If you’re reading this, you’re probably seeking to improve your understanding of your personal finances. Financial terminology can be confusing, but this cheat sheet for financial terms should help. If they aren’t already, these concepts will likely become relevant at some point in your financial journey and being informed can help you make smarter decisions.
What are the investment terms you should know?
Stock – What is a stock? A stock is a share of ownership, or equity, in a company. The term equity is often synonymous with stock.
Bond– What is a bond? A bond is a form of debt issued by corporations, governments, or other organizations to which an investor loans money to the issuer in return for repayment of principal plus interest. Bonds are often referred to as fixed income because they provide a predetermined stream of interest payments.
Mutual Fund / ETF – What is a mutual fund/ETF? Rather than individually buying 10 different candy bars at the store, you could buy a bag of candy with an assortment already organized for you. This is the same way mutual funds and exchange-traded funds (ETFs) work. The fund owns all the securities (stocks and bonds), and you purchase the fund, making you an owner of all the subsequent underlying holdings. The key takeaway with these funds is ease of access to diversification. There are technical differences between a mutual fund and an ETF that we will not get into here.
Dividend – What is a dividend? A dividend is a portion of a company’s earnings made as a payment to shareholders, generally in the form of cash. These tend to happen on regular schedules. Dividend payments are not guaranteed, and investing solely for dividend payments is generally not prudent.
Expense Ratio – What is an expense ratio? An expense ratio is a percentage fee charged by the mutual fund or ETF company for the operation and management of the fund. This is the most common way fund managers are compensated. However, there may be additional fees associated with these funds that you should be aware of.
What are the tax terms you should know?
Tax Brackets – What are tax brackets? The U.S. has a progressive federal tax system where ordinary tax rates for income like wages or IRA distributions rise as your income increases. To best illustrate this, picture several buckets of water filled up before you, each bucket representing a higher tax rate. Only the water in that respective bucket is taxed at that bucket’s rate. It is only when new water is added to the next subsequent empty bucket that the new water is taxed at a higher rate. Keep in mind there are other miscellaneous taxes out there and state taxes differ depending on the state.
Capital Gains Tax – What is capital gains tax? This is the tax on the profit that an investor makes from the sale of an investment, such as stock or real estate. There is no capital gains tax within retirement or other tax-deferred accounts. Capital gains tax rates can be more favorable than ordinary income tax rates, depending on your income.
Standard vs. Itemized Deduction – What is difference between the standard and itemized deduction? Once your income is totaled on your federal tax return, one of two deductions is applied to your income before it is taxed. The standard deduction is a specific dollar amount given to you based on factors like your filing status and age. Itemizing deductions is a customized deduction based on expenses like charitable donations, mortgage interest, and state and local taxes. For most taxpayers, the standard deduction is more than what they could itemize. There are limits on what you can and can’t itemize.
Commonly Used Financial Planning Terms You Should Know:
IRA vs. 401(k) – What are some differences between an IRA and a 401(k)? An IRA is an individual retirement account. A 401(k) is an employer-sponsored retirement plan that often you and the company can contribute to. Each type of account has its own contribution limits, rules, and investment options. There are no restrictions for opening an IRA. There must be an employer affiliation with a 401(k). It’s common for 401(k) participants to roll over their 401(k) into an IRA or another 401(k) plan when they change jobs or retire.
Roth vs. Pre-Tax – What is the difference between Roth and Pre-tax contributions? To pay tax now or later… this is essentially the difference between Roth and Pre-Tax. Pre-tax means you have not paid federal income tax on that money yet and are generally pushing off paying the tax until a later date. Roth means rather than deferring the tax, you will pay the tax now, but then down the road, the money and any growth will be withdrawn tax-free (assuming you follow the rules).
Be confident in your personal finances and work with someone who can help make you feel this way.
