Do You Know These Basic Financial Terms? An Expert Decodes Them All
Does the mere thought of calculating your cut of the dinner tab or logging into your bank account online send shivers down your spine? It turns out that money anxiety disorder is a thing, but you don't need to be a Wall Street pro to know that being smart with your finances pays off. Think about it: There's no reason the funds in your checking account should sit idly by, especially if you're dreaming of saving up for a vacation as you're clocking into the office every day. If you're a finance newbie who wants to take control of your money, then getting to know some of the most basic financial terms is the best place to start.
To get more insight into the top money words to know—and ultimately learn how to make your money work for you—we turned to LearnVest founder and CEO Alexa von Tobel. "Just because you are learning the basics doesn't mean you should feel intimidated to ask questions or talk about your finances," she tells MyDomaine. In a 2016 survey, the financial planning website found that nearly half of Americans don't know the balances of their partner's investment accounts, while a third have no idea how much their significant other earns in a year, proving that money continues to be a sensitive topic even among people in intimate relationships. (In fact, the study also found that 68% of Americans would rather share their weight than their credit score with friends.)
"I know that talking about money can be difficult, but for your own financial well-being, it's important to feel comfortable talking about it with your friends, family, and partners," the certified financial planner explains. Not a math whiz? Don't worry—you don't need to be an expert at crunching numbers to tackle topics like retirement accounts, investing, and banking.
It's time to stop being a money newbie—these are the nine basic financial terms everyone should know, straight from an expert.
Retirement Account Terms to Know
1. 401(k): A retirement account that you can only get through an employer, this type of fund pulls money directly from your paychecks, and some employers will "match" your contributions. "Traditional 401(k) plans grow tax-deferred, meaning that you'll pay taxes when you take the money out, not when you put the money in," says von Tobel.
2. Roth IRA: With this type of retirement account, "you pay taxes up-front at today's tax rates," explains von Tobel. "So while you don't get any tax breaks today, you never have to pay taxes on your investment earnings."
3. Traditional IRA: "[This] is set up so that your contribution each year is tax deductible (if you're under a certain income limit), and you aren't taxed on the income you make as it grows," von Tobel says. "You pay those taxes when you withdraw it for retirement, which you're required to start at age 70 and a half. Anyone with earned income can open a traditional IRA."
Banking Terms to Know
4. Compound Interest: "When you're investing or saving, this is the interest that you earn on the amount you deposit, plus any interest you've accumulated over time," says von Tobel. "It will make your savings or debt grow at a faster rate than simple interest, which is calculated on the principal amount alone." If you're borrowing money, this interest is charged on the original amount you are loaned in addition to any interest that's added to your outstanding balance over time. "Think of it as 'interest on interest.'" she explains.
5. FICO Score: An acronym for the Fair Isaac Corporation, this number measures borrowers' creditworthiness and calculates your credit score based on your payment history, length of your credit history, and the total amount of money owed. "FICO scores range from 300 to 850, and the higher the score, the better the terms you may receive on your next loan or credit card," says von Tobel. "People with scores below 620 may have a harder time securing credit at a favorable interest rate."
6. Net Worth: The difference between your assets and liabilities, this can be calculated by "adding up all the money or investments you have, including the current market value of your home and car, as well as the balances in any checking, savings, retirement, or other investment accounts," says von Tobel. "Then subtract all your debt, including your mortgage balance, credit card balances, and any other loans or obligations. The resulting net worth number helps you take the pulse of your overall financial health."
Investing Terms to Know
7. Asset Allocation: "[This is] the process by which you choose what proportion of your portfolio you'd like to dedicate to various asset classes, based on your goals, personal risk tolerance, and time horizon," says von Tobel. The three major types of asset classes are stocks, bonds, and cash or cash alternatives (like certificates of deposit), "and each of these reacts differently to market cycles and economic conditions." For example, investing in stocks may result in strong growth over the long-term, but they're also subject to more volatility. "A common investment strategy is to diversify your portfolio across multiple asset classes in order to spread out risk while taking advantage of growth," she adds.
8. Bonds: Usually referred to as fixed-income securities, this type of asset class tends to have slower growth but is usually perceived to be less risky. "Bonds are essentially debt investments—When you buy a bond, you lend money to an entity, typically the government or a corporation, for a specified period of time at a fixed interest rate (also called a coupon)," explains von Tobel. "You then receive periodic interest payments over time, and get back the loaned amount at the bond's maturity date."
9. Capital Gains: "This is the increase in the value of an asset or investment (like a stock or real estate) above its original purchase price," says von Tobel. "The gain, however, is only on paper until the asset is sold. A capital loss, by contrast, is a decrease in the asset's or investment's value. You pay taxes on both short-term capital gains (a year or less) and long-term capital gains (more than a year) when you sell an investment." It's worth noting that a capital loss could also help reduce your taxes.
Up next—seven personal finance hacks that'll help you whip your bank account back into shape.