By the time children are in their teens—and, hopefully, familiar with budgeting and savings—they should be ready to learn more advanced financial concepts. Then again, many adults (perhaps even you) still regard interest and credit scores as a foreign language. Here’s a refresher course:
Cash flow: balance between income and spending. Healthy cash flow means reserving ample income to meet all likely expenses.
Compound interest: a savings- or investment-account approach that pays interest both on money deposited by the account owner and on interest earned on that original amount. For example, if you open a savings account with $500 and don’t touch it for five years, with typical simple-interest rates you would gain about $125 during that time, for a total of $625. Compound interest, calculated on that $125, could raise the total another $10.
Credit: a person’s ability to make purchases under the expectation of paying the actual monetary value later, with interest. This includes loans made by financial institutions for major purchases, or to businesses for expenses required toward growth plans.
Credit history: a person’s or business’s complete record of paying (or not paying) credit debts.
Credit rating: an estimate of a person’s likelihood to pay back a loan, based on credit history, payment history, outstanding debt, and types of credit used and requested. A credit rating is used by financial institutions in deciding whether to grant loans.
Credit report: a compiled record of loans and payments that sums up a credit history.
Credit score: a number based on a credit rating. A score of 780 or higher is “excellent”; those who score below 620 are considered bad risks for lenders.
Fixed expenses: expenses that take a set amount of funds every month and change only occasionally. These include rent, insurance premiums, and (relevant for kids) club dues and regular special events.
Flexible expenses: expenses that vary in exact amount from month to month, including groceries, auto maintenance, and medical bills.
Interest: extra fees assessed during loan repayment, in addition to the original amount borrowed; usually calculated according to a percentage of the amount still owed. Interest also means “bonus” money added to saving accounts, calculated according to total value in the account and how long it is kept there.
Rule of 72: the formula 72 / interest rate = years to double your money. A 6 percent interest rate would double the initial investment in 12 years (72/6 = 12), assuming no withdrawals or deposits.
Simple interest: interest calculated only according to the amounts deposited by the account owner.
To Maximize Your Finances:
- Take withdrawals from interest-bearing accounts only when absolutely
- Choose the highest-interest savings accounts, and make deposits regularly.
- Use credit only for important major purchases.
- Limit credit accounts to 3 or 4 at a time.
- Whenever possible, repay loans in full before the official due date.
- Keep your credit score up; pay all your bills on time.
- Learn to calculate compound interest. (The U. S. Securities and Exchange Commission provides one calculator at https://www.investor.gov/tools/calculators/compound-interest-calculator.)
- Use the rule of 72 to plan your financial goals (if you have a double-the-money-in-8-years goal, look for a 9 percent interest rate—72/8 = 9).