5 basic principles of finance you should know

Time value of money

This principle suggests that a dollar received today is worth more than a dollar received in the future due to the potential to earn interest or investment returns. It is the foundation of many financial decisions, including investment strategies and loan repayment plans.

For example, if an investor bought 1 Bitcoin (BTC) for $10,000 in 2017 and held onto it until 2021, when its value reached $50,000, the investor would have earned a return of 400% on their initial investment. This demonstrates the time value of money, as the investor was able to earn a significant return by holding onto their investment over time.

Another example of time value of money in the cryptocurrency market is the concept of staking. Some cryptocurrencies, such as Cardano (ADA) and Ether (ETH), allow users to earn interest on their holdings by staking them. In return for this service, stakers earn rewards in the form of more cryptocurrency. This demonstrates the time value of money, as stakers are able to earn a return on their investment over time by holding and using their cryptocurrency.

Diversification

The principle of diversification means to spread your investment portfolio across multiple assets to reduce risk. It is a way to protect your portfolio from the negative impact of any one investment.

Holding both stocks and cryptocurrencies may help an investor diversify their investment portfolio. By distributing the investment among a variety of assets with various risks and returns, this can reduce risk.

For instance, if the stock market declines, the value of the investor’s stocks may go down, while the value of their cryptocurrency may remain the same or even rise. Similar to this, if there is a correction in the cryptocurrency market, the value of the investor’s equities may make up for any losses.

2:) Diversify your portfolio: Don't put all your eggs in one basket.

Diversification is a key principle of investment that involves spreading your investments across a variety of different assets in order to minimize risk and maximize potential returns. pic.twitter.com/fNhYQKogLa

— Micheal OLATUNDE (@WF_Miczino) January 9, 2023

Risk vs. reward

This principle states that the higher the potential reward of an investment, the higher the risk involved. Investors need to weigh the potential rewards against the potential risks before making investment decisions.

As noted earlier, an investment’s potential benefit is often connected with its risk level. Since they are not backed by any government or central authority and because their prices can be extremely volatile, cryptocurrencies are typically seen as being riskier than equities. Investors might be willing to take on more risk as a result in exchange for the possibility of better profits. The investor’s risk appetite and investing objectives will, however, affect this.

Asset allocation

This principle involves dividing an investment portfolio among different asset classes, such as stocks, bonds and real estate, to optimize returns while managing risk. Asset allocation is critical in creating a well-diversified portfolio that aligns with the investor’s goals and risk tolerance.

An investor might choose to allocate a certain percentage of their portfolio to stocks and another percentage to cryptocurrencies based on their investment goals and risk tolerance. For example, an investor who is more risk-averse may allocate a higher percentage to stocks, while an investor who is more risk-tolerant may allocate a higher percentage to cryptocurrencies.

Compounding

This principle involves reinvesting earnings from an investment to generate more earnings. Over time, compounding can lead to exponential growth in investment returns. It is a powerful tool for building long-term wealth, but it requires patience and consistency.

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This principle applies to both stocks and cryptocurrencies. For instance, a shareholder of a stock that pays dividends may reinvest those payments to purchase further shares, which will result in the creation of additional dividends. Similarly, a cryptocurrency owner who receives interest can reinvest that money to earn even more interest. Compounding’s cumulative impact can grow over time and contribute to an investor’s overall return.

Coin Telegraph

Boost your financial literacy with nine essential terms. From interest to assets, improve your money management skills.

Financial literacy is a critical life skill that can have a significant impact on an individual’s financial well-being and overall quality of life. It is important for individuals to continuously educate themselves on financial terms and concepts to make informed decisions and achieve their financial goals.

Financial literacy is important for a variety of reasons:

Making informed financial decisions: Those who are financially literate are able to make wise financial decisions that are consistent with their aims and values. This involves choices on how much to spend, save, invest and borrow.
Avoiding financial pitfalls: Financial literacy can assist people in avoiding typical financial risks, such as high-interest debt, excessive spending and investment fraud.
Creating long-term wealth: By knowing how to efficiently save and invest, people with financial literacy can help generate long-term wealth. Understanding ideas such as compound interest and diversification is part of this.
Enhancing quality of life: Financial literacy can enhance your quality of life by lowering stress brought on by financial uncertainty and giving people the abilities and information they need to reach their financial objectives.
Contributing to the economy: Financial literacy can also contribute to the overall health of the economy by promoting responsible financial behavior and reducing the risk of financial crises.

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— Mwenda Thuranira (@mwendathuranira) February 27, 2023

Here are nine essential finance terms that everyone must be familiar with.

Budget

A budget is a plan that outlines expected income and expenses over a period of time. To keep track of spending and make sure that money is being spent responsibly, a budget is necessary. A monthly budget might, for instance, contain revenue from a job and costs for things, such as rent, utilities and groceries. A budget can assist people in better managing their money and preventing overspending.

Interest

Interest is the cost of borrowing money, usually expressed as a percentage. Depending on the type of loan or credit instrument, the interest rate may change. For instance, a credit card may impose an interest rate of 18% on outstanding balances. To avoid taking on high-interest debt and to make wise borrowing decisions, it is crucial to understand interest rates.

In the context of cryptocurrencies, “interest” can refer to two different things, including interest earned on crypto investments via staking and interest earned by lenders on their crypto holdings by lending them out to borrowers.

Credit score

Based on variables, such as payment history, credit utilization and length of credit history, a credit score is a numerical indication of a person’s creditworthiness. A high credit score can lead to better terms on loans, credit cards and other financial items. For instance, a Fair, Isaac and Company (FICO) score of 700 or higher is generally regarded as favorable.

Since cryptocurrencies are decentralized and unrelated to established credit systems, there is no exact analog of a credit score in the realm of cryptocurrencies. Yet some cryptocurrency borrowers and lenders may determine creditworthiness using alternative credit scoring models built on blockchain technology.

A cryptocurrency lender, for instance, might assess a borrower’s creditworthiness based on their blockchain transaction history, taking into account details such as their payment history, the volume and magnitude of their transactions, and how long they have had their crypto assets. Additionally, some cryptocurrency lending services might ask for cryptocurrency as collateral from borrowers, which might reduce the chance of default and give lenders more protection.

Cryptocurrency

Cryptocurrency refers to a digital or virtual currency that uses cryptography for security and operates on a decentralized, blockchain-based system. Cryptocurrencies such as Bitcoin (BTC) offer an alternative to traditional fiat currency by allowing peer-to-peer transactions without the need for a central authority and can be used for a variety of financial transactions, such as buying goods and services, investing, and sending and receiving money across borders.

Asset

An asset is a resource with economic value that can be owned or controlled. A digital asset, such as BTC, or another cryptocurrency, that can be purchased or traded on a platform built on a blockchain is referred to as an asset in the context of cryptocurrencies.

Similar to conventional assets like equities, bonds or real estate, these digital assets are frequently viewed as a store of value. However, cryptocurrencies are a high-risk investment since they are frequently quite volatile and can undergo large price swings.

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Liability

A liability is a financial obligation or debt that an individual or organization owes to another party. A liability in the context of cryptocurrencies refers to any obligation that an individual or organization has to pay back or return cryptocurrency.

For instance, if someone borrows cryptocurrency from a lender, they would be responsible for paying back the borrowed cryptocurrency plus interest to the lender. Similarly, until the customer receives their money back, all funds held by a cryptocurrency exchange would be seen as a liability.

Net worth

Net worth is the total value of an individual’s assets minus their liabilities. A positive net worth indicates that an individual’s assets exceed their liabilities, while a negative net worth indicates the opposite. Understanding net worth is important to assess financial health and plan for long-term financial goals.

Inflation

Inflation is the rate at which the general level of prices for goods and services is rising. Over time, inflation can reduce the purchasing power of money and have a substantial impact on savings and investments. For instance, if inflation is 2%, a $100 purchase made today will cost $102 in a year. To make informed financial decisions and prepare for the future, it is crucial to understand inflation.

Diversification

Diversification is a risk-management strategy that involves spreading investments across different assets or asset classes. Over time, diversification can help lower risk and boost profits. To lessen the risk of losses in any one sector, an investor can diversify their portfolio by making investments in stocks, bonds, cryptocurrencies and real estate. In order to reduce investment risk and amass long-term wealth, it is crucial to comprehend diversification.

Money management