Written By: Corey Janoff
The term “financial literacy” is thrown around a lot these days. Fellow financial planner, Tyler Olson, discussed on a recent podcast episode with us how he doesn’t like the term – he feels it is demeaning.
“Literacy in itself makes me think of developing the ability to read and write. Not everyone has the opportunity to be literate. I think that it is a stain on the real privilege of literacy to apply finance to that because financial literacy is trying to understand money…and it is an important skill to develop…but financial literacy is a never-ending process. And it’s not because there isn’t enough intellect with people, it’s because the world of finance is overly complicated.”
The world of finance is overly complicated. Similar to the English language, some terms have multiple meanings, and there are multiple terms with the same meaning! Also, different rules surrounding investment and taxes can make people's heads explode. It’s the equivalent of I before E, except after C, and when sounding like “A” as in neighbor and weigh.
It can get very confusing, and the rules are continuously changing, evolving, and updating.
That being said, given April is Financial Literacy Month, we figured it would help boost people’s financial literacy by putting together a short glossary of common finance vocabulary and jargon. You would need an entire dictionary or encyclopedia to cover all of the terms, but below are some of the more popular financial words or phrases you might hear and what they mean.
We’ll try to have some fun with this too. 😉
Credit Score – A confusing number that nobody truly understands, but everyone frets about more than they should. It’s a way for lenders to attempt to determine how likely you are to pay them back if they lend you money. The higher the score, the more likely you are to make on-time payments in full, and therefore can secure loans with more favorable terms than someone who has a lower credit score.
Like a reputation, it takes time to build and can be destroyed in an instant.
Equity – Ownership of an asset. Stocks are a form of equity in that you are part-owner of the companies you own stock in.
Also, the difference in the value of an asset minus the outstanding debt on it. If you have a house worth $500,000 and the mortgage balance is $300,000, you have 40% equity in your house ($200k equity out of $500k value).
Fixed Income – A fancy term for bonds. Bonds are a fancy term for debt. Debts pay interest, typically fixed interest (meaning the interest does not change). That income can be viewed as income to the person on the receiving end. Hence the term fixed income.
Yield – A fancy term for the interest that bonds pay. Bonds paying 5% interest have a 5% yield. For example, if you pay $1,000 for a bond paying 5% interest, you will receive $50 in interest per year and then get your $1,000 back when the bond term is up.
Simple Interest – Bonds pay simple interest. Simple interest is calculated as a percentage of the original value. See the above example.
Compound Interest – Typically how interest is calculated for everything else in the world. The interest amount complies on top of itself. The interest compounds on itself. Inflation is calculated using compound interest—credit cards, mortgages, stocks' growth rate, etc.
For example, let’s pretend you have a credit card with a $10,000 balance and a 20% interest rate. If you don’t make any payments, after a year, your balance will be $12,000 ($10k + 20% of $10k for interest. This assumes the interest compounds annually, when most credit cards compound interest monthly, or even more frequently). If you don’t make any payments on your credit card in year two, the balance will rise to $14,400 ($12k + 20% of $12k for interest).
Security – a stock, bond, or other tradable assets. It is pretty much the opposite of the more commonly known definition of “security,” meaning safe and free from danger.
Asset – Another term for an equity or something you own.
Liability – Another term for debt or something you owe money on.
Net Worth – What people should use to measure how financially successful they are. The sum of your assets minus your liabilities. What you own, minus what you owe.
Risk – Carl Richards defines risk as, “Risk is what’s leftover when you think you’ve thought of everything.” If you can plan for something, you can mitigate the downside, and it is not really an issue. If you didn’t think of it and/or can’t plan for it, then it’s a risk. Who would have thought a silly little virus would have toppled our entire economy and tipped life as we know it upside down for over a year?
Opportunity Cost – All the things you are giving up to do the thing you are doing now. You could be having so much fun right now, but instead, you’re reading a blog post about financial words. Money spent on one thing is money that can’t be spent on something else. It’s not just the money you are spending; it’s all the other things you are forgoing that you could be spending that money on instead.
Time Value of Money – The value of a dollar today versus the value of a dollar tomorrow, next month, next year, next decade, etc. Some might equate it to a bird in the hand is worth more than two in the bush. The value of a dollar today is worth more than a dollar tomorrow. However, patience is a virtue in finance – if you are patient, your dollars can potentially grow at a rate faster than inflation from compound interest. I told you this stuff was confusing.
Bull Market – Stocks have risen in value in the recent past, and many people assume that you can draw a straight line forever into the future, mapping out the trajectory of stocks moving forward. Envision a bull charging through the streets of Pamplona. There is no stopping it. It will only stop running when it decides to stop.
Bear Market – When the bull stops running, it transforms into a bear and goes into hibernation. Stocks are no longer running upward. They are asleep at the wheel and falling off a cliff. The consensus is we are in a bear market when stocks decline by more than 20%.
Currency – An agreed-upon medium in society that can be used universally in exchange for goods and services.
Cryptocurrency – Not a real form of currency.
Pre-Tax – Before taxes (duh). If you earn $100k this year and make a $10k pre-tax deposit into your retirement account at work, the IRS only taxes you on $90k of income. Pretty cool! It’s like the IRS is hi-fiving you for saving for retirement -- What a nice government we have. However, you have to pay ordinary income taxes on all the money you withdraw from pre-tax accounts in retirement.
Post-Tax – After taxes (duh). If you earn $100k and make a $10k post-tax deposit into your retirement account at work, the IRS still taxes you on $100k of income.
Roth – A special type of post-tax account where you can withdraw the money completely tax-free in retirement.
Cost Basis – The amount you paid for an asset or investment.
Capital Gains – Money your investment earns for you while you’re sleeping. When you sell an asset or investment for more than your cost basis, the profit is considered a realized capital gain. You can discuss your tax implications with the IRS.
Economic Forecasting: - activity economists engage in to make astrology look respectable. Predicting the future is hard.
I could go on, but most of you didn’t even make it this far. Hopefully, these terms are more understandable for you now when you come across them in the world of personal finance.
Happy Financial Literacy Month!