Financial vocabulary is often opaque and difficult to understand for those who don’t have a professional or educational background in the field. But the fact is that many of the terms we so often hear thrown around in economic contexts are tied to our financial wellbeing.
That’s why it’s critical to understand some of the most frequently used terms in finance. They’re the building blocks of the systems and concepts that impact our bottom lines and influence how our money works.
Take a look at these 10 financial terms you should know.
You’ve probably heard “net worth” applied to very wealthy people like Warren Buffet or Bill Gates. These folks are often referred to as “high net-worth” individuals because of the vast sums of money they’ve accumulated. But the truth is that everyone has a net worth. The term refers to your assets, like equity in your house, car, and savings account, relative to your liabilities, such as debt or loans. Tracking your net worth over time shows your progress toward goals that you may have, like paying for retirement or saving for a big purchase.
Another everyday term with nuanced financial meanings is “interest.” In financial contexts, interest is the price you pay to borrow money or the cost you charge for lending money. It’s a percentage of the total loan, or the principal, added to the repayment. Interest rates fluctuate depending on many market factors, but the higher the interest rate, the more you’ll pay back.
A frequent buzzword among politicians, inflation refers to the increase in the cost of goods and services over time. If you’ve noticed that your grocery bill is higher than it used to be even though you’re purchasing the same products, then you’re seeing inflation firsthand. Understanding how inflation works is essential to keeping your costs under control.
Simply put, asset allocation is where you place your money. This refers to major asset classes, including stocks, bonds, and cash or cash equivalents. Each of these placements has its own benefits and drawbacks, but all are considered important to maintaining a diverse, balanced portfolio.
Your FICO Score is your credit score. This is a number based on your credit history, payment history, and amount owed. It tells lenders how reliable you are when it comes to paying back debt. FICO scores range from 300 to 850, with higher scores resulting in better loan terms and more approvals for borrowing.
Capital gains are the profit you make when you sell an investment for more than you paid for it. So, if you bought your house for $150,000 and sell it for $350,000, your capital gain on that purchase is $200,000. However, if you sell investments for less than you paid, you can also incur a capital loss. Each has different tax implications that can impact your overall financial picture.
If you work for a big company, there’s a good chance that your compensation package includes stock options. Companies offer these as incentives to managers or for sticking with the company for a long time. You’re given the option to purchase stock in the company for a pre-set price, which often means you can buy a stake in the company for a lower rate than you’d find on the market. These can be important when considering compensation packages for a new job or perhaps as a new incentive at work.
Annual Percentage Rate And Yield
You’ve probably heard about APRs and APYs for years, but what do those acronyms really mean? Annual percentage rate is the total amount it will cost you to borrow money per year, whether it’s through a loan, credit card, or other vehicle. APRs include the interest rate and any fees. Conversely, annual percentage yield represents the total amount you’ll earn on an investment or savings account.
It’s essential to keep the right mix of investments in your portfolio and invest based on your risk tolerance. As the market changes, rebalancing allows you to maintain a steady asset diversity and risk management baseline according to your goals. You can accomplish this by buying and selling different assets to align your portfolio with your expectations and keep your investments healthy.
If you have an account with compounding interest, as your account earns interest, future interest payments are made based on the new total in each reporting period. It’s often thought of as “interest on interest” and can be lucrative over long periods. Popular retirement accounts, like 401(k)s, use compound interest to grow investors’ money.
Financial terms can seem tricky and confusing, but they don’t have to be mystifying. Most of them have a relatively simple definition that you can apply to your decisions. This leads to better outcomes and a more secure financial future.