April is Financial Literacy Month, a great time to consider your financial situation and to review some of the basics of personal finance. You probably understand the importance of having good credit, paying down debt and the necessity of spending less than you earn. However, it is important to understand some other financial concepts as well.
Here are three personal finance terms that you should know to get an even better grip on your financial situation.
1. Net worth. If you want a measure of how your wealth is growing, you can use net worth. To figure out your net worth, you first need to add up all of your assets. This includes things of value that you have — things you can sell for cash. Assets include property (including the market value of your home), cash, investments and other similar items. After you have added up your assets, you add up your total liabilities. These are obligations that you have, including credit card debt, medical bills and your mortgage balance. Now, subtract your liabilities from your assets. What remains is your net worth. You can use your net worth as a good way to measure the financial progress you are making.
2. Cash flow. Understanding the concept of cash flow is vital if you want financial freedom. Cash flow is a way of tracking your money as it moves through your own personal system of finances. It illustrates where your money comes from (your income) and where it is spent (your expenses). Cash flow also looks at the timing of expenses in relation to when you receive income. Knowing when bills are due and how much money you have to cover them is important, and part of understanding your cash flow.
3. Asset allocation. It is vital to understand where your assets are and how they are contributing to your long-term prosperity. Asset allocation involves looking at different types of holdings and making sure they are spread out in a way that helps you reach your goals. For example, your home might fall into the asset class of real estate. Asset allocation also includes how much of your portfolio is in stocks, bonds or other investments. Asset allocation requires that you consider risk and return, and whether or not your portfolio will help you beat inflation and build wealth at a rate that will help you live in comfort later on.