20 Must-Know Financial Terms to Improve Your Money Skills
Mastering key financial terms is like unlocking the cheat codes to wealth—once you know how money works, you can make it work for you!
- Alyana Aguja
- 6 min read
This means understanding key financial terms, on which smart money management is founded, helping one build wealth and avoid debt traps and make smart decisions. Whether it’s about compound interest, budgeting, passive income, or financial independence, these concepts empower you to take control of your financial future. The more you know, the more you can make your money work for you—unlocking opportunities, security, and financial freedom.
1. Compound Interest
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Compound interest is one that grows both on your initial money and on the interest that has already been added. This is like a snowball rolling downhill-your money keeps growing faster over time. The earlier you start investing, the more you can benefit from this magical force.
2. Inflation
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Inflation is the gradual increase in prices over time, making your money worth less in the future. A candy bar that costs $1 today might cost $1.50 in ten years. This is why keeping all your cash under a mattress isn’t a great idea—you need investments that beat inflation.
3. Net Worth
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Your net worth is what you own minus what you owe. If you have $10,000 in the bank but are indebted to the tune of $5,000, then your net worth is $5,000. It is by tracking this figure that you get to know your true financial health.
4. Assets
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Assets are things you own that have value, such as cash, property, stocks, or a car. The more assets you have, the stronger your financial position. But remember, some assets lose value over time (like cars), while others grow (like real estate).
5. Liabilities
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Liabilities are debts or obligations, including student loans, credit card balances, or a mortgage. The more liabilities, the more money you pay them off instead of building wealth. The fewer your liabilities, the sooner you become financially free.
6. Liquidity
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Liquidity refers to how easily you can liquidate an asset without losing value in the process. Your savings account is very liquid as you can have access to it immediately; however, a house is relatively inelastic because selling it requires much time. The more liquid your assets are, the easier it is to handle financial emergencies.
7. Credit Score
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Your credit score is a three-digit number that tells lenders how reliable you are at paying back money. When your score is high, you have lower interest rates on your loans and credit cards and save money. Paying your bills on time and keeping a low credit card balance can lead to an increased score.
8. Debt-to-Income Ratio (DTI)
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DTI is the percentage of your total debt divided by how much you earn in one month. So, the greater your DTI, the greater the likelihood you’re paying more for your monthly debt. Hence, getting any kind of loan can be tougher when your DTI is large. By keeping it small, you’re offering yourself financial leeway and tranquility.
9. Diversification
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Diversification refers to the spreading of investments across different types of assets with the objective of increasing returns by reducing risk. If all your money is in one stock, when that stock crashes, you lose big, whereas if you spread it across multiple investments, losses are cushioned. It’s the old adage “don’t put all your eggs in one basket.”
10. Emergency Fund
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An emergency fund is the money saved for unexpected spends such as medical bills, car repairs, or job loss. Experts recommend having three to six months’ worth of living expenses saved. This fund acts as a financial safety net, so you do not have to rely on credit cards or loans when life surprises you.
11. Budgeting
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Budgeting is a plan on how you will spend and save your money each month. It helps control your spending, avoid debt, and help you attain financial goals. It’s like giving every dollar a job so you stay in control of your money.
12. Roth IRA versus Traditional IRA
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Both are retirement accounts, but they are different in terms of tax benefits. A Roth IRA allows you to withdraw money tax-free during retirement because you pay taxes at the time of contribution, while a traditional IRA gives you a tax break now but taxes your withdrawals later. The choice is based on your current and future tax situation.
13. 401(k) Match
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Most companies offer a 401(k) plan, and they will match a percentage of what you put into retirement savings. If the company you are working for is offering a 100% match up to 5%, if you contribute 5% from your paycheck, they give you another 5% for free. That is like leaving money on the table.
14. Stock Market
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The stock market is where people buy and sell shares of companies, hoping to make a profit. Prices go up and down based on company performance, economic conditions, and investor emotions. While risky in the short term, investing in the stock market historically leads to long-term growth.
15. Bonds
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Bonds are essentially loans you make to governments or companies in exchange for interest payments. They are less risky than stocks but offer lower returns. Adding bonds to your portfolio can help balance risk, especially in uncertain times.
16. Index Funds
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An index fund is an investment that tracks a market index, such as the S&P 500. Instead of trying to pick individual winning stocks, these funds automatically invest in many companies, spreading risk. They are great for beginners because they require little maintenance and have low fees.
17. Dividends
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Dividends are the payments that companies make to their shareholders as a share of their profits. Not all stocks pay dividends, but those that do give you additional income while holding onto the investment. Reinvesting dividends can supercharge your long-term wealth growth.
18. Capital Gains vs. Capital Losses
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When you sell an investment for more than you paid, that’s a capital gain; if you sell for less, it’s a capital loss. Gains are taxed but losses can offset taxes. A prudent investor uses strategies so that the taxes paid are to the minimum while getting the most out of their investments.
19. Passive Income
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Passive income refers to income earned with relatively little effort over time, such as rental income, dividends, or royalties. This is the concept behind financial freedom: you can be paid even while you are sleeping. The greater the number of passive income streams you have, the less dependency you have on a traditional job.
20. Financial Freedom
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Financial independence means having enough savings and investments to cover your living expenses without needing a job. It gives you freedom to work on your own terms, travel, or retire early. Achieving it requires smart money habits, patience, and consistent investing.