Building long-term financial success involves more than securing a good job. Even a high-paying career might not be enough to create real wealth unless you understand basic financial concepts. In addition to building a financial safety net, you’ll need to grow your savings, practice lawful tax planning, and maximize your retirement accounts. Then, all the hard work you put in through your career will truly pay off.
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Here’s a look at the key terms that every first-generation American should know when it comes to investing, taxes, insurance and retirement planning, including the foundational basics that underlie all of them.
If you’re looking to make informed financial decisions and build generational wealth, you should become familiar with each of these concepts.
Compound interest is simply “interest paid on interest.” If you have $1,000 and earn a 10% return, you’ll have $1,100. If you earn another 10% the following year, you’ll have $1,210. In the first year, you earned $100, but in the second year, you earned $110 because you earned interest on your interest.
Over time, the effects of compound interest can be dramatic. Let’s say you start with a $10,000 investment and earn an annual return of 10% for 30 years. With simple interest, you’d earn $1,000 per year, for a total balance of $40,000 (your original $10,000 plus the $1,000 you earned each year for 30 years). But with compounding, that $10,000 becomes about $174,494 after 30 years — far more than simple interest and a vivid example of why starting early matters.
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Diversification refers to blending a mix of different types of investments in your portfolio so that you can reduce risk while preserving return. Owning different asset classes, such as stocks, bonds and real estate, can be a way to level out the ups and downs of your portfolio because these investments don’t always move the same way at the same time.
Within an all-stock portfolio, owning so-called “defensive” stocks that hold up better during market downturns can reduce the downside risk of more aggressive growth stocks.
Your net worth is simply your total assets minus your total liabilities. Assets include the value of your home, car, 401(k), savings and investment accounts and other possessions. Liabilities include your mortgage, auto loan, credit card balances and any other debts.