Personal Finance: Glossary and Reference Guide

Personal finance has a language all its own. If you don’t know the language, a lot can get lost in translation.

Those mistakes can be costly, and they’re unnecessary because the language of personal finance isn’t as hard as it seems.

Glossary of Personal Finance Terms

This glossary of personal finance terms offers brief definitions of terms you are likely to come across when doing things like opening a bank account or buying a house.

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Banking Terminology

Banks offer several different products and services. The following are some basic terms that could help you understand those products and services better:

Certificates of deposit (CDs)

These investment accounts are written pledges from a bank to pay a specified interest rate over a set period of time. When offered by an FDIC-member institution, CDs are typically insured by the FDIC – but you should check in each case.

Compared to other deposits such as savings accounts and money market accounts, CDs usually offer higher interest rates but require you to lock up your money longer. There is generally a fee if you want to get money out of a CD before its term expires.

CD term

Certificates of deposit usually require your money to be committed for a set amount of time. That period is referred to as the CD’s term.

Early withdrawal penalty

This is a fee a CD customer would have to pay for taking money out of the CD before its term is finished. These penalties can represent several months’ worth of interest, and are generally steeper for longer-term CDs.

Maintenance fees

These are fees financial institutions charge (usually monthly) just for keeping an account open. Maintenance fees are usually a fixed dollar amount and can be especially burdensome on smaller accounts.

Money market accounts

These are bank deposit accounts similar to savings accounts. They allow immediate access to deposits, though payments to a third party are limited to six per month.

Because they allow easy access, money market accounts typically pay fairly low interest rates.

Money market accounts at FDIC-member institutions are covered by deposit insurance. They should not be confused with money market funds, which are mutual funds and therefore not covered by FDIC insurance.

Savings accounts

These are deposit accounts that allow immediate access, though transfers to third parties are limited to six per month. Like money market accounts, savings accounts offered by FDIC-member banks are covered by FDIC insurance.

Credit Card Terminology

Here are some terms that explain how credit cards work. These can help you when shopping for a credit card or when managing your payments.

Annual percentage rate (APR)

The APR is the annual interest rate that will be charged in monthly increments on the credit card balance you owe.

Balance transfer credit card

A card offering special terms such as 0% interest for a period of time to encourage you to transfer debts from other credit cards onto this card. Doing this can help you manage payments more easily and reduce the cost of your debt.

Credit limit

The credit limit is the maximum amount you are allowed to owe on your credit card at any one time. Once you reach your credit limit, you can no longer charge any more to the card until you pay off some of your balance.

Minimum payment

The minimum payment is the least amount you are required pay toward your balance each month without being charged a penalty.

Rewards credit card

A rewards credit card is one that gives you awards based on the amount you spend using the card. Those rewards may be in the form of cash or points toward services or merchandise.

Economic Terminology

Economics is a complex study, but it can also affect your day-to-day finances. Below are definitions for some commonly used terms you might encounter:

Economic cycle

A period which includes both a sustained expansion in economic activity and a recession. In other words, this is a period which includes a full range of economic conditions, both good and bad.

Expansion

An economic expansion is a period of sustained growth in a nation’s GDP.

Gross domestic product (GDP)

A measure of overall economic output. It is usually reported as an annual rate of change adjusted for inflation to indicate whether the economy has grown or shrunk.

Inflation

A measure of how much prices have changed on average. The most common measure of U.S. inflation is the Consumer Price Index, which measures changes in prices of goods frequently bought by consumers.

Recession

A sustained period of decline or contraction in economic activity.

Government Agencies

Here are some government agencies that regulate and/or produce information about things that may affect your personal financial activities:

Bureau of Labor Statistics (BLS)

A division of the U.S. Department of Labor, the BLS is a primary source of key pieces of economic data such as the Consumer Price Index and the unemployment rate.

Consumer Financial Protection Bureau (CFPB)

The CFPB is a U.S. government agency designed to educate and protect consumers in their financial dealings. It is both a source of information and a place to make complaints about financial professionals.

Federal Deposit Insurance Corporation (FDIC)

This is an independent agency of the U.S. government that plays a number of roles to help oversee banking.

The most prominent of its roles is providing deposit insurance of up to $250,000 for certain accounts at FDIC-member institutions. Insured deposits include savings accounts, money market accounts and certificates of deposit (CDs).

Federal Housing Administration (FHA)

A government agency that oversees a program providing lenders with mortgage insurance for certain loans. This insurance gives lenders the confidence to make loans to people with limited financial histories and low down payments. That makes it easier to get a mortgage.

Federal Reserve

Commonly known as the Fed, this government agency plays several key roles in overseeing U.S. banking activity. This includes setting interest rates that banks pay for the use of funds. Those rates then influence the loan rates available to consumers and businesses.

Investment Terminology

Investing is always changing so you never stop learning, but here are some terms that could help you get started:

Active management

A style of investing that involves making ongoing buy and sell decisions in an attempt to perform better than the market as a whole.

Bear market

A period of sustained and significant decline in the value of a financial market. Often used in connection with the stock market.

Since the stock market goes up and down every day, not every decline is a bear market, but those big enough to take a long time to recover from are considered the bear market phase of a market cycle.

Beta

A statistic that is commonly used to represent a stock’s volatility relative to a market index. A stock with a beta of 1.0 would have the same degree of ups and downs as the S&P 500, while one with a beta of 1.2 would be assumed to have 20% more volatility. Since beta is based on short-term changes in value, it is not necessarily a measure of long-term risk or return potential.

Bonds

These are debt securities, meaning that the issuer receives money up front in return for promising to pay the owner of the bond interest at regular intervals plus to repay the principal on a set date in the future.

Bonds can range from the high-security of U.S. government-issued bonds to the high risk of bonds issued by companies or other entities that have a strong possibility of defaulting.

Book value

Book value is a measure of the accounting value of a company’s assets. It can be a general indicator of the fundamental value of a company, though the accounting value can differ greatly from what the company could get by selling its assets.

Broker

A financial professional or company that facilitates the buying and selling of investment securities in exchange for a commission or other compensation. While brokers perform a valuable service, they may also make money from the trading activity of their customers – so their interests may differ from yours.

Bull market

In contrast with a bear market, a bull market is a period of a sustained rise in the prices of stocks or other securities.

Calls

These are options that represent positive bets on a stock’s price. Owning a call option allows you to buy the stock at a prearranged price within a limited period of time.

If the stock has risen above that prearranged price before the time expires, you may profit from the difference in price.

If the stock does not rise above the call price within the time period, the option would expire as worthless. This makes calls very risky because you can lose the entire amount you paid for them.

Capital gain or loss

This is the difference between the sale price of a stock and what you paid for it. If that difference is positive, it is a capital gain. If it is negative, it is a capital loss.

Discount broker

A broker that trades securities for customers at sharply reduced trading commissions. These often offer primarily automated services as opposed to the more personal advice and recommendations you might get from a traditional stock broker.

Dividends

These are cash payments made to shareholders by publicly held companies. They are usually paid quarterly. Dividends represent a portion of a company’s earnings, though dividends change less often than earnings do.

Not all stocks pay dividends, and those that do pay them do not guarantee that the dividend will not change or even be eliminated in the future.

Diversification

This describes spreading money out over different investments in order to reduce risk. The risk-reduction benefit of diversification depends not just on how many securities you own, but also on whether those securities are moved by different economic forces.

Earnings (stocks)

Corporate earnings represent the profit made by a company. For publicly traded stocks, earnings are normally reported on a per-share basis. This shows the portion of total earnings that would be attributed to each share of stock, which can be a useful basis for comparison with a stock’s price (see price-to-earnings ratio).

Exchange-traded funds (ETFs)

ETFs are mutual funds that are structured to mimic the full range of securities that make up a specific investment market.

ETFs are good for investors who are looking for a cost-effective way to get broad representation in a market without picking individual stocks.

Expense ratio

For mutual funds, the expense ratio is the total annual percentage of fees and other costs charged to the fund. The types of fees charged by mutual funds varies, so expense ratio is a good way to measure the total cost of owning a particular fund.

Flat-rate commissions

These are trading charges that are assessed as a fixed dollar amount per trade, instead of being based on the size of the trade. Flat rate commissions are especially cost effective for larger trades.

Foreign exchange (FOREX)

FOREX trading allows investors to attempt to capture increases or decreases in the value of specific national currencies. Currency trading can be very risky and should be approached only by sophisticated investors.

Futures

A future is a contract to purchase a security at a specific price on a set date in the future.

If the security rises to a higher place in the meantime, you benefit from being able to buy it at the prearranged price and sell it at the higher price.

However, if the security is at a lower price when the futures date arises, you lose money by having to buy the security at a higher price than its market value.

Inactivity fees

These are charges some brokers assess for periods when you do not make any trades.

Because brokers make money when you trade in your account, so they charge inactivity fees to cover the cost of maintaining the account when you don’t trade. You should check for inactivity fees before opening a brokerage account if you don’t expect to be a frequent trader.

Indexing

This is an investment strategy based on imitating the holdings of a market benchmark, such as the S&P 500 for U.S. stocks.

Indexing is a form of passive management because it involves simply owning whatever is in the market index instead of making active decisions about individual securities.

Since there is a wide variety of indexes used to represent domestic and foreign markets, the choice of which index to own is a key to this investment approach.

Interest rate

While consumers are probably accustomed to paying interest on mortgages and other loans, when investors buy bonds and similar debt-based securities, the investor becomes the lender. This means the investor receives interest from the issuer of the security.

It works in your favor as an investor if interest rates fall after you have bought a security that pays interest, and it works against you if interest rates rise. Market interest rates can change at any time, primarily because of changing expectations about inflation and the riskiness of each security.

Margin interest

This is the interest charged by a brokerage firm for the amount borrowed for margin trading.

The margin interest rates that brokers charge tend to be lower for larger amounts of borrowing. This can make margin interest rates especially steep for smaller investors.

Because margin interest is a built-in cost of margin trading, the level of the interest rate charged is a key factor in the success or failure of this type of strategy.

Margin trading

Trading on margin means investing with money borrowed from a brokerage firm. It is a way of leveraging a portfolio, which means to increase the potential risk and return.

Because some of the money you are investing is borrowed, the gains and losses of your investments represent a higher percentage of your money.

Besides this higher risk, margin trading requires that the returns you earn must exceed the margin interest rate you are paying in order to earn you a positive net return.

Market cycle

A market cycle is a period comprising both a single bull market and bear market phase. It is a useful period for performance measurement because it shows how an investment has behaved through both favorable or unfavorable conditions.

Mutual funds

These are known as pooled vehicles, which means that several investors share ownership in the investments owned by the fund.

Mutual funds can pursue a variety of investment approaches that are described in a detailed prospectus. Because of their shared ownership, mutual funds can be cost-effective tools for allowing smaller investors to get diversified participation in a market.

Online broker

This is a broker that offers accounts that are handled exclusively online as opposed to through traditional branch offices.

Because operating online allows these firms to save on the overhead of staffing physical offices, online brokers often offer deeper discounts than traditional brokerage firms.

Options

These are agreements such as puts and calls that give you the right to buy or sell a particular security at a set price within a specified time frame. This can allow you to benefit from price movements with very little up-front investment.

The trade-off is that these securities pose a substantial risk of losing your entire investment.

Passive investing

In contrast with active investing, passive investing is an approach such as indexing that calls for owning whatever is in a market index, rather than making individual decisions about each security.

Price-to-earnings ratio (P/E ratio)

This is a common measurement of a stock’s value. The P/E ratio shows how high a stock’s price is relative to the amount of money the company earns.

For example, a stock trading at $20 and earning $1 per share would have a P/E ratio of 20.

While P/E is not a perfect measure of whether a stock is cheap or over-priced, historically lower P/E ratios have been indicators of higher long-term returns going forward.

Puts

These are options that represent a negative bet on a stock’s price. Owning a put option allows you to sell a stock at a specified price within a limited period of time.

If the stock has fallen below that price within the time limit, you may profit from the difference between the option price and the current market price. If the stock moves the other way, you do not have to exercise the option and it will expire as worthless. This makes puts a very risky investment because you can lose the entire amount you paid for them.

Realized gain

Since capital gains are generally not taxed until a security is sold, the gains on securities sold are referred to them as realized gains to distinguish them from the price appreciation of holdings that have not yet been sold.

Realized loss

Similar to a realized gain, a realized loss is the change in value of an investment between when it is bought and when it is sold. Realized losses can often be offset against realized gains for tax purposes.

Revenues

These are the gross receipts of a company. Expenses are subtracted from revenues to determine net earnings.

Short selling

Short selling is a negative bet on a stock’s price because it involves selling a stock you do not yet own.

You benefit if the stock’s price falls because you will have previously agreed to sell it for more than the current price. On the other hand, if a stock’s price rises, you will be responsible for making up the difference between the current price and the short-sale price.

Short selling is very risky because there is theoretically no limit to how high a stock’s price can go. Because a short sale is a negative bet on a stock’s price, that means you could lose a lot more than your original investment amount.

Stocks

A stock represents partial ownership of a company.

The value of this ownership share will rise and fall according to the public’s changing perception of the value of that company. Public perception of a company’s value is affected by things like assets and liabilities, current earnings and future business prospects.

Stock market

This is a place where shares of companies are bought and sold. There are multiple such markets around the world, including the New York Stock Exchange and NASDAQ in the U.S., and national markets in other developed countries as well as many emerging market countries.

Stock split

Sometimes a company will increase its number of shares by a given ratio. For example, a 2-for-1 stock split means that each existing share will now be replaced by two shares. This does not generally add to the total market value of an individual’s position because the price generally changes in proportion to the stock split. So, a 2-for-1 stock split is likely to see the stock’s price drop roughly in half.

Trading commissions

This is the fee charged by a broker for completing a trade. Historically commissions were generally based on the number of shares traded, but now it is common for discount and online brokers to charge a flat-rate commission.

Volatility

This is one measure of a security’s risk. Volatility is a term for describing how widely a security’s price changes are. It is a factor in common statistical risk measures such as beta.

While volatility is commonly assumed to correlate with return potential, that is not always the case. Also, temporary volatility is not necessarily the same as the risk of long-term losses in a security.

Loan Terminology

Below are some terms that will help you understand how a loan works. Also see the section on mortgage terminology since some of those terms apply to other loans as well.

Amortization

The schedule by which your loan is paid off. When you take out a loan, you should be given an amortization schedule that shows the date and amount of the payments that are due and how much each payment consists of principal and interest.

Interest rate

The percentage rate charged on the principal amount of the loan you owe.

Monthly payment

The amount you are required to pay each month, generally consisting of both principal and interest.

Principal

The amount of the loan you still owe.

Term

The length of time over which your loan must be repaid.

Mortgage Terminology

Too often, people don’t really start to understand their mortgage loan until they have already started paying it back. The following terms might help make you a little more familiar with mortgages:

Adjustable-rate mortgage (ARM)

An ARM is a home loan with an interest rate that the lender can change over time according to market conditions. This could save you money if interest rates fall, but it could cost you if interest rates rise. These changes would impact your monthly payments, so an ARM carries the risk that a mortgage might become difficult for you to afford at some point.

Amortization schedule

This is a schedule of all the payments that will become due in the course of paying off your mortgage. It shows the total monthly payment, how that payment breaks down between principal and interest, and how quickly the mortgage balance will be reduced over time.

It is a good idea to review this information before you sign up for a mortgage so you understand what you will be expected to pay each month, how quickly you might build equity in your home, and what the total cost of the loan will be.

Cash-out refinancing

Basic refinancing involves replacing the balance owed on one mortgage with a balance on a new mortgage with different terms.

With cash-out financing, you borrow more than your existing mortgage balance and receive the difference in cash. This would leave you with a larger mortgage balance, so it amounts to a combination of refinancing your existing mortgage and borrowing an extra amount against the equity in your home.

Closing costs

In addition to a down payment, you are likely to have to pay closing costs to get a mortgage. These are fees involved in initiating the loan. Closing costs add to the expense of the loan over and above the interest rate being charged.

Default

Default is a condition of not meeting the repayment terms of a mortgage. If not resolved, defaulting on your mortgage could result in the loss of your home.

Down payment

A down payment is an initial amount of money you have to put up as security against a loan. While it might seem desirable to pay as small a down payment as possible, that means taking out a larger loan and paying more in interest over time.

Equity

This is the value of your home that you own free and clear. It is the difference between the current market value of the property and the remaining amount owed on any mortgages on the property.

Equity is considered part of your net worth, and can increase by the price of the property rising and/or by paying down the amount you owe on your mortgage.

Fixed-rate mortgage (FRM)

This is a home loan with an interest rate that will remain unchanged throughout the life of the loan.

Foreclosure

This is the process by which a mortgage lender takes legal possession of a property that serves as collateral on a mortgage. This can happen due to the loan being in a state of default that cannot be resolved.

Home equity line of credit (HELOC)

This is a form of home equity loan that does not require you to take the full loan amount all at once. Instead, it makes that amount available for you to tap into as needed. The advantage is that this means you don’t start paying interest until you actually start using the money.

Home equity loan

This is a form of mortgage that uses the equity in your home as collateral.

Because home equity is considered a fairly reliable form of security, home equity loans are often cheaper than most other forms of borrowing.

Taking out a home equity loan reduces the amount of equity you have remaining, which can restrict future borrowing options and reduce the amount of money that becomes available to you upon sale of the home.

Interest rate

This is a percentage you have to pay a lender in order to borrow money. It will generally add a substantial amount to the cost of a loan over the long run, so comparing interest rates is a central part of shopping for a mortgage.

Mortgage

This is a loan secured by a property. That security means that, if you fail to make the agreed-upon payments on the loan, the lender may be able to take the property from you.

Mortgage insurance

Many home loans require you to pay mortgage insurance premiums. This is insurance for the lender against the risk of the borrower failing to repay the loan. Mortgage insurance premiums often consist of an up-front payment and then ongoing additions to your monthly payments.

Prepayment penalty

This is a charge for repaying a loan ahead of schedule. This can add to the cost of refinancing or reduce the benefit of paying a loan off early.

It is wise to check prepayment penalties before signing up for a loan because they might impact subsequent decisions you make about handling the loan.

Points

This is a percentage of the loan amount paid to the lender upon closing. Paying points up front generally results in a lower interest rate over the remaining term of the loan. Since points are an up-front cost that can be recouped gradually over time, paying them makes more sense if you plan to be in the home for a long time than if you anticipate selling in a few years.

Property tax

This tax is usually levied by local government and is based on the assessed value of a property.

Where a mortgage loan is in place, payment of property tax is often handed through the mortgage company as part of your monthly payments. This is because failure to pay property tax could result in the local government placing a claim on the property.

Refinance mortgage

A refinance mortgage is a mortgage that replaces your existing mortgage loan.

Reasons for refinancing may include lowering your interest rate, reducing your long-term interest expense by shortening the remaining term of the loan, or reducing monthly payments by spreading the remaining balance out over a longer term. Often refinancing involves a trade-off between near-term benefits and an increased long-term cost of borrowing.

Reverse mortgage

A reverse mortgage is a type of loan available to homeowners aged 62 or older. It uses equity in your home as security; but unlike ordinary home equity loans, it does not require a regular schedule of loan repayments.

Instead, a reverse mortgage is designed to be paid off from the proceeds when the home is sold. While the idea of borrowing money without having to pay it back right away can seem appealing, reverse mortgages are complex instruments that can prove to be an expensive way to borrow in the long run.

Retirement Plan Terminology

Retirement plans often encourage long-term saving by offering tax advantages. The more you understand about how retirement plans work, the better prepared you’ll be to use them to your benefit. Here are some common terms that can help:

401(k) plans

These are a common form of defined contribution plan for retirement savings.

Though some employers may contribute to 401(k) plans on behalf of their employees, these plans are primarily funded by how much each employee chooses to put into the fund.

In addition to deciding how much of their wages to put into their 401(k) plans, employees must choose from a menu of investment options to decide which will best help them meet long-term retirement savings goals.

Automatic enrollment

Retirement plans like 401(k) plans that depend on employee contributions might have an automatic enrollment feature to encourage participation. This directs a standard percentage of each employee’s pay into the plan and allocates it to default investment options unless the employee gives different instructions.

Default investment options

In defined contribution plans with automatic enrollment, default options are the investments a participant’s money will be directed into if that participant does not actively make another choice.

Default investment options are assigned based on characteristics like age that are presumed to define the participant’s needs, but they may not be the best fit for all participants.

Defined benefit plan

Though defined benefit plans have become rarer in recent decades, they can still be found in heavily unionized professions like teaching or among other government jobs.

Instead of relying on employees to put money into their retirement plans and make decisions about how they should be invested, defined benefit plans are funded by employers who guarantee a specific amount of retirement benefits based on a formula that usually factors in wages and length of service.

Defined contribution plan

Defined contribution plans such as 401(k) plans allow employees to determine how much to contribute. The retirement benefit the employee ends up with depends on how much the employee puts in and for how long, plus how well the employee’s investment choices perform.

Early distribution tax

Most retirement plans such as 401(k) plans and IRAs require that you wait until age 59 1/2 before you start taking money out of them.

Unless you qualify for an exception, if you start taking money out of a retirement plan before age 59 1/2, those distributions will be subject to an additional 10% tax, on top of any ordinary income tax liability.

Employer matching contributions

Some employer-sponsored defined contribution plans like 401(k) plans offer employees an added incentive to contribute to the plan. This is money the employer will put into the plan on your behalf based on some specified portion of your contributions.

Participants in such plans should contribute at least enough to take full advantage of the employer match, or else they will miss out on this benefit.

Health savings account (HSA)

This is a tax-deferred employee benefit account that can be used by participants in high-deductible health plans to set aside money for medical expenses.

An HSA can be used both to pay immediate out-of-pocket healthcare expenses and to accumulate savings for future expenses.

Contributions to HSAs are tax-deductible and money is not taxed even when withdrawn from the HSA as long as it is used for legitimate medical expenses.

Life expectancy

This is an estimate of how much longer you will live.

Life expectancy is critical to retirement planning because it is the basis for estimating how many years of expenses you will have to save up to fund.

Life expectancy is usually based on a broad average and is not an exact science. You might outlive your life expectancy and, as a result, need retirement money for a longer time.

Required minimum distributions (RMDs)

Retirement plans such as traditional IRAs and 401(k)s allow you to defer taxes on money going into the plan. They are designed so you eventually have to start taking money out and pay taxes on it at that point.

These RMDs begin at age 72. They are based on a formula intended to spread the remainder of your money in the plan out over your remaining life expectancy. Roth IRAs are not subject to RMDs because contributions to them are made after taxes.

Rollover plan

Taking money out of a qualified retirement plan generally has tax consequences, but there are ways a person can move money from one qualified plan to another without tax consequences. This process is referred to as a rollover, with the new plan that receives the money called the rollover plan.

Roth IRA

Individual retirement arrangements (IRAs) are tax-deferred plans that individuals can use to save for retirement outside of an employer-sponsored plan. In the case of a Roth IRA, contributions are not tax-deferred but investment earnings and retirement distributions are not taxed.

Tax-deferred plan

Retirement plans such as 401(k)s and traditional IRAs allow you to delay paying taxes on contributions and investment earnings until you draw money out when you reach retirement age.

However, in exchange for this benefit, tax-deferred plans typically don’t allow you to draw money out of the plan until you reach age 59 1/2, or else you will probably pay a 10% penalty on top of any applicable income taxes.

Traditional IRA

This is a type of tax-deferred plan in which neither contributions nor investment earnings are taxed until the money is withdrawn from the plan.