Personal Finance Terminology
A quick guide to the most important personal finance terminology
One of the first things about finance that puts people off is the language. The moment an expert starts to bandy around terms like ‘dividend’, ‘yield’, ‘compound interest’ and ‘net present value’, it all starts to sound very intimidating.
Like every other area of life, finance has a specialised language. It has its own jargon. Jargon is actually very useful; we need precise terms that are clearly defined so that there is no confusion about what is being said. On the other hand if you don’t understand what the jargon means, you are automatically at a disadvantage. Financial institutions are obliged to use legal phrasing and disclaimers to describe their products but, unfortunately, this can also confuse their customers. And customers who don’t understand something are hardly in a position to ask awkward questions, or to compare value for money.
In this chapter we will, therefore, look at four important terms used in personal finance. Never again will you be dependent on someone else to explain any of the following to you:
• Percentages;
• The difference between capital and income;
• Compound interest; and
• Gearing.
Other terminology you may find useful is explained in the ‘Jargon Buster’ section at the back of this book.
Percentages Made Easy
You are not alone
If you aren’t entirely comfortable with percentages you are not alone. People in most walks of life are not trained to work out the ‘yield’ on their investment property, or even how to calculate an interest-only repayment on their mortgage. Life is lived at such a fast pace nowadays that people just about have time to direct their attention on the two most important facets of their lives: family and work. Is it any wonder that the majority of people struggle to sort out their money matters?
What is a percentage?
The word ‘percentage’ literally means ‘parts per 100’ — ‘cent’ being the Latin word for 100. Because percentages always deal with parts per 100 they allow you to compare things that would otherwise be very difficult to compare. They are particularly useful when it comes to choosing a loan or deciding on the relative worth of different investment opportunities.
For instance, 85% of home borrowers in the United States use a financial adviser rather than go direct to a lender. In the UK, 65% of borrowers use an adviser, while here in Ireland less than 40% of borrowers go to an independent adviser.
How to work out percentages
You calculate the percentage by turning your numbers into a fraction, divide it out and then multiply by 100.
To give an example of how percentages are used as a basis of comparison I’m going to use an analogy from one of the other great passions of my life: football.
Imagine you are the manager of a Premiership team and you have three footballers who specialise in taking penalty kicks. You want to establish which of the three is the most effective or has the highest score rate. You could, of course, have all three take 20 penalties each against a top-class goalkeeper, with the player scoring the most being judged the best. However, the only real comparison should be based on their performance in the heat of battle over the course of a number of seasons. The figures could look as follows:
Penalties taken:
Player A-25 Player B-20 Player C-30
Penalties scored:
Player A-22 Player B-17 Player C-24
From the above figures it is obvious that in absolute terms Player C has scored the most goals, but which player is the most effective? If you express these figures in percentage terms the answer then becomes clear.
Player A converted 22 of his 25 penalties so the calculation would look as follows:
22
–––– x 100 = 88%.
25
If you were using a calculator you would key it in like this: 22 ÷ 25 x 100.
Player B converted 17 of his 20 penalties so the calculation would be as follows:
17
–––– x 100 = 85%.
20
Player C converted 24 of his 30 penalties so the calculation would be as follows:
17
–––– x 100 = 80%.
20
Converting numbers to percentages allows us to make a fair comparison between the penalty skills of the three players. Player C converted 80% of his penalties, Player B converted 85% of his penalties, but Player A, with an 88% success rate, is clearly the best.
'From The Money Doctory by John Lowe'
