A 2021 report by The Milken Institute, a California-based economic think tank, described financial literacy as “a complex concept, encompassing multiple aspects relating to how individuals manage their resources and engage in financial decision-making.” Basically, it is a combination of all the knowledge that is necessary for us to make smart, informed, responsible financial choices. Of their findings, The Milken Institute reported that their analysis painted a worrisome picture and showed that many Americans, regardless of age, lack the basic skills and knowledge required to engage in “sound financial decision-making.”
While there is a lot more to financial literacy than simply knowing what certain acronyms stand for, having a grasp on financial terminology is an excellent place to start. Do you know what EFTs are? What about Term Life Insurance? If you answered no, you’re not alone. Many millennials in the United States hear these terms tossed around, but don’t necessarily have a deep grasp on what they mean.
Here we break down 20 financial terms you need to know.
APR stands for annual percentage rate and refers to the yearly rate of interest that’s assessed to you on money you borrow. An APR is helpful when it comes to comparing credit cards, lines of credit, mortgages, car loans, etc., since it acts as a bottom-line number.
- Asset Allocation
Asset allocation is where you put your money, from stocks and bonds to cash or cash equivalents. Each asset class reacts differently to the economy and the markets, so investors use asset allocation as an investment strategy to balance risk and reward based on their personal goals, risk tolerance, and time horizon.
- Capital Gains/Losses.
Capital gains and losses are the difference between how much an asset or investment is worth now versus how much it was purchased for originally. For example, if you invested $40,000 and it’s now worth $60,000, you have a capital gain of $20,000. You pay taxes on capital gains when you sell an investment, while a capital loss could help reduce your taxes.
- Compound Interest.
Compound interest is interest on the amount of money you have deposited—in other words, “your money making money.” However, the flip side is that if you’re borrowing money, compound interest is charged on the original amount you were loaned, as well as the interest charges that are added to your outstanding balance.
- Defined-Contribution Plans.
These are retirement plans that some companies offer as an employee benefit in which you and/or your employer make regular contributions. An example of a defined-contribution plans is a 401(k).
Diversifying means mixing a wide variety of distinct asset types and investment vehicles within a portfolio instead of putting all your eggs in one basket. On average, a diversified portfolio will yield higher long-term returns while lowering your risk profile.
EFT stands for exchange-traded fund and is a type of pooled investment security that trades on an exchange just like a stock does. An ETF is a way to invest without having to go all in on a single stock, which helps to minimize an investors risk. Typically, ETFs will track a particular index, commodity, or sector.
- FICO Score.
The Fair Isaac Corporation (FICO) was a pioneer in developing a method for calculating credit scores. Standard FICO scores range from 300 to 850, but there are industry specific scores as well that can go higher. Your score is used to evaluate your creditworthiness—the higher the better.
- Flex Spending Account.
A Flexible Spending Account is an account provided by your employer where you can contribute part of your paycheck pretax. Money in your FSA can be used for a variety of medical expenses and sometimes even to pay for daycare for your dependents. Unfortunately, if you don’t use up the money in your FSA by the end of each year, you could lose it.
Liquidity refers to how easy or difficult it is to convert an asset or security into cash without affecting its market price. Most really large companies have stock that is considered liquid, while real estate is usually said to be illiquid.
- Mutual Funds.
Mutual Funds are an older version of ETFs that were created to allow investors to gain access to a variety of stocks with a single trade. Where ETFs are passively managed, most Mutual Funds are actively managed, meaning that a team of professionals oversee which stocks the mutual funds should contain.
- Net Worth.
You can calculate your net worth by subtracting your liabilities (what you owe) from your assets (what you own). Be sure to include all your money and investments, the current market value of your home and car, any retirement or investment accounts, your debt, your mortgage balance, and any other loans or obligations.
Rebalancing is the process of realigning your portfolio to maintain a desired level of asset allocation or risk. Not only does it safeguard an investor from being overly exposed to risk, but it also ensures that any exposures remain within the portfolio manager’s area of expertise. Although there is no set rule, rebalancing should occur annually.
Return on Investment (ROI) is used to evaluate the profitability of an investment and is expressed as a percentage that is calculated by dividing an investment’s net profit or loss by its initial cost.
- Roth IRA.
A Roth IRA is a retirement account that is funded with after-tax dollars, meaning that you pay taxes on your contribution, but once you start withdrawing funds, the money is tax-free. Roth IRAs are a smart choice in you think you will be in a higher tax bracket when you retire than you are now.
- Stocks and Bonds.
While stocks and bonds are often paired together, they are starkly different. When you buy stocks, you are essentially buying a tiny piece of a company, whereas when you buy bonds, you are loaning a company your money in return for the eventual repayment of your loan plus interest. Neither stocks nor bonds guarantee repayment.
- Stock Options.
A stock option gives an employee the right to buy or sell their employer’s stock at an agreed-upon price and date. They are most often offered by companies as incentives.
- Tax Withholding.
Tax withholding is the set rate at which funds are taken out of your salary to cover income taxes throughout the year. If not enough money is withheld, an employee will have to pay additional taxes when they file their tax return, while the opposite will result in a tax refund.
- Term Life Insurance.
Term life insurance is a type of life insurance that provides coverage over a set period, typically anywhere between five and 30 years. If you die within the set term, your beneficiaries receive a payout, however, if you don’t, the policy expires.
- Traditional IRA.
An Individual Retirement Account (IRA) is an option for saving and investing money for retirement in a tax-advantaged way. Earnings have the potential to grow tax-deferred until you withdraw them during retirement. Unlike with Roth IRAs, withdrawals are taxed at your income tax rate when you make them.
At The Humphreys Group, we wholeheartedly believe in the power of financial literacy. After all, without financial literacy, women can’t build their wealth. But with it? They are equipped with the knowledge they need to make confident and informed choices that will affect their financial futures for years to come.
Are there any important terms we missed? Reach out to continue the conversation!