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Understanding a core group of financial concepts can make the difference between retiring comfortably and never being able to retire. Most high schools and colleges don’t teach financial literacy, and as a result, many of us have to learn the hard way to manage our money. The good news is you don’t need a degree in finance to get the most out of your employer-provided 401(k) retirement plan.
Basic Financial Concepts
Five financial concepts that will help you make the best decisions for your money. These concepts are:
- Return on Investment (ROI)
- Opportunity Cost
- Fees
- Compound Interest
- Diversification
All of these concepts are related to each other. The better you understand each of them, the easier it will be to make sound financial decisions.
Return on Investment
Return on investment (ROI) is the most important number for your financial health. This tells you how much money you are making from an investment. The most financially successful people work hard to maximize their ROI. Your 401(k) will give you a better ROI than putting your money in a savings account. However, as your income grows, you may find other investments that offer an even better ROI. You are in charge of your money and your retirement savings. You can use ROI to make sure your money is working as hard as you are.
Opportunity Cost
Opportunity cost, a fundamental concept in decision-making, implies that choosing one option comes at the expense of others. Just as you can’t spend the same five dollars on both a latte and lunch, decisions involving your retirement account carry their opportunity cost. Failing to maximize your contribution may mean forfeiting additional compounding benefits or employer-match contributions. If you have a more lucrative investment strategy in mind, the opportunity cost might be acceptable. However, neglecting to consider opportunity costs may lead to suboptimal financial decisions. Ensure you weigh these costs carefully for informed financial planning.
Compound Interest
Compound interest can either be your best friend or your worst enemy. When you carry significant credit card balances, compound interest is working against you. Every month it costs you more money just to have borrowed that money. However, when you invest money in your employer-provided 401(k), you are making more money over time just for having the foresight to have invested it in the first place.
Fees
One of the most significant threats to your retirement savings is often overlooked—fees. While fees might seem insignificant compared to your overall account balance, a mere one or two percentage points in fees can translate to the loss of tens of thousands of dollars over time. Paying fees comes with an opportunity cost, as it means having less money available for leveraging compound interest. As part of your investment decision research, it’s crucial to understand the fee structure to make informed choices that maximize your retirement savings.
Diversification
What does your retirement savings look like? Is everything in your 401(k)? What happens to your investments if there is a recession? Blindly saving money and hoping everything turns out okay is not an investment strategy. You need to understand the risks you are taking. All investments carry some risk. You can use diversification to protect yourself against some risks. As your income and investment income grow, you want to invest in a variety of different asset classes with varying levels of risk.
The better you understand diversification, the more secure your retirement investments will be.
Talk to an OmniStar Advisor today. We can illuminate the blind spots of your financial plan.
