Basic Finance Jargons Everyone Should Know (2)

Famous French philosopher Jean-Jacques Rousseau once said "Man is born free, and everywhere he is in chains. One man thinks himself the master of others, but remains more of a slave than they are."

That's particularly true when you think your boss is your "master" at work, however, in turn they have "masters" ahead of them too! After reading my last post about finance jargons, I believe you would have chosen to become a free man, at least financially, and free from being a "slave" to the 9-to-5 rat race.

To become financially-free, we must continually educate ourselves, and here comes the second part of basic finance jargons.

6) Investment & Total Return

An investment is an asset purchased with the idea that the asset will provide income in the future and/or will later be sold at a higher price for a profit.

Total Return = Capital Appreciation + Investment Income

For the above equation, I put Capital Appreciation ahead of Investment Income. It is because a lot of investors actually put their main focus on the first term and overlooking the second. You may have already heard about the phrases "Buy Low Sell High"; "Sell in May and Go Away"; Day-traders / Day-trading strategy, etc. These are all investments strategies focusing on reaping Capital Appreciation.

It is also not surprising to find that some investments are only offering returns ONLY in the form of Capital Appreciation, for example, gold bullion, foreign exchanges, land banking, etc.

7) Capital Appreciation / Capital Gains

Capital appreciation is an increase in the price or value of assets. It may refer to appreciation of company stocks or bonds held by an investor, an increase in land & property valuation, or other upward revaluation of assets. You get this type of profit by "Buy Low Sell High".

8) Investment Income & Cash Flow

The purpose of doing investments is to yield income. Some investments could make you earn periodic incomes such as interests (e.g. fixed deposit), dividends (e.g. common shares, preference shares, etc.), rentals (real estate, automobiles, etc.), coupons (bonds).

Cash flow is the actual "cash" that "flows" into your account, in this case, it is the actually money that banks into your account resulting from an investment. Please kindly note that what "cash flow" means here might be different from professional accounting point-of-view. I'm not trying to give accounting lessons in this blog post.

9) Cash Balance

Looking at net worth alone doesn't tell how much of your assets are liquid. For example, if all of your assets were invested in land banks & real estate, it might be hard to sell and turn the assets into cash instantly. Many small & medium enterprises go bust during financial crisis not because of lack of income, but the deficiency of cash - capital chain rupture, which refers to the enterprise's inability to pay its matured debts because of all kinds of internal and external causes or its inability to run on the normal track because of cash shortage.

This applies to personal finance as well. It would be one's nightmare to be in short of cash to meet monthly debts such as credit card debt, which would be highly penalising for any late payment by charging extremely high interest rates. A non-paying credit card debt could quickly spiral down into a disaster if left unattended. Therefore, make sure to have some cash available at all times to cover expenses and debts that come up.

10) Emergency fund balance

Building an emergency fund (a minimum of three to six months worth of living expenses) is a major step that many financial planners recommend for anyone, in order to avoid the pitfall outlined at point 9 above. 

Putting cash into an emergency fund provides a cushion against settling unexpected bills (e.g. hospital bills) and events (e.g. redundancy; unemployment;) coming up. This practice also establishes the habit of saving money instead of spending every penny of your monthly paycheck.

For me, I always maintain a cash reserve equivalent to nine to twelve months of living expenses. This serves as an emergency fund as well as an equity reserve for investment in case an opportunity arises.