Financial vocabulary is often opaque and difficult to understand for those who have no professional or educational training in the field. But the fact is that many of the terms we hear so often in economic contexts relate to our financial well-being.
This is why it is essential to understand some of the most frequently used terms in finance. They are the building blocks of systems and concepts that affect our bottom line and how our money works.
Here are some of the 10 most important financial terms you should know.
You’ve probably heard that “net worth” applies to very wealthy people like Warren Buffett or Bill Gates. These people are often referred to as “high net worth” people because of the huge sums of money they have accumulated. But the truth is, everyone has net worth. The term refers to your assets, such as the equity in your home, car, and savings account, versus your liabilities, such as debt or loans. Tracking your net worth over time shows your progress towards goals you may have, such as paying for retirement or saving for a big purchase.
Another common term with nuanced financial meanings is “interest.” In financial contexts, interest is the price you pay to borrow money or the cost you charge to lend money. It is a percentage of the total loan, or principal, added to the repayment. Interest rates fluctuate based on many market factors, but the higher the interest rate, the more you will repay.
A frequent buzzword in politics, inflation refers to the increase in the cost of goods and services over time. If you have noticed that your grocery bill is higher than before even though you are buying the same products, then you are seeing inflation first hand. Understanding how inflation works is key to controlling your costs.
Simply put, asset allocation is where you put your money. This refers to major asset classes including stocks, bonds, and cash or cash equivalents. Each of these investments has its own advantages and disadvantages, but all are considered important for maintaining a diversified and 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 repaying debt. FICO scores range from 300 to 850, with higher scores translating to better loan terms and more loan approvals.
Capital gains are the profit you make when you sell an investment for more than you paid. So if you bought your house for $150,000 and you 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 may also incur a capital loss. Each has different tax implications that can affect your overall financial situation.
If you work for a large company, chances are your compensation package includes stock options. Companies offer them as incentives to managers or to stay with the company for a long time. You have the option of buying shares of the company at a predefined price, which often means that you can buy a stake in the company at a lower rate than what you would find in the market. These can be important when considering compensation packages for a new job or perhaps as a new work incentive.
Annual percentage rate of charge and return
You’ve probably heard of APRs and APYs for years, but what do these acronyms really mean? The annual percentage rate is the total amount it will cost you to borrow money per year, whether through a loan, credit card, or other means. APRs include the interest rate and any fees. Conversely, the annual percentage return represents the total amount you will earn in an investment or savings account.
It is essential to keep the right mix of investments in your portfolio and to invest according to your tolerance for risk. As the market moves, rebalancing allows you to maintain a stable asset diversity and risk management baseline based on your goals. You can achieve 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 compound interest, as your account earns interest, future interest payments are made based on the new total for each reporting period. It is often referred to as “interest on interest” and can be lucrative over long periods of time. Popular retirement accounts, like 401(k)s, use compound interest to grow investors’ money.
Financial terms may 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, leading to better results and a more secure financial future.
Finance FYI is presented by 1st Security Bank.
To 1st Washington Security Bank, we take a personalized and personal approach to your financial well-being. We live in the communities we serve, so our branches offer tailored solutions to their communities. We believe relationships make the difference, which sets 1st Security Bank apart.