8 important financial terms to help teenagers become savvier adults with money

As clients of HarperLees Financial Planning, it’s likely that you are familiar with terms including “pension” and “inflation”. Yet research by Aviva suggests that many young adults aged between 18 and 24 years are probably not so familiar, with just 57% understanding what inflation is and 61% of them knowing what a pension is.

The findings are particularly interesting when you consider the importance of these concepts when it comes to budgeting and ensuring your future financial security. So, against this backdrop, you might be considering helping your teenage children or grandchildren to understand financial expressions like these so that they can make better decisions with their money later on.

As financial education is something we are very eager to promote, read on to discover eight important financial terms you may want to consider teaching them, and a simple explanation of each.

1. Pension

A pension is a tax-efficient savings plan that allows you to put money aside to use as an income in retirement. If you have a defined contribution (DC) pension – otherwise known as a “money purchase scheme” ­– the money you place into it is invested so that it’s also exposed to growth potential.

This potential growth is also boosted by the government, which typically provides tax relief on the money contributed. As such, every £100 placed into a DC scheme usually costs you £80 if you’re a basic-rate taxpayer and £60 if you’re a higher-rate taxpayer. Additional-rate taxpayers may only pay £45.

While you can contribute any amount into a pension, there are limits on the amount that receives tax relief – especially if you’re a high earner. It’s also worth explaining to your teenager that if they save into a pension earlier in life, they could significantly reduce the contributions they need to make in order to achieve the standard of living they want in retirement.

2. Inflation

Inflation measures the rising cost of living – something we saw a lot of in 2022. This means that £100 today is likely to buy you more than it will in the future. To demonstrate this, you may want to consider the following example.

An inflation calculator reveals that you need £204 in January 2023 to have the same spending power as £100 in January 2003. This means that your cash had to grow by a whopping 104% to keep pace with inflation during the period, which averaged 3.6% a year – significantly lower than the UK’s inflation rate of 10.1% in January 2023.

If your money didn’t keep pace with this growth, its spending power would have reduced, meaning your cash fell in value in real terms.

3. Environmental, Social and Governance funds

Environmental, Social and Governance (ESG) funds allow investors to place their money into companies that are more environmentally and socially responsible. The heading describes the three main criteria that determines a company’s impact on society and the planet:

• Environmental – how the company’s operations affect the environment, including its energy use and how it manages its waste.
• Social – how the company treats its workers and suppliers, and whether it works with firms within its supply chain to ensure the ethical treatment of staff.
• Governance – how a business is run and managed, including whether shareholders can vote on key issues and how transparent the company is around accounting.

As more young adults are interested in investments that are socially and environmentally responsible, understanding the term “ESG” could be particularly important.

4. Compounding

Compounding is where growth or interest is added to the growth or interest your money has already accrued. A compound interest calculator reveals that at the end of 10 years you’ll receive a total of £9,816.65 if you invest £20,000 and receive an average compounded interest rate of 4% a year.

This compares to the £8,000 you would have received if you had received 4% on the original amount every year for 10 years. As you can see, “compounding” can boost growth potential. That said, if the interest you’re paying is compounded, such as on a credit card, it could result in your interest charges spiralling.

5. Credit score

Lenders and credit providers make their decision on whether to accept an application for a loan based on the applicant’s credit score. This is a record of how well they have managed previous or existing credit, which includes whether repayments were made in a timely manner.

Without a good credit score, any application for a loan or credit card is unlikely to be approved.

6. Investment

Investing refers to placing money into assets such as stocks and shares with the aim of increasing its value. As clients of HarperLees Financial Planning you will know that investing should never be entered into lightly as it carries risks and, typically, should always be seen as a long-term venture.

The latter is particularly important when you consider FTAdviser reveals that two-thirds of UK investors are willing to prioritise short-term gains. This could increase the risk of losses if the stock market suffers a downturn.

Furthermore, the article shows that 75% of investors feel forced to take more risk than they would like, which, as you know, exposes an investor to a greater chance of losses. This is why encouraging your children or grandchildren to work with a financial planner when they decide to invest could help them ensure they maximise their chances for growth potential and minimise the risks.

7. Asset and liability

An asset is anything of value that you own that can be converted into cash. Some assets, such as your home, could increase in value over time, while others, such as your car, could decrease in value.

A liability, on the other hand, costs you money, as it refers to expenses that you have. This may include a loan or debt, such as an overdraft on your bank account.

8. Interest rate

The interest rate is the amount you pay to a bank, building society or other lender when you borrow money from them. This is added to the amount you are borrowing, and paid off during the duration of the loan.

It is typically referred to as the annual percentage (APR), which includes the upfront fees that have been charged annually by the lender, and any other costs. So, if you borrow £1,000 at an APR of 10%, you will pay £100 in interest and charges over the year.

More often than not lenders refer to a “typical APR”, as they tend to offer different interest rates depending on your circumstances and credit score.

Get in touch

We hope the above list and short descriptions helps you teach your teenage children and grandchildren about these important financial terms. If you have any questions about your own finances, or know someone who you feel would benefit from talking to us, please get in touch as we’d be very happy to help.

You can email us on info@harperlees.co.uk or call 01277 350560.

Please note

This blog is for general information only and does not constitute advice. It should not be seen as a substitute for financial advice as everyone’s situation will be different.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change. The information is aimed at retail clients only.