Last year, we came out with an article about how financial literacy was declining among Aussie youths, among other nationalities (hey, we Pinoys also know that mitochondria is the powerhouse of the cell, but still get tripped up by a tax return form every single time).
It’s really quite a crying shame that practically nothing in our fifteen or so years (more if you went on to medicine or law) of education really prepared us to be a fully-functioning adult, especially where money is concerned. We know what it takes to save up and buy a few things, but very few of us know how to multiply our money, short of working two or three jobs at once.
As further proof that majority of us are managing our finances in varying degrees of misunderstanding, here are five common terms that tend to get us all mixed up:
This term refers to a contractual financial product, which you’re supposed to fund regularly for a fixed period. After which, it’s supposed to provide you with a stream of payments, much like a pension.
Some people tend to look upon annuities negatively because the money you store in them can’t really be used until the fixed period is up. (Otherwise, you’d be charged fees for pre-terminating the investment.) Yet, while annuities might not be the most liquid financial vehicle, they can still be a beneficial part of your long-term portfolio, not least because they’ll prevent you from frittering away a portion of your income while guaranteeing future returns.
However, it’s important to note that having several variants of just one asset class, such as having ten different mutual funds or even ten different kinds of stocks, doesn’t necessarily equate to diversification. Markets work in cycles, so it’s likely that while one asset class is underperforming or down, the others are either holding steady or possibly even thriving. The goal of a diversified portfolio is to reduce your exposure to one asset class so that your financial standing isn’t drastically affected during a downturn, what with other assets continuing to hold up their end to compensate.
3. Fee-Based vs. Commission-Based.
Brokers and advisors typically earn money by handling that of other people’s, and fee-based compensation packages are quite different from commission-based ones, though they may sound similar.
For starters, fee-based compensation is fixed, usually upon a set percentage of a client’s total assets. In this set-up, your advisor or broker earns the same regardless of how many trades you make or how many asset classes you buy into, so long as the capital remains the same. Commission-based compensation is quite the opposite.
Thus, to avoid buying an asset which could potentially benefit your advisor or broker more than you, ask about how they are earning off the transaction first. Those on a fee-based commission will have to disclose their fees, and also have a fiduciary responsibility to their clients, which means they have to prioritize the latter’s interests. On the other hand, financial professionals working on commission only have a suitability responsibility. This means that so long as an asset fits their clients needs and timeline, they can put the client’s funds there, even if doing so might benefit them more than their client.
4. Financial Advisor.
Speaking of advisors, the term “financial advisor” is being bandied about far too liberally these days. We might think that anyone who calls themselves this should be qualified to coach us on how to manage our money, but the truth is, “financial advisor” is more of a generic, blanket term.
Stockbrokers, insurance agents, investment managers, tax preparers, and estate managers all fall under the said term, but there is hardly anyone with that title who can perform all the aforementioned functions. These days, most people who call themselves “financial managers” are usually insurance agents, and while they can probably help you avail of the best insurance package, they can’t really do much else if your needs call for something different.
To get the best results from a consultation, figure out what sort of financial advise you need first. Do you need help mapping out a financial plan? Figuring out how to transfer your parent’s property over to you? Or do you simply need investment advice? This way, you can determine if your prospective advisor’s specialty lines up with what you require.
Strictly speaking, volatility pertains to how uncertain or risky an asset is, particularly how abruptly and/or drastically its value might change over time.
Many of us consider volatility to be a negative, which is understandable when a highly volatile portfolio can go from doubling in value to being reduced by half within the same week. However, the absence of volatility isn’t really a good thing either, especially when it comes to long-term investments. No volatility means no risk, which, in turn, means no reward or return, and that completely defeats the purpose of investing in the first place.
This is where diversification (see item no. 2) comes in. By all means, put your money into low-risk, liquid assets which you can draw from in a pinch, but be sure to put aside enough that you can invest in comparatively more volatile instruments so that you don’t miss out on some serious future gains.
It’s not our fault if our schools failed to teach us the basics of financial management, but we do have a responsibility as adults to address that deficiency. Plus, with all the information available at your fingertips these days, there really is no excuse not to educate yourself further, no?