Financial Terms to Know

Posted on February 5, 2016 in AdviceSaving Money

11 Financial Terms Worth Knowing in Order to Reach Your Goals

One of the most intimidating aspects of managing money is the (often nonsensical) financial jargon. It sometimes seems like advisors, economists and bankers speak a different language, fraught with financial terms like ‘diversification’ and ‘proprietary.’ And what about the baffling phrases like ‘stalking horse bid,’ ‘triple witching’ and ‘style drift,’ which call to mind strange images that have nothing to do with money?

Don’t be intimidated
The truth is, understanding personal finance and investment terms shouldn’t be that complicated. The average person doesn’t need to know what the obscure investing terms mean—you just need enough information to save and invest wisely.

Like any specialized area, the financial sector is filled with professionals who toss around financial terminology that’s not typically used by those outside the world of investing, banking and economics. (In the same way, if you’re not an engineer, you probably don’t know what ‘kingpin inclination’ is—and that’s okay.)

But while you can safely skip over half the jargon you come across in the newspaper or on the web, there are a few financial terms you should make part of your regular vocabulary. “To truly have a handle on your finances and meet your goals, you need to amass some basic financial knowledge,” writes Nancy Mann Jackson over at DailyWorth.

Where to start
You could ask for clarification or look up the definition every time you hear a confusing piece of financial jargon—but in the end it’s better to familiarize yourself with the more commonly-used terms that ‘everyone’ is supposed to know (trust me, not everyone does).

Here are 11 financial terms and definitions to start you off on the road to financial success.

1. 401(k)
A 401(k) is an employer-sponsored retirement plan. Employees can contribute a percentage of their pre-tax earnings to their 401(k) account, where the money is typically invested in mutual funds or ETFs. Many employers will match up to a certain amount of your contribution, which is why you’ll sometimes hear advice like “invest in your 401(k) up to the amount that’s matched.” A match from your employer is literally free money.

2. Certificate of deposit
A certificate of deposit (also known as a CD) is kind of like a savings account, except that you choose a pre-determined length of time to keep the money in the account. Generally, the longer the money is in there, the higher the interest rate will be (meaning you’ll earn more interest on it – more free money). CDs can make sense if you feel the need to lock your savings away from yourself, but be aware in today’s low interest rate environment that there’s usually not much money to be made in these instruments.

3. Credit report/score
Prepared by a credit bureau or other institution, a credit report tells the story of your history with debt and gives you a three-digit score based on the results. Credit bureaus analyze things like the amount of debt you have and your history of paying debt on time. If you ever want to take out a credit card, a mortgage loan or a personal loan, you’ll want to take good care of your score – lenders use it to determine whether to lend money to you and at what interest rate (which affects how expensive your loan is).

4. Interest rate
You’ve probably heard much ado about interest rates in the news, but where you’ll actually experience them is with your loans and savings accounts. On the loan side of things, interest rate is the amount a lender charges you in exchange for lending you money. Savings accounts can have interest rates, too—albeit very meager ones these days. Interest rates differ across products and banks, but they generally follow the Federal Reserve’s fed funds rate, which is currently very low.

5. Annual percentage rate (APR)
You may see the interest rate for your credit card or loan displayed as an annual percentage rate (APR). This number represents the actual yearly cost of the money you’re borrowing, including interest and fees. For example, some loans charge origination fees (which is basically just an upfront fee for giving you a loan). The APR would include this fee, while the interest rate would not.

6. Diversification
When investing, it’s generally considered safer not to put all your eggs in one basket. This means that instead of putting all your money into one stock, you would buy multiple stocks (and maybe even some bonds, too). Diversifying your portfolio makes it more likely your investment can weather the ups and downs of the market over time.

7. Mutual Fund
While diversification is generally considered a smart strategy, most investors don’t have enough money to buy hundreds of stocks at a time. Mutual funds make that possible, by allowing multiple people to pool their money in one fund that buys hundreds or thousands of stocks (or bonds, or commodities, or whatever the fund’s focus is) on behalf of the fund’s investors.

8. Exchange-traded fund (ETF)
ETFs are like mutual funds that trade on the stock exchange. Both mutual funds and ETFs can give investors access to a diversified portfolio of securities (i.e. stocks, bonds, etc.), but ETFs tend to have lower management fees than mutual funds.

9. Index fund
Index funds are mutual funds designed to track a financial index. For example, an S&P 500 index fund would invest in the same 500 large cap U.S. company stocks that are included in the S&P 500 index. Investors often favor index funds because they’re diversified (see above) and because they tend to come with fairly low fees. And, FYI, Warren Buffett is a big fan.

10. IRA (individual retirement account)
An IRA allows you to invest for your retirement with some tax advantages. Similar to a 401(k), a traditional IRA allows you to make tax-deductible contributions on the front end (up to a certain amount each year). Your investments grow over time, then you pay taxes on the withdrawals you make at retirement. A Roth IRA is essentially the opposite – you put post-tax dollars into the account up front, then withdraw the money tax-free at retirement. In both cases, there are penalties for withdrawing the money prior to a pre-determined retirement date (currently age 70 ½).

11. Refinancing
Replacing an old loan with a new loan at a lower interest rate. The most common form of refinancing is with a mortgage loan, but you can also refinance student loans and even credit cards using another card or a personal loan. Refinancing has potential benefits like lowering your monthly payments and reducing the amount of money you spend on interest over the life of the loan.

Of course, there are plenty of other financial terms—both simple and complicated—that are good to know if you want to reach your financial goals. But the point is not to become an expert—rather, spend a little time familiarizing yourself with the basics, and you’ll get a lot back in return.

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