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Key financial terms and meanings

1. Compound interest

Compound interest is interest on the amount of money you have deposited or borrowed.

When you’re investing or saving, compound interest is earned on the amount you deposited, plus any interest you’ve accumulated over time.

However, when you’re borrowing, compound interest is charged on the original amount you were loaned, as well as the interest charges that are added to your outstanding balance over time.

2. Net worth

Your net worth is simply the difference between your assets (what you own) and liabilities (what you owe).

You can calculate yours by adding up all of the money or investments you have, including the current market value of your home and car, as well as the balances in any checking, savings, retirement or other investment accounts.

Then subtract all of your debt, including your mortgage balance, credit card balances and any other loans or obligations.

The resulting net worth number helps you take the pulse of your overall financial health.

3. Capital gains

Capital gains are the difference between how much something is worth now versus how much it was originally purchased for.

The gain, however, is only on paper until the asset or investment is actually sold. The flipside is a capital loss, which is the decrease in the asset’s or investment’s value since you purchased it.

You pay taxes on both short-term capital gains (a year or less) and long-term capital gains (more than a year) when you sell an investment.

By contrast, a capital loss could help reduce your taxes.

4.Net Present Value:

In the field of finance, NPV tells you the value of future cash flows relative to current cash flow. It helps you compare investments or projects in terms of profitability even though they have different pay-outs at different times. You can use NPV to evaluate competing investment choices and select the best one. Investments with positive and highest NPV should be opted rather than negative ones. A smart investor knows that a higher NPV comes from innovative and in-demand businesses. Thus, an investment in a start-up growing 50% every year will result in a higher NPV in 12-18 months or in half the time as an investment in a large MNC. But the golden rule of high return-high risk applies everywhere.

5.Hedge Risk:

Diversification is a commonly-used method to reduce or hedge risk to your wealth by investing in different asset classes, so that even if one or more of these underperform, the others can balance it out and cushion your finances against an extreme situation. The asset classes in your career include skills that you acquire and the network of people that you develop. If you are invested in one type of investment or one sector favoured investment, you are at a high risk. If you have multiple investments and maturing at different periods, you are well paced to handle any sudden changes or downfall in the economy. The current pandemic is a great example of diversifying your portfolio to minimize your risk.

6. Return on Investment:

ROI measures the efficiency of a financial investment where the gains from the investment should well exceed the costs. You normally choose between assets by comparing their ROI. When applied to your investments, this means understanding the amount you are investing in order to get the returns along with other associated risks. It is a performance measure used to evaluate the efficiency or profitability of an investment or compare the efficiency of a number of different investments. It is the direct measure of the amount of return on a particular sum invested relative to other costs and risks.

7. Amortization. This is the process of paying off your debt in regular installments over a fixed period of time. Your mortgage is amortized using monthly payments that are calculated based on the amount borrowed, plus the interest that you would pay over the life of the loan.

8. Escrow. An account held by an impartial third party on behalf of two parties in a transaction. During the homebuying process, the buyer will deposit a specified amount in an escrow account that neither party can access until the terms of the purchase contract, such as passing an inspection, have been fulfilled and the sale is completed.

An escrow account can also hold money that will later be used to pay your homeowners insurance and property taxes. You can put money in escrow every month, so that when your premiums and taxes are due, you have enough to cover those bills.

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