The finance world is filled with a dizzying array of terminology that can be quite overwhelming. Most likely, you have heard a number of finance words and either misunderstood or not understood at all, without a chance to ask for definitions. We’ve all been there!
It’s common as well that finance words are thrown around, their simplest and most direct meanings being diluted. In this piece, we take the time to define many tricky finance terms you can then use in banking, investing, and day to day chats about money.
As an added bonus, it’s in alphabetical order!
This term stands for “annual percentage rate,” is related to, but not the same as “interest rate.” APR is your interest and other fees all bundled together, so it’s the cost of borrowing plus costs connected to borrowing.
For example, a mortgage APR will come with origination fees, discount points, and closing costs, so that’s why it’ll be higher than the interest rate percentage on your loan amount.
When you’re looking for a loan, you may be tempted to compare and contrast interest rates, but it’s really the APR you have to watch out for.
Next on our list is APY, or “annual percentage yield.” This is the amount you earn annually on savings or that you pay whilst borrowing. Unlike APR, APY comes with compounded interest.
You want to think about APY when looking for investment products, credit cards, loans, and savings accounts.
Here’s a term you’ll likely only hear when you are diversifying to lower risk of investment. If this is in fact what you’re doing, then allocating assets is a safe bet. The way you do this is to take your portfolio and divvy it up amount stocks , real estate, cash, and bonds.
If you’re in the stock market game, you can also allocate your investments to different types, like small-cap, large-cap, technology mutual funds, and international mutual funds.
Technically a term used in accounting, cash flow is something you definitely need to know. Fundamentally, it is the money a business receives and then uses within a certain time frame. You can re-define it as how much money is available at any given moment. So next time you want to tell your friends you can’t make it to the pricey cocktail bar, you can say you have a low cash flow.
This term is a little tricky, though it’s also a lot of fun. Compound interest is what’s earned and then added to your balance so that your interest earns interest.
This might be the most important term on the whole list. Credit scores are very important, as they are representative of your worthiness toward credit.
Credit reporting agencies give you a score to predict how well suited you may be to paying back a loan or charge on your credit card. They could be the three most important digits in your life, as lenders use them to figure out whether they want to extend credit and/or lend money, and the accompanying interest rates.
The most common credit score is the FICO score, which begins at 300 and ends at an impressive 850. There are other types of scores, though most likely you will be utilizing your FICO most of the time. Your FICO and other scores derive from Equifax, TransUnion, and Experian data - these are the three main credit agencies.
Exactly what it sounds like, diversification is putting money in a varied number of places. This is one expert way to minimize risk, and be a savvy investor with a mixed cornucopia for a portfolio. To diversify, think about investing in more than one place, such as bonds, stocks, cash, and even real estate during good periods.
Stocks aren’t the only thing you can trade on the stock exchange. ETFs, also known as “exchange-traded funds,” follow a similar logic to index mutual funds, and are based on index performance. For instance, you have the Standard & Poor’s 500 Index. Be wary, though, as ETFs don’t track indexes. Really think about what you’re investing in before making an ETF commitment.
If you own a mutual fund, please keep reading. If not, then this term may not be so important for you.
The cost of owning and operating a mutual fund is your expense ratio. It’ll be in your 401(k) as a percentage in the disclosure statement. They don’t look so daunting, though keep your eye on them, as they may add up to loads of cash as the years go on.
You may think it’s risky to invest in stocks on an individual basis. You’d be right in thinking so. Turns out, there is another way. Mutual funds consist of a various collection of bonds and/or stocks. When you have a mutual fund, you can make investments in a larger amount of companies, on a smaller scale.
Whether you own a company or are an employee, the term net income is definitely important to know. You can define it as revenue minus all of your expenses, including those pesky taxes. Basically, the more your net income gets, the better. This can either be because revenue is getting higher, or you are paying less to keep the company, or yourself, afloat and thriving.
This can either be your favorite or most dreaded term. Net worth is basically everything you own, minus what you owe, compiled together as one (hopefully) big value. Smash together your assets and subtract your liabilities, and you’ll arrive at your net worth.
The Rolling Stones said it best when they declared, “you can’t always get what you want.” If you want something, it means you might have to give something else up. Opportunity cost is a term that describes the value of what you have to give up in this scenario.
For instance, if you are in a decently lucrative job, but you really want to get a PhD that’d make working impossible, the money you would lose out on upon enrolling would be your opportunity cost.
This term is actually much more specific than you think. In general, we tend to confuse realtors with real estate agents, though this is a misnomer. In fact, realtors are real estate agents who are part of the National Association of Realtors, who actually have ownership of the Realtor trademark.
Sometimes things don’t go according to plan. In the world of finance, that’s probably doubly true, especially in the investing game.
Rebalancing is what you do when your allocations change. It’s purchasing or selling shares, for instance, to bring balance to your investment allocation plan. So check your portfolio at the end of each year to see whether you need to balance those stocks and bonds.