As you become an adult and will start to take control of your finances, you’ll need to understand some basic financial concepts.
And when you start to master these important concepts, you’ll set yourself (and your family) up nicely because you will start to make better decisions with your money.
At least, that’s the goal, right?
If you want to live a financially stress-free life, build wealth, and manage your money like a pro — you’ll have to dedicate time to learning and addressing any financial challenges head-on as early as possible.
While there is certainly much to learn, you can start with these financial concepts below and you’ll have an amazing start compared to many others. Ready to get started?
What Are The Basic Financial Concepts?
Ideally, the basic financial concepts will cover everything from banking, understanding credit and credit cards, how to save money, investing basics, and how to earn more money. To be well established later in life, you want to understand these topics before the age of 30, but getting a later start is okay too.
As a functioning adult, the below financial concept examples will be some of the best areas that will help you crush your personal finances.
- Net Worth
- Compound Interest
- Money Mindset
- Bull & Bear Markets
- Appreciating Assets
- Pay Yourself First
- Risk Tolerance
- Multiple Streams of Income
1. Net Worth
Your net worth helps you measure your current financial wealth and is calculated by taking your total assets minus the total amount you owe. When you have a positive net worth, it means you have no debt and the assets that you own have some monetary value.
Additionally, you must understand your liquid net worth as well. This is slightly different from just net worth, as your liquid net worth is the number of assets you have that you could sell quickly and turn into cash at a moment’s notice.
For example, stocks and bonds are considering liquid where real estate holdings would be considered non-liquid.
2. Compound Interest
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein
To fully understand how to build your net worth and be able to retire comfortably, you have to appreciate the value of compound interest. This is when you invest your money and it earns interest over time, but then you let that interest also receives interest.
Eventually, as you keep adding money and letting interest go to work, your money starts to compound and get this big curve of growth.
- You invest $10,000 and never add to this amount again. With a 7% return rate in the stock market, your money would compound to $70,000+ in 30 years.
- You contribute $10,000 every year to your retirement account. With a 7% return rate in the stock market, your money would compound to $900,000+ in 30 years.
While you want to have an emergency fund and save your money, you have to maximize the power of compound interest and investing.
Inflation refers to the consistent increase in the cost of goods and services. As prices of goods or services rise due to inflation, it means you’ll able to afford less and less. Essentially, when inflation rises your money has less power.
Not exactly a fun financial concept to understand, but it is necessary because inflation is a real part of the economies of the world.
If you are interested in diving in a bit further, you can get some more data from Statista that shows the annual inflation rate in the U.S. from 2010 to 2019 with additional projections up to 2021.
Here’s a graph from their report showing inflation percentages from the last 11 years:
I somewhat alluded to the concept of liquidity in the net worth section, but let’s dive into this a bit further. Simply, liquidity is about how accessible your money is currently if you needed it.
For example, the cash you have in a savings account is very liquid. Meaning you can go to your bank and get the cash out that you need quickly.
However, your home or retirement investments generally are not very liquid as they take time to build value and worth. Plus selling these can take time and in the case of your retirement accounts, could accrue penalties for early withdrawals.
5. Money Mindset
The way you think and feel about money (or about those who have money) is a critical concept that shapes the way you will approach your finances. Unfortunately for many people, money can be seen as evil, frustrating, or impossible to grasp.
Too often as a society, we let money control us instead of being the ones in control. That’s where your money mindset becomes important to work on and I think is one of the most valuable financial concepts on this list.
When you work on your mindset it helps shape your views towards money. But it also can help you master things like delayed gratification, impulse spending, practicing gratitude for what you have, evaluating what is important to you, and much more.
6. Bull & Bear Markets
Investing can be intimidating at first and a bit overwhelming. But you can certainly teach yourself and not spend much time managing your investments but still generate results.
That said, you’ll want to understand what bull markets and bear markets are and how they impact your investments.
- Bull Market: The market is on the rise and is continuing to grow. Share prices are continuing to go up and your returns can be high like many have seen in 2020. Typically this is a good sign that the economy is relatively healthy but there are lots of factors at play.
- Bear Market: The market is on the decline and stock prices continue decreasing. While it might be scary, this can also be a golden opportunity to continue investing when shares cost less. When you have time on your side to invest, you can take some bear market hits, and only when you sell do you actually lose money.
7. Appreciating Assets
As you look to improve your finances and build wealth, you’ll want to understand appreciating assets.
These are assets that tend to go up in price over time and are designed to increase your net worth and diversify your portfolio. Remember, there is no guarantee that appreciation in price will happen, as there will be times where assets can lose value. But overall, these assets tend to recover and will grow in the future.
Examples of appreciating assets include things like:
- Real estate
- Private Equity
- Savings Accounts
- Starting A Business
“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” – Robert G. Allen
Beyond investing in appreciating assets, mastering the simple financial concept of diversification will help you overtime during economic downturns. Putting all your money into one stock, one category, or one asset class is very risky.
When you invest in various categories, you help balance out your portfolio if one area takes a hit. This helps ensure your capital does not get destroyed but takes a more conservative downturn.
For example, you might invest heavily in stocks, but you should consider mixing where your cash is like maybe in savings, investing in some bonds, maybe buy real estate, or own a business. All have risk, but if one is affected, you have other assets that may have a low correlation to the other.
9. Pay Yourself First
Out of this entire list, paying yourself first might be the most obvious yet super impactful financial concept many fail to actually practice.
The idea here is that your money goes towards your financial goals first — like an emergency fund or investments before paying any monthly bills, debts, or using it for any spending. While you do want to pay your obligations and debt, start by putting this money to work for you first.
Often, many people will pay bills, debt, maybe spend on some items and then save or invest with the little that remains (if anything remains). When you flip the process, you are less tempted to overspend and will begin to build better financial habits.
10. Risk Tolerance
Remember in the earlier point, diversification is a great way to minimize your exposure to one asset and help reduce risk. But we need to talk about risk tolerance further as it is something you must always understand with your personal finances.
Your risk tolerance is based on how comfortable you will be during economic swings. When you understand how the economy and markets work, what will your reaction be to the volatility? Your risk tolerance is how you determine how much and how aggressive you’ll be with your investments.
Figuring out your risk tolerance is based no your personal circumstances beyond understanding the nature of the markets. Things like your income, how much time you’ll have to be invested, the assets you own, risk vs. reward, etc.
11. Multiple Streams of Income
If wealth accumulation is an important goal for you, then you need to start understanding how to get there. While wealth can be built from a 9-5 job, not everyone will make 6-figures, 7-figures, or more which can make that goal easier.
But everyone does have an opportunity to create multiple streams of income that can be used to elevate their wealth over time.
Author Tom Corley did a five-year-long study and surveyed wealthy individuals on their daily habits, and then compared them with lower-earning individuals.
What he discovered is that most self-made millionaires generated their income from multiple sources, up to 7 streams of income. The breakdown ended up being:
- 65% had three streams of income
- 45% had four streams of income
- 29% had five or more streams of income
You can have a 9-5, invest for dividend income, buy rental properties, start a side business, do freelance or consulting work on the side, take part in the gig economy, etc. Having multiple streams of income helps you build wealth, increase your income, and helps you diversify in case one income stream disappears.
There are plenty of ways to make extra money and boost your overall finances. More than you may have even realized!