In finance, means not putting all your eggs in one basket, but instead choosing to invest in range of investments to reduce the risk of losing some or all of your money.
Think of the plates and china in your house: you have different sets, with different qualities, shapes and sizes. Their values are different and costs are different. Some you use daily; others you keep on the top cabinet or in a case for special occasions, to reduce the risk of wear and tear or stop them from breaking! It’s the same thing with your money – you don’t want to lose it, so rather than buy the same investment (plate), you buy different ones.
In finance, the equivalent would be to own some shares, bonds, property, maybe a little bit of gold etc.
How do you allocate your resources (time, money) to between the various things you need and want? There never seems to be quite enough. Economics is the study of the decisions we make to obtain the best (optimal) outcome for ourselves, given the constraints we face.
Imagine that you have £1,000. But you need to buy a new TV for your house, a new sofa, a car, and some new clothes, do the food shopping. The £1,000 may not be enough for all this.
Economics is all about making the most of your situation, and getting the best deal possible to meet your needs with what you have. It focuses on your behaviour, and by extension your interactions with others and the outcomes of those interactions.
A term used in finance that refers to the price of items rising over time.
Imagine you go to the market to buy some fruit and veg. You find a guy with a stall with good quality produce. You end up spending £5 on a bag of fruit and veg. You then come back the week after to buy the same things you bought last week. This time it ends up costing you £6 for the same amount you got the week before. This is inflation. It’s when the price of something rises over time, so you can’t get the same amount for your money.
[There are many reasons this can happen: the harvest could have been bad due to weather, so there’s not as much available and so it costs more; farmers went on strike; the government banned it due to health scare.]
Share – gives you ownership in a company; a slice of everything the company owns.
Imagine we bake a pie, and we slice it into 10, and 10 people buy a slice each. This means each got a slice, or share of the pie. It’s the same thing here. You can buy a slice, or share, of a company. This means you own a share of its net assets – the difference between what the company owns, like its office block and computer screens and desks, minus the stuff it owes to others, like its tax.
Still don’t fully understand? Imagine you and your mates put some money together to buy lottery tickets. That means you own a part of those lottery tickets, and if one of those tickets wins, you own a bit of that money. It’s the same as buying a share in a company. It means you own a bit of what that company owns. You are called a shareholder.
A share is also known as a stock. Its value (known as return or profit) can change from day-to-day, month-to-month, year-to-year. Because you own a share of the company, it entitles you to receive dividends (a type of income) if the company issues one. Dividends are a type of payment you receive when the company is doing well and making money, like a bonus at work.
A shareholder is someone that owns a share in a company – a slice of that company. You have certain rights as a shareholder, which can include:
Being able to sell your share(s)
Being able to vote in the decisions of the company, similar to how you vote for your MP or in a referendum
Being able to buy more shares
Being able to receive dividends (a type of income like a bonus at work)
A type of payment you receive from a company for being a shareholder when the company is doing well. It is similar to you receiving a bonus a work; if your company is making profits, then you may receive a bonus. This size of your bonus depends on how well the company has done. It’s the same for your dividends. An equal amount is set apart for each share.
So if the company has 10,000 shares, and pays £10,000 in dividends, each share will receive £1 (£10,000 ÷ 10,000 shares). If you have 2 shares, for example, it means you would receive £2 (£1 per share * 2 shares).
Inflation on steroids!
That bag of fruit, instead of going to £10, goes to £20, then £30, £40... and soon enough it's costing £100!
Hyperinflation is generally accepted to occur when prices increase by over 50% in a month
Risk, in finance, refers to the unpredictability surrounding your investments, and the potential for them to perform negatively and result in a financial loss.
Compare this to Thorpe Park (or any other amusement park. You may not want to go on some of the rides due to fear, but then you may not have as much fun. That’s fine; because we all have things we're comfortable and not comfortable with. If you’re not comfortable going on some of the extreme rides, this is known as risk aversion. If you don’t mind which rides you go on, this is being risk neutral. If you only want to go on the extreme rides, this is known as risk lover. It’s similar when it comes to finance.
Different investments have different levels of risk, which affects how likely you are to: a) lose your money (feel sick when you come off the ride; b) keep your money (you feel fine when you come off the ride), and; c) make some money (want to go on the ride again).
A type of I.O.U. It is used by companies and governments to raise money for their projects. These bonds are loans that pay you interest (known as a coupon, over the life of the loan, which can typically be anywhere from < 1year to 30 years. The company or government will then return the money you originally loaned them at the end of the loan.
Government bonds are known as sovereign bonds.
An interactive note on bonds is available here.
A type of payment you make (receive) if you’ve borrowed money (saving money). The amount of interest you are charged (given) depends on the size of the money you borrowed (saved).
Think of it as a sort of penalty or reward depending on who’s doing the lending.
For example, when you put money into your bank account, you receive some interest every month on that money. If you use pay-day loans or credit cards, you are charged interest on the money you’ve borrowed.
Return, in finance, refers to the actual profit or loss you make on your investments. It's how much money you make or lose on your money
Like the lotto tickets you bought with your mates or colleagues; when the draw is made, you either make money (the lotto prize fund), or you lose (the money you spent on the tickets). How much you make or lose is called performance. If you get none of the numbers, you lose your money; if you get some of the numbers correct, you may win some money; if you get all numbers, you win a lot of money. A loss is known as negative return. In finance, it’s the same story with your investments.
The return is consists of:
The change in the value of your original investment (known as capital appreciation)
any interest you receive on top.
The performance of your investment can change from day-to-day, month-to-month, and year-to-year.