Basic Financial Concepts that School did not teach you
Updated: 16 May 2022
Inflation is the natural process where the cost of living, increases. At the moment we are seeing sky rocketing rates of inflation meaning that the cost of living just keeps on increasing. This wouldn't be a problem if wages increased at the same rate, but a lot of the time: they don't. Wages remain the same whilst the cost of living increases.
One cause of inflation is the higher cost to produce items. In New Zealand this was seen when the minimum wage increased. Minimum wage increases are supposed to effect those earning the smallest incomes in NZ; however, when the minimum wage increases, small businesses have a sudden increase to their costs of production. Their costs of production increase because labour to make their products does. So, what does the small business do? They hike their prices in reflection of this. This in turn makes products more expensive to purchase for consumers therefore causing higher rates of inflation.
Higher rates of inflation cause families to decrease their spending. Some of the hardest hit families are low income earners who sometimes end up going hungry, not being able to pay their rent or power.
*Image not using NZD
And coffee in 2020 was about $5 and now, in 2022 they're about $6.
Liquidity is a measure of how available your money is to pull out of wherever it is being stored.
Example: Money in a bank has high liquidity whereas money in a property has low liquidity because it takes about 3 months to fully sell a house.
Liquidity is important in financial literacy because one must know how easy or difficult it is to access their money. This may be important for if an emergency comes up, the market is booming and you want to pull your profits, or simply for peace of mind. I invest in the stock market which has a reasonably good liquidity. If I wanted to remove my money for something then all I would have to do is sell my shares, wait for someone to buy them and then pull out my money.
Diversification is the act of putting your investments in different industries.
The more diversified your portfolio is, the less risk you have of becoming destroyed during a crisis in one geographical area, or of one sector. For example, during the Russian invasion of Ukraine certain countries have not been happy with the behaviour of Russia and have therefore cut trading with them. This has affected the Russian economy so much so that their stock market has been closed. Other examples may be that during a global pandemic, the tourism sector does poorly. This means that your investments in this area would depreciate.
The important thing to remember when investing is that the more diversified your portfolio is, the safer it is.
Bull Market vs. Bear Market:
A bull market refers to a time in which a market is on the rise. This means that the economy is doing well, and unemployment is low.
A bull market is a sign that the economy is doing well.
A bear market is the opposite of a bull market. So, the market is about to dip, the economy is not doing too well and unemployment is high.
You'll hear these terms in a lot of finance guru talk or if you listen to the finance news.
Someone's risk tolerance is how comfortable they are with risk.
The general rule of thumb is that if you're older then your risk tolerance will be lower. This is because you're closer to retirement and so you wish not to be in many risky investments. If you're younger you have more time to ride out the lows and so we normally have higher risk appetites. My risk tolerance is medium. I am in a low risk Kiwi Saver fund because I intend to use this money to buy a house in the next 5-10 years. My stock portfolio is mainly in medium risk funds such as the s&p500 or NZX50.
Interest is an amount of money which you earn when you allow someone to use your money, or an amount of money which you pay to borrow money.
The Reserve Bank of New Zealand is commonly referred to in a lot of financial information. Understanding how the RBNZ works and operates will allow you to understand a fuller context of finance in New Zealand.
The RBNZ is responsible for financial stability in New Zealand.
Some of the RBNZ's roles include:
Currency needs for the public
Promotes a sound and efficient financial system
implement and formulate monetary policy
Or, as per the Reserve Bank of New Zealand Act 1989, the role of the RBNZ can be compared to the purpose of the Act:
(1) The purpose of this Act is to promote the prosperity and well-being of New Zealanders, and contribute to a sustainable and productive economy, by providing for the Reserve Bank of New Zealand, as the central bank, to be responsible for— (a) formulating and implementing monetary policy directed to the economic objectives set out in subsection (1A), while recognising the Crown’s right to determine economic policy; and (b) promoting the maintenance of a sound and efficient financial system; and (c) issuing bank notes and coins in New Zealand to meet the needs of the public; and (d) carrying out other functions, and exercising powers, specified in this Act. (1A) The economic objectives are— (a) achieving and maintaining stability in the general level of prices over the medium term; and (b)supporting maximum sustainable employment.
If you would like to read more about what the RBNZ is, you can click here.
They implement 'Monetary Policy' by setting the Official Cash Rate (OCR). The OCR is an interest rate established by the Reserve Bank of New Zealand. The OCR is determined 7 times a year. How do the OCR rates effect us?
The OCR rates are what banks base their interest rates from. This enables the RBNZ to basically control all of the interest rates in New Zealand and therefore, in turn control inflation.
When market interest rates increase, people spend less on goods and services. This is because their savings get a higher rate of interest and there is an incentive to save; and conversely, people with mortgages and other loans may experience higher interest payments. When people save more or spend less, there is less pressure on prices to rise, and therefore inflation pressures tend to reduce.
If you would like to learn more about the OCR rate, you can click here.
Compound Interest :
Compound interest is a process of earning interest upon your principle, then interest on the principle and that first round of interest, then interest on the principle, interest on the principle plus the first round of interest, then interest on the principle plus the first round of interest plus that second round of interest also.
Anyways, that's all from me.
Let me know in the comments if there are any other terms that you do not understand.