Meaning of key terminologies in personal finance and family wealth management literacy

Net worth

• It is the total value of your wealth.
• Calculated as Total Assets – Total Liabilities.
• A positive (increasing) net worth indicates that you have more assets than liabilities, which is a good thing.
• A negative (decreasing) net worth shows that you have more liabilities than assets, therefore you may need help on personal financial planning.

Real Net Worth

• It is total value of your wealth less personal use assets
• Calculated as Net Worth – Total Personal Use Assets
• In other words; Real Net Worth = Investment Assets + Liquid Assets – Total Liabilities
• You should spend more money in investment assets than personal use assets in order to create more wealth

Asset

• Any physical or intellectual property that hold which raises your net worth or income
• For example, a rental building, rental car, business – and others
• Classes of assets are liquid assets, investment assets, and personal use assets including other valuable possessions

Liquid Assets

• Include cash (money in hand, mobile money etc.) and cash equivalents
• Cash Equivalents are liquid assets that can be converted into cash very quickly
• Examples: treasury bills (91-182 days), money market funds, merry go round / table banking

Investment Assets

• Comprise items that generate substantial income including higher fixed income and growth potential, depending on risk tolerance
• Examples: Treasury bills (364 days), treasury bonds, corporate bonds, bond funds, Savings and Credit Co-operative Societies (SACCO) shares, Real Estate Investment Trusts (REiTs),
• Rental property, farmland, stocks / shares (securities exchange), private equity / shares in own business, equity funds, balanced funds, investment linked life assurance policies, retirement schemes, investment groups – and others.

Personal Use Assets

• Consist of items of basic needs and others that people acquire to gratify egos, social approval or an elevated lifestyle
• Are “liabilities” in that they do not earn any money, instead, you spend money on them e.g. maintenance costs of a car, house etc.
• Examples: Personal or family residential house / home, personal cars, household furniture and properties etc.
• However, basic needs like housing, clothing and food must be affordable and meet the desired use

Liability

• Liabilities include loans, debts and financial obligations that you owe to others and it needs to be paid back
• They can be acquired to finance investments and personal use assets
• A liability also means something that costs you money without a compensating income, e.g. a residential house or personal use car that incurs maintenance costs
• A liability is not necessarily a bad thing such as mortgage to purchase a home or a loan to finance a well-managed business
• Before taking a debt, consider that:
  • It must be affordable
  • Benefit delivered from the loan must be higher than the cost of debt (interest)

Investment Liabilities

• Are loans acquired to finance investment opportunities like rental property, agricultural land, a commercial venture etc.
• Also referred to as good debts in the sense that they are used to finance income generating ventures or appreciating asset
• Caution on investment debts:
  • Get correct information about investment before taking the debt. This is because you will still be required to pay the debt even if the asset fails.
  • Ensure the return from the investment is more than the cost of the debt

Personal Liabilities

• Personal loans are acquired to finance personal use assets and other possessions, examples:
  • Home mortgage
  • Car loans
  • Credit cards
  • School loans
  • Equipment Loans (Asset Financing) etc
• Also referred to as bad debts, because the:
  • Personal use assets acquired do not generate income and
  • Benefits accruing from their use may be less than the costs of acquiring and maintaining them

Cash Flow

• It is a record of income (cash inflows), expenditure (cash out flows) and the net cash flow (balance) left after spending
• Main sources of income are:
  • Employment income: salaries, bonuses, commissions etc.
  • Passive income: business, farming, property rental income etc.
  • Portfolio income: interest, dividends, royalties etc.
  • Professional practice such as for lawyers, accountants, doctors, engineers etc.
  • Sports and celebrities
  • Inheritance – and others
• Basic Rules on expenditure
  • Do not spend more than you earn
  • Spend less than income and put the money left to savings and investments
  • Savings and investments will then earn additional income overtime to help you meet specific financial needs (goals)
  • Master your spending habits by budgeting and controlling your expenses