5 personal finance terms you need to know

The world of personal finance can often feel daunting. It may seem that it is filled with a multitude of complex terms and concepts to grasp. However, understanding these key terms is essential for anyone looking to succeed financially.

The sooner you familiarise yourself with some of these terms, the better equipped you will be to manage your finances. This will help you make decisions and create a sustainable financial future.

Whether you are an experienced investor or embarking on your investment journey for the first time, having a solid grasp of these foundational concepts can significantly enhance your financial literacy and empower you to achieve your investment goals.

Here are some key personal finance terms that you ought to know about.

Asset allocation

Asset allocation refers to the distribution of your money across various asset classes within a portfolio. It is a fundamental investment strategy aimed at balancing risk and reward based on your financial goals, risk tolerance, and time horizon.

The primary asset classes typically include equities (stocks), debt (bonds), gold, real estate, insurance, etc. Each of which reacts differently to economic conditions and market fluctuations. Diversifying across multiple asset classes can reduce the overall risk of your portfolio while potentially enhancing returns.

Diversification

Diversification involves spreading investments across different securities or asset classes within a portfolio to reduce the overall investment risk. The rationale behind diversification is that different assets react differently to market conditions and economic events. Holding various investments lowers the impact of an adverse event affecting one asset or sector and potentially mitigates it by positive performance in others.

You can combine more than one product to ensure that your money grows systematically while providing for the future. There are ULIP plans like the HDFC Life Smart Protect Plan. As a ULIP, it provides life insurance coverage and can create wealth. There are 4 plan options available for life cover and 7 different funds¹ to invest and optimise your returns. You have the flexibility to choose the premium payment option, maturity benefit, death benefit, Minimum Assured Benefit² in the form of capital guarantee even if there are market fluctuations, etc.

A dual product can aid in diversifying your portfolio and the risks you face while optimising your returns.

Long-Term Goal Based Savings

Savings is not just about setting aside funds for a rainy day. It is also about investing in plans that can help in creating a corpus for the future for you and your family. When you look at a plan like  HDFC Life Click 2 Achieve, you see that it is a plan that provides life insurance coverage, and can help in fulfilling your child’s future goals.

This plan has two options to choose from and comes with unlimited choices on premium payment, life cover, and survival benefits. It also comes with a built-in premium waiver in case of death, critical illness or total permanent disability, monthly income under ‘Monthly payout mode’, and increasing income by up to 10% p.a³.

Portfolio rebalancing

Portfolio rebalancing is a strategic process of periodically buying or selling assets within your investment portfolio to realign them with your desired asset allocation. Portfolio rebalancing is a proactive approach that helps maintain your preferred risk level and ensures that your portfolio remains in tune with your long-term financial objectives, even when market conditions fluctuate.

Risk tolerance

Risk tolerance signifies how much you are willing to risk losing in your investments. When you are younger, you might have a higher risk appetite as you have more time to recover from potential losses. However, your risk tolerance may decrease as you age, particularly as you approach retirement and prioritise capital preservation.

Understanding your risk tolerance is essential as it helps you determine your asset allocation strategy. There are multiple low-risk assets like term insurance that can work best for you. High-risk assets like stocks can make equity work for you if you are willing to take the risk that comes with market fluctuations. It is always best to ask a financial advisor or planner to understand the rate of returns you may get on both low-risk and high-risk assets.

Having a good handle on concepts like asset allocation, diversification, risk tolerance, etc can make a difference. It helps you stay on track, make smart decisions, and adapt to whatever twists and turns come your way.

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ARN: ED/03/24/9925