Money Measures
 

Here are a few basic financial terms you need to understand in order to build your financial security. When these figures of yours are good, you’ll grow rich.

Income - This is simply how much money you earn, whether it is per year, month, or week. You have to have money coming in to live. What you do with that money determines how well you live. In most cases people bring home the bacon by working at a J-O-B. No job usually means no income and lots of problems. Wealthy people, however, receive income from their investments and don’t have to work to survive if they choose not to. Their money does the work for them.

Expenses - This is the money you pay out that you don’t expect to see again. Whether you spend it on taxes, groceries, car payments, loan payments, rent or mortgage payments, utilities, or other stuff you buy, it’s all the same. It’s money going out of your pocket. Investments are not expenses because you can reasonably expect their value to grow with time and increase your wealth. With your mortgage payment, the portion that is principal is an investment. The payment on interest though, is lost and is an expense.

Cashflow - Income minus expenses for a given period. If in a month you brought home income of $4,000 and had $3,000 in expenditures you had $1,000 of positive cashflow. On the other hand if you brought home the same amount but spent $4,500 you’d have $500 of negative cashflow. If you brought home $4,000 and spent $4,000 you’d break even.

Assets - Everyone has stuff. Your house, car, stocks, bonds, furniture, clothes, electronics, collectibles, furnishings, and so on. They’re all considered assets and have some monetary value. Some are easy to value and convert into cash, hence the phrase liquid assets. Cash, common stock, and certain securities are generally considered liquid. Others like clothes and electronics are harder to value. They have no set value. The true value is whatever someone will buy them from you for, and is usually much less than what you paid to buy them new. One exception is real assets, which is real estate you own or control. When calculating the value of your assets, only count cash, liquid assets, real property, retirement funds, and automobiles. You can ignore personal belongings because they are hard to value and probably won’t have much bearing on your asset value.

Debt - Everything you owe. Your mortgage, car loan, credit card balances, and the $50 you owe your buddy are all debts. The total of the principal you owe on all your loans is your total debt. Net worth

Your net worth is your total assets minus all your debts. If it’s greater than zero your net worth is positive. If it’s less than zero your net worth is negative. This is how wealth is determined. It’s not a measure of your income, which is what you bring in. It’s a measure of what you accumulate, what you keep.

Interest rate - The interest rate on a loan is the periodic fee charged by the lender for the right to use the money borrowed (principal). It’s “rent” to borrow money and the rate depends on a number of factors, primarily the current rates set by the Federal Reserve, the borrower’s credit rating, the purpose of the loan, and whether or not it is secured by collateral. It is essentially based on broad economic conditions, risk to the lender, and market demand. It is often expressed as APR (Annual Percentage Rate) which makes it simple to compare rates between lenders and loan terms.

Return-on-Investment (ROI) - This is a variation of interest rate. But instead of making payments this is where you get paid. You invest or “rent” your money with the expectation that you will eventually receive your principal back plus a gain of some amount. The percentage gain is your profit, and ROI is calculated from that, the original principal, and the length of time your money is invested. Most investments don’t have a guaranteed ROI and hence have an element of risk.

Say you invest in a stock that is trading at $50 per share. Two years later it’s worth $75 per share. Your investment has increased $25 per share, or 50% over two years. That works out to an ROI of 25% per year (it’s actually 22.47% compounded annually but I’m getting ahead of myself).

Inflation* - The Merriam-Webster dictionary defines inflation as “An increase in the volume of money and credit relative to available goods and services resulting in a continuing rise in the general price level”. What this means is that money is worth less each year. A dollar tomorrow will buy less than a dollar today. That is why investing is so important. It’s the only realistic way of increasing your wealth despite inflation.

* - Note that we as individuals can’t influence or do a thing about it.

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