A Super-Sexy Glossary of All the Money Terms You Need to Know
You’ve been spending money since, well, always. But if someone were to quiz you on the definitions of the most major—and minor—financial terms, you’re not 100 percent sure how you’d do. (Hey, everyone confuses the difference between a traditional IRA and a Roth, right?) That’s why we tapped Priya Malani, founder of financial planning firm StashWealth, to give us the non-jargony scoop.
APR. This stands for Annual Percentage Rate—aka the rate of interest that’s assessed to you on money you borrow. If two people borrow the same amount of money, the person with the lower APR will pay less over the life of the loan. Generally, the better your credit score, the lower your APR. All kinds of loans including mortgages, car loans, lines of credit and credit cards have an APR. Because the APR is inclusive of additional fees or credits that may apply (for example, closing costs in the case of a mortgage) it’s a great indicator of the true cost of your loan (as compared with the base interest rate).
FICO Score. For the record, FICO used to be known as the Fair Isaac Corporation until a big effort to rebrand in 2009. (Good move, guys.) While there are three major credit reporting agencies—Equifax, Experian and TransUnion—FICO developed its own model to evaluate your creditworthiness and calculate your FICO score. This number is used when you borrow money to buy things like a car or a home. The higher the FICO score, the better the loan in most cases. (Keep in mind that standard FICO scores range from 300 to 850, but there are industry specific scores that might go as high as 900, like for a car loan.)
ROI. Short for Return on Investment, your ROI can be positive or negative depending on whether the thing you invest in goes up or down in value. For example, if you buy a home and after five years, it’s gone down in value, you have a negative ROI. But if the home goes up, you have a positive ROI. Here’s the rub: You won’t know what your ROI is until you make an investment.
Compound Interest. This term is commonly tied to investing and described as “your money making money.” In other words, when you save or invest money, you earn interest on that money. In the first year, whatever you save will grow by the rate of interest. But the next year, not only will your savings grow by the rate of interest, but so will the interest you earned the previous year.
Money Market Account. This is basically a traditional bank account where you can keep cash savings. The good news: It usually offers a higher interest rate than a typical checking or savings account. The not so great news: MMAs tend to have a few stipulations (like minimum account balances) before your account qualifies for the higher interest rate.
High Yield Savings Account. High Yield Savings Account are like regular savings accounts except they pay a higher than average interest rate on your balance—typically 1.8 to 2 percent (versus the the standard .25 percent you’d earn with a non HY account.) That said, not all HY savings accounts are created equal—so it’s important to do your homework. Some may require minimum balances or come with hidden fees. These days, the most popular HY savings accounts are found at online banks, like Ally, Marcus and CapitalOne360 (but there are a ton of others popular ones like Barclays, Amex, etc.).
Stocks and Bonds. When a company needs to raise money, it has the option to issue stocks or bonds to the general public. In turn, you have the option to give them money by purchasing its stock or bonds. By buying stocks, you are essentially buying a very small piece of the company. If the company does well, your stock will go up in value. If the company does poorly, your stock will go down in value. If you buy bonds, it means you are loaning the company your money in return for an interest (income) payment and the eventual return of the amount you loaned. Stocks and bonds do not guarantee repayment.
Diversification. In a nutshell, this is a fancy way of saying, “Don’t put all your financial eggs in one basket.” Every investment has a different level of risk associated with it. When you make an investment, you want to spread your risk over different companies, industries and even countries. This is very difficult to do if you’re young and don’t have a lot of money to invest. This is why ETFs (and/or Mutual Funds) are a great diversification tool.
ETFs. Exchange Traded Funds are the newer, cooler Mutual Funds. An ETF is a way to invest in the markets without having to go all in on a single stock, which can be a risky move. Instead, ETFs contain a preselected collection of stocks and bonds, so that if a single stock or bond is performing badly, there's a chance another one in the batch will even it out and help minimize loss. ETFs are also usually cheaper than Mutual Funds and they are considered “more liquid” because you can buy and sell them throughout the trading day, whereas Mutual Funds can only be bought/sold once a day, at the end of the trading day.
Mutual Funds. The older version of ETFs, Mutual Funds were created to allow investors to get access to a bunch of stocks with a single trade. Most Mutual Funds are actively managed, whereas ETFs are passively managed. Active management means a team of professionals are in charge of deciding which stocks the mutual funds should contain and in what mix. Passive management does not involve a team of professionals. Instead the fund is linked to an index, like the S&P 500—a list of the 500 largest publicly traded companies like Facebook or Johnson & Johnson, all weighted by market capitalization—and contains those exact 500 stocks.
Traditional IRA. IRA stands for Individual Retirement Account. There are many different kinds, such as a Traditional IRA or a Roth IRA, but similar to a 401(k), the point of an IRA is to save—and invest—money for retirement. With a traditional IRA, you can make contributions (up to $5,500 per year) with money you may be able to deduct from your tax return and any earnings have the potential to grow tax-deferred until you withdraw them when you retire. (Tax-deferred means that if your investments pay income—like a dividend—in a given year, you don't have to pay income tax on those earnings until you use the money in retirement.)
Roth IRA. A Roth IRA, on the other hand, allows you to save for retirement using after-tax dollars (money from your checking account). The big benefit of this account is that your contribution grows tax-free and when you go to use the money in retirement, none of it will be taxed again. This is a really great option for people who expect to be in a higher tax bracket when they retire than they are presently—in other words, they will pay less in taxes over the lifespan of the account.
Rule of 72. This is a simple way to approximate how many years it will take your money to double in a specific investment. To calculate it, divide your expected rate of return by 72. For example, historically, a diversified portfolio invested in the market has earned approximately 8 percent per year over the long run. (72/8 = 9.) This means that if your portfolio averages 8 percent per year, you can expect your money to double every nine years. What’s cool is that it takes the exact same amount of time for your money to double, no matter what the value is. So, it will take nine years for $10K to become $20K, but also nine years for $20K to become $40K. In other words, the sooner you start investing, the more opportunities you have to double what you put in.
Vesting. When you are awarded additional compensation from your company in the form of equity (stock options) or an employer match on your 401(k), that money is normally held hostage by the company for a period of time to protect the company from employees that might quit right after receiving it. The vesting period is the amount of time you need to remain at the job before the money is officially yours, regardless of whether you leave the job. The most common vesting schedule is four years, with 25 percent of the award vesting each year.
Tax Withholding. This is the rate at which you choose for funds to be taken out of your salary to cover income taxes in a give year. Your employer withholds those funds and pays it to the government for you. Your W4 form (which you filled out on your first day of work) sets what that withholding rate will be. It’s important to fill this form out correctly or you may end up owing more money at tax time.
Flex Spending Account. Flexible Spending Accounts are accounts provided by your employer. Sometimes employers will contribute money to your FSA on your behalf, but most often you can choose to put some money from your paycheck into this account. Any money that you add won’t be taxed as part of your income. You can use the dollars in your FSA for a variety of common medical expenses and sometimes for dependent daycare. The drawback of an FSA is that if you don’t use up the money by the end of each year, you could lose it. (Certain exceptions apply.)
Capital Gains/Losses. This is the difference between how much money you invested and the current value. So, say you invested $10K last year and it’s worth $13K today. You have capital gains of $3K. Those gains aren’t actually yours until they are “realized”—aka you sell your investment.
Liquidity. This term refers to how easy or difficult it is to sell your investment. For example, if you buy the stock of a really large company, like Apple, you could sell it pretty quickly—Apple is liquid. If you try to sell your home, it might take a long time. Real estate is usually said to be illiquid.