5 things you must understand about money as a grown-ass adult
You're a grownup. You know you should be worried about the economy right now. You know you need to pay your rent, student loan repayments and credit card bills on time. You know you deserve a raise (and need to practice the right way of asking your boss for more cash). And you know you should spend less.
Maybe you even got five out of five on this financial literacy test.
But you still have loads of unanswered questions about money.
How do you grow more of it? Which bank should you use? Which credit card is best? How do you improve your credit score? Which health insurance should you choose? And what does it mean, exactly, to refinance your student debt?
While there's no end to the list of financial concepts you could still learn about, at a certain point, you need to call it: There's only so much time in a day for busy adults.
With that in mind, Mic compiled five key — but undersung — concepts that all grownups should but don't always understand about money.
Here's what you really need to know.
The difference between a credit card and a debit card
If you carry a debit card and a couple credit cards you may use them interchangeably. But did you know there are better times to use credit versus debit?
First, the main difference between debit and credit cards: A debit card pulls money directly out of your bank account to pay a retailer. It's like writing a check, but faster — the money comes out of the account almost immediately.
Meanwhile, a credit card allows you to essentially borrow money to make a purchase. The money isn't coming from your bank account; you're borrowing it to purchase the item, and receiving a monthly bill for use of credit.
The best times to use a debit card are when you are trying to closely monitor your spending and you don't want to overextend yourself.
With a debit card, you can access only what's in your bank account. For this reason, many people prefer using debit as a way to keep track of and control spending. You are not borrowing anything and once a purchase is made, it is simply bought and paid for — there's no bill to settle.
What makes debit cards so appealing can also make them dangerous. If you can spend only what you have, so could anyone who steals that card — and they're likely to spend all of what you have.
The differences between a stolen credit card and a stolen debit card are significant: This is why you should never let your debit card out of your sight.
Read more about the difference between debit and credit cards here.
How compounding works
Would you rather get $100,000 a day for a month — or a penny on the first day that doubled every day of the month? It might seem tempting to snag the $100,000 a day: You'd end up with about $3 million at the end, after all.
But that penny? You'd end up with nearly $11 million by the end on the month.
That's because of the power of compounding. Compounding is your friend: It means your money grows by leaps instead of baby steps.
You may have heard it called compound interest. This exponential growth happens because the amount of interest gained in each period is a percentage of an ever bigger number that includes your original investment and its growth.
It's a big reason why financial experts often recommend reinvesting money you earn on your holdings.
Here's a simple example: Let's say you make a smart $1,000 investment. In the first year it earns 20% — lucky you! Now your entire investment is worth $1,200. In the second year, the investment grows by another 20%. Now your investment totals $1,440.
Note that the total is not $1,400 — which is what you would have ended up with if you got only another $200. Instead, the 20% applies to the new amount, netting you an additional $240.
In the next cycle, assuming the same rate of growth, you'd earn 20% of $1,440 — so your investment will go up by $288. And so on.
Now that you understand the math, you can see for yourself how much compounding might earn you by using this interest calculator from the Securities and Exchange Commission.
What "diversification" means
No, this doesn't have to do with improving racial or gender diversity in the workplace — though that's important, too.
In the financial world, diversification is an approach to managing risk by making sure you have a well-rounded mix of different investments as you try to grow your money. To put it simply, you don't want all your eggs in one basket.
For example, if you use all your investment money to buy many shares of a single stock — instead of buying a few shares of several different stocks — you're risking steep losses, should that one stock fall.
You don't want to be that unlucky investor whose single stock dropped by 40% in a day: You could wipe out your savings in the blink of an eye.
And even if you buy different stocks, but they are all in the same industry — say, retail stores — and then there is a trucking and transport strike and the stores cannot get their goods, your stocks will fall all together: It's called correlation, and it can happen across geographies as well as industries, too.
Diversification may also mean you hold a diversity of asset classes (not just stocks, but also bonds, and maybe real estate). And the concept can even extend beyond investing to areas like career planning — where it pays off to have a diversified skill set — as well as tax planning.
For example, one argument for using Roth IRAs and Roth 401(k)s is tax diversification: These types of accounts are a hedge against the possibility that you end up in a high tax bracket during retirement. With regular or traditional tax-deferred IRAs and 401(k)s, you pay tax in the future, when you withdraw money; with Roth accounts, you pay tax now so you don't have to later.
What "the time value of money" means
The time value of money is a principle that holds that money available right now will be worth more in the future because of its earning potential.
Understanding this principle will help you better understand the power of compounding as well.
The idea is that the faster you get your hands on money, the more quickly you can put it into an investment that will earn interest and grow bigger.
The ingredients you'll need to put together the future value, or "FV," of your money are: the present value, PV; the interest rate, i; the number of compounding periods a year, n; and the number of years the money is invested, t. Or: FV = PV x (1 + (i / n)) ^ (n x t).
Let's say we have a $1,000 investment. That's the present value. We're going to invest it for one year at a 10% interest rate.
It would look like this: FV = 1,000 x (1 + (10% / 1) ^ (1 x 1). The future value of this investment is $1,100.
That's $100 more than you started with. And now that you understand the math, you can use this calculator to figure how much your money could make you over time.
The difference between the debt and the deficit
Everything else on this list so far has been about personal finances, but it's also important to understand how financial forces work more broadly in society.
Here's a breakdown: The deficit is the amount by which a government's expenses are greater than its revenue during a financial year. The debt is the total amount of money a government owes to the folks it needs to pay back.
Boiled down, a deficit is a one-year figure, debt is all money owed. Or in an analogy: The deficit is one tree, the debt is the forest.
This year's U.S. deficit, just announced on Oct. 14, is higher than it was last year: It is now $587 billion, up from $438 billion, which comprised 2.5% of the gross domestic product (essentially, the economy).
That's not good: While running deficits can have upsides, particularly if they provide business stimulus, one of the best reasons to keep them low during good times is it's then easier to widen them with spending when you actually must — say, during a recession, when people need more food stamps.
The federal debt is the whole amount of money that the U.S. government owes to its creditors. That's any individuals, businesses, governments and other groups that hold debt securities, such as government bonds.
Currently national debt stands at nearly $19.8 trillion, with about $14.3 trillion of that held by the public and the rest held within the government.
High levels of debt, especially relative to GDP, can be a sign that a country's economy is at risk.
Read more about the difference between the debt and the deficit here.