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5 Financial Concepts Everyone Should Understand

Managing your personal finances is very important. Those that have a good grasp of their personal finances will ultimately be more able to achieve their financial goals and even prevent identity theft. There are five key financial concepts that all people should understand, which could help them to achieve their financial goals.

Net Worth 
The most important financial concept that all people need to understand is their net worth. While this is a very common term, many people do not know what it is or how to calculate it. Essentially, your net worth is a summary of your assets less all of your liabilities. This is a balance sheet item that can fluctuate daily based on your consumption, investment returns, and other factors.

Liquidity 
While your net worth is important, you also need to understand your liquidity position. A liquid asset is either cash or an asset that can quickly be converted into cash. Some examples of liquidity include money in the bank accounts, stocks that can be sold, CDs, and any other account that can be closed and converted to cash. Assets such as your home, loans that you have given out, and your car are harder to convert to cash and therefore not liquid.

Inflation 
While many people are able to predict future investment values and make financial decisions off of it, most do not properly account for inflation and its impact. Inflation is the amount that currency is devalued each year. Effectively, money that you have saved will decline in value each year due to inflation as it affects the purchasing power.

APR vs Interest Rate 
Whenever you are taking out a loan, you will see two rates quoted, the interest rate and the APR. While most people naturally pay more attention to the interest rate, the APR of a loan is much more relevant. The interest rate is based only on the amount of money that you will spend on interest. The APR also factors in all of the money you will spend on loan fees which makes it the true cost of the loan.

Diversification 
Investing the markets is very important for anyone that wants to achieve long-term financial goals. When you are looking to invest, you need to understand the concept of diversification and asset allocation. Those that are looking to diversify will invest their capital in a variety of different stocks, funds, and industries. This will protect against downside in the event a stock goes the wrong way.

These five financial concepts are extremely important. Those that are able to understand and implement them into their daily lives could benefit a number of different ways. This includes understanding your current financial position and knowing how to reach your goals.