Thursday, 24 January 2019

The Basic Ideas of Finance - What You Need To Know

The Basic Ideas of Finance - What You Need To Know

This presentation is merely a brief overview of the topic covered in the chapter and should not be considered a substitute for reading the chapter. This chapter covers
  1. Income and Expense
  2. Assets
  3. Debt and Equity
  4. Income and Risk

Income

Income is a cash inflow, in other words, it is money that comes to you, there are 2 ways to earn income
Selling Labor - which means working
 Selling Capital - which means investing

Expenses

Are cash outflows for items that are consumed, most of us have an expense for housing, transportation, food, and entertainment, just to name a few.

Surplus Vs Deficit

If your income is greater than your expenses, you have a budget surplus, in other words, you have money left over after you've paid your expenses, you can do with this money as you wish

Getting ahead in a personal financial sense almost always requires creating a budget surplus and then investing that surplus. 

If your income is less than your expenses, you have a budget deficit. This means that you run out of money and probably have to borrow to pay your bills

Read: Introducing to the Financial Management - What You Need To Know

This is extremely undesirable, a possible solution to turning a budget deficit into a surplus is to increase your income maybe by getting a second job and/or cut your expenses.


Assets

 An asset is an item with economic value, that can be converted to cash. Here we see three assets
  • Gold
  • Stock
  • House

While there are some generalizations here and it is possible to find exceptions, it is most likely that one invests in gold to store wealth, and potentially increase income by buying low and selling high

A stock is usually held for the same reasons

A home may reduce our expenses over time when compared to renting, and it typically stores wealth fairly well


Debt

Most of us are probably all too familiar with debt. Technically debt means renting someone else's money for a period of time, we usually call this renting borrowing, while debt such as credit card debt that carries high-interest rates and if used for unnecessary items, is bad

Some debt like student loans which allow us to get an education, we might otherwise not have been able to obtain, is good


Equity

Represents ownership. Let pretend that you want to buy a vacation cottage and you have saved $100,000 for such a purpose, you find the perfect cottage but it cost $150,000

Instead of saving up the extra $50,000 or borrowing it, you decide to approach a friend who will put up $50,000 to buy part of the cottage, you spend $100,000 and your friend spends $50,000, so you have thirds ownership and your friend has one-third ownership. 

These ownership stakes represent equity. 


Debt

Now let's look at another way you could have bought the cottage

You could borrow $50,000 from the bank, of course, you would have to pay the money back plus interest so it would cost you more than $50,000 over time but you would own 100 percent of the cottage and not have to share it with your friends


Income and Risk

Finally, let's turn our attention to risk, we must not put all of our focus on getting more of what we want. We must also focus on protecting what we have. Most of us have two sources of income, labor, and investment

Those sources of income are a risk, laborers can lose their jobs due to economic downturns or poor performance

They can also have accidents or illness that causes them to be unable to work so selling their labor is no longer an option. 

With investments we know that not all of them pan out, sometimes we pick winners and sometimes we pick losers

How can we minimize the risk to our income sources? 

Diversifying or spreading our risk is probably the best way. By not putting all of our eggs in only one basket we minimize the risk to significant sources of our income, we diversify our labor by learning as many skills as possible instead of just being really good at one thing

We can also sell our labor to more than one employer or perhaps start out own small business on the side and investing, we can spread our risk by diversifying our portfolio, and that includes
  • Stocks
  • Bonds
  • Mutual fund
  • Real State
  • And other investments

Taking these step can help minimize our risk and make use sleep better at night. 



That concludes this presentation, I hope you enjoy reading the chapter

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