Risk tolerance isn't just emotional, it depends on how much time you have to invest, your future earning potential, and the assets you have that are not invested, such as your home or inheritance," says Parboo.
This is perhaps the most important concept to understand. Most people know that if they save money they will earn interest, however they often do not realise the huge impact the passage of time has on an investment: the longer you spend invested in the market, the quicker it will grow because you earn interest on interest.
"The biggest mistake people make with their savings is to keep accessing them and starting from scratch again. Saving for the long-term will yield the growth that you want and need," Parboo says.
