A lot of change comes with the transition into adulthood. Personal finance is arguably one of the hardest aspects of adulthood to grasp. This post aims to explain some of the most important personal finance terms every adult should know.
While this post is not an exhaustive article, it does lay the foundation for building one’s financial literacy. I must also say that I am not giving any financial advice in this article. When it comes to money always do your due diligence.
With that being said, let’s get started!
Checking vs Savings Account
A checking and savings account are among the most basic of the personal finance terms every adult should know.
A checking account is a bank account that is usually connected to your debit card. It is geared to be your go-to daily transaction bank account. This is probably where your checks or direct deposits from work will go.
Alternatively, a savings account is where you stash funds that you aren’t ready to use yet, often with the goal of accumulating more into the account. Savings accounts don’t usually come with a debit card.
Often you are limited with how many times you can withdraw money from these accounts without facing penalties. The industry standard is no more than six withdrawals a month.
A savings account is where you want to keep money that you don’t immediately need. It is also a type of account where you should consider building an emergency fund.
Debit Card vs Credit Card
A debit card uses funds from your bank account. It is issued by a bank to their customers to access funds without needing to make a cash withdrawal or writing a check.
On the other hand, a credit card uses a credit line that can be paid back later. Since the credit amount can be paid later it gives you more time to pay. A person’s credit amount depends on their creditworthiness which I will get into later.
In pretty much all other aspects, a credit card can serve the same purpose as a debit card. In fact, in many cases, a credit card is thought to be the safer of the two. If someone steals your credit card they do not have direct access to your personal bank accounts. If someone steals your debit card, they do have direct access.
Compound interest is the interest you earn on interest. Interest can be compounded at various periods such as daily, monthly, and yearly.
It is essentially what people are referring to when they say to make your money work for you.
A very simple example pulled from investor.gov illustrates the idea mathematically:
“If you have $100 and it earns 5% interest each year, you’ll have $105 at the end of the first year. At the end of the second year, you’ll have $110.25. Not only did you earn $5 on the initial $100 deposit, but you also earned $0.25 on the $5 in interest.
While 25 cents may not sound like much at first, it adds up over time. Even if you never add another dime to that account, in 10 years you’ll have more than $162 thanks to the power of compound interest, and in 25 years you’ll have almost $340.”
Annual Percentage Yield (APY)
Annual percentage yield is the total amount of interest you earn on a deposit account over one year. It is based on the interest rate and frequency of compounding.
So the higher a bank’s APY, the more money you will be earning on your deposit.
High-Yield Savings Account (HYSA)
A high-yield savings account or HYSA is usually offered by online banks. An HYSA usually offers a higher interest rate compared to regular brick and mortar banks. This means you will have the opportunity to grow your money faster with compound interest.
An HYSA is great for housing an emergency fund due to its higher interest rates.
There are plenty of banks for you to choose from, so of course, do your own due diligence.
Below is a chart comparing rates between some regular brick and mortar banks vs online banks with an HYSA.
|Marcus by Goldman Sachs
|Bank of America
An emergency fund is for getting you through an unexpected loss of income or covering large unexpected one-time expenses.
The emergency fund’s primary purpose is to ensure that you have the money you need to cover all your core financial expenses if you lose your job or method of earning income.
So, the rule of thumb is to have at least six months of expenses set aside in your emergency fund.
If you want to know how to set up an emergency fund from scratch, check out my article titled “How To Start An Emergency Fund As A Young or New Adult.”
Credit Score/FICO Score
Your credit score, or FICO Score, is a number calculated by considering multiple financial factors from your past like your credit payment history, number of credit accounts, and available credit.
To put it simply it is one of the most impactful personal finance terms every adult should know. It affects your capability to finance a lot of things.
What is your credit score used for?
Loan distributors and creditors use your credit score to determine your credit or loan eligibility.
Simply put, the better your credit score the better your chances will be of getting lower interest rates and higher credit limits.
More importantly, though, you essentially need a credit score to be able to apply for a mortgage, get a car loan, or an apartment lease. You even need a credit history to finance your new cell phone.
Pretty much establishing a credit history and increasing your score is one of the best things you can work on as a new adult.
What is a good credit score?
Credit scores fall between a range of 300 to 850. A good credit score is usually thought to be around the 670 mark. Credit scores that are over 740 are considered as being “very good.” And if you have a score that is above 800, you are usually considered to have excellent credit.
Now, if your score is around 650 or below, you are considered to have okay or poor credit. Your chances of getting approved and qualifying for more reasonable rates decrease with a score of 650 or below.
How Does A Low Credit Score or No Credit Hurt Me?
Having a low score or no credit at all will usually mean that lenders charge you higher rates with lower credit limits if you even get approved.
What Factors Determine My Credit Score?
I believe credit scores are one of the most important subjects to grasp early as a new adult. Because of that, below I explain the six biggest contributors to your credit score and the impact they have on it. Keep reading!
Very High Impact On Your Score
A history of on-time payments helps show lenders that you can manage credit responsibly. A payment that’s late 30 days or more is often reported to the credit bureaus. To help make sure you are not late on payments, set up autopay or bill pay reminders to receive notifications when your bills are due.
Oldest Credit Line
Moderate Impact On Score
The age of your oldest credit account shows lenders how much experience you have handling credit. So the older your line, the better. If possible, be sure to keep your oldest credit account open and in good standing. This can help build a positive credit history.
Credit Used ( Utilization )
High Impact on Score
If you use too much of your available credit, you may not have enough credit when you need it. To lenders, this could be a sign that you may be financially overextended.
The rule of thumb for utilization is to try and use less than 30% of your available credit. If you are just starting your credit journey, then it will be much easier to reach that 30% threshold. That is alright.
Remember that in order to build your credit you must use it.
So, keep in mind that using some available credit and paying it off monthly is usually better than not using any credit at all.
Note: If you have high utilization and pay the bill in full when it’s due, you usually see a slight drop in your overall score. However, it increases again once the bill payment is recorded.
Low Impact On Score
Having a few inquiries in a year is normal. However, someone with too many inquiries within a short period of time could be seen as someone who is financially overextended. You should mostly apply for credit only when you need it.
For most new adults, these inquires rack up when we are shopping around for credit accounts like a mortgage or auto loan. In these cases, try to keep the inquiries within a short time period, so when they do eventually fall off, they disappear in the same short time span.
Note: According to CapitalOne, most inquiries that appear in your credit file within a 14-day window are counted as a single inquiry.
Low Impact on Score
If you open too many accounts in a short period of time, lenders might begin to wonder if you are overextended financially. As always, be sure to apply for credit responsibly. Once you open an account, be sure to manage it well by paying your bills on time every month and only using as much credit as you need – remember that 30% utilization.
Low Impact on Score
If you don’t have enough available credit, a lender might see this as a sign that you might yet again be overextended financially and could be at risk of not being able to pay the money back.
For adults with lower limits, especially new adults, try and stick to the 30% utilization goal. As you show a history of controlled and responsible credit usage you will see your credit limit grow.
A 401(k) is the most common retirement plan. It is the plan that employers often offer, allowing employees to designate a portion of their paychecks to an account.
It is probably one of most common term that comes to mind when people think about personal finance terms every adult should know.
The money put into this account is considered pre-tax money. Your employer withholds your contribution from your paycheck before the money can be hit with the income tax.
Therefore a 401(k) is a tax-deferred account. The money gets taxed when you withdraw it.
Once you hit the qualified 401(K) age, which is currently 59 ½ years old, you gain access to the account. Any withdrawals from the account are then taxed as if it is income.
A 401(k) is a great way to start investing, especially since many employers offer matches. An employee match means you will pretty much get free money from your employer every year as a benefit up to a certain amount.
A rule of thumb is to always max out your match contributions to get as much “free” money as possible.
A Roth IRA is another common retirement plan. It is however different from a 401(k). An individual sets up a Roth IRA at an investment firm. They do not have to wait on an employer to do this.
Now, the Roth IRA is vastly different from the 401(K) because of how it is taxed. A Roth IRA is funded with after-tax dollars. Because of this, the money in the account grows and can be withdrawn tax-free once you reach retirement age.
Additionally, unlike a 401(k), a Roth IRA has yearly contribution limits. As of this writing, an individual can contribute a max of $6,000 a year to their Roth IRA account.
Calculate your net worth by subtracting your liabilities from your assets.
You can figure out your assets by adding your money, investments, and other asset account balances together.
You can determine your liabilities by adding together anything that you owe money on such as a mortgage or credit card debt.
Once you have both totals, just subtract the liability amount from the asset amount and that is your net worth. Don’t worry too much if you find that your net worth is very low or negative.
As a new adult, we often begin adulthood with more liabilities than assets. Just be sure to create a plan to grow your assets and minimize your liabilities.
What are your thoughts? Are there personal finance terms every adult should know that I did not cover? Share them in the comments below!
Best of luck adulting!
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About The Author
Donald Williams, Jr.
Donald is an avid believer in helping young people prepare for adulthood. He spends his time working on Adulting Starts Here and helping new adults plan for the future. In his free time, he enjoys spending time with his family and going to the beach.