For millennials, financial literacy is going to be one of your most important assets as you navigate the years ahead – it’s how you make educated decisions that help your future self. My M$M readers already know that, and I take great pride in the fact that you are all some of the savviest people out there. But in the rare case that you need some extra clarity on an idea or term, I put my teacher hat back on and made you a glossary of the most important personal finance terms.
The personal finance terms in this article are going to be things I’ve covered on M$M plus some basic knowledge nuggets that will help you on your road to wealth.
Here are 37 personal finance terms you need to know:
Credit and debt terms
1. Credit score – This number is used by lenders to see how likely you are to repay a loan or handle a line of credit. It is determined by several factors, including open lines of credit, payment history, total amounts owed, the age of credit, etc. Credit scores run from 300-850. If you have a high credit score and are responsible, travel hacking can save you a ton of money on travel.
2. Credit utilization rate – This term is used to express the difference between your total balances and your total credit limit. To figure this out, you would divide your balance by your total limit. This is an important factor in determining your credit score, and ideally, your credit utilization rate should be less than 30%.
3. Debt consolidation – By rolling multiple debts into one payment, possibly lowering your interest rate, you are consolidating your debts.
4. Refinancing – This is replacing one loan with a different one. The potential benefits are receiving a lower interest rate, a lower monthly payment, reducing the number of years on your loan, and switching from an adjustable rate to a fixed one.
5. Student loan refinancing – This is bundling your student loans together and taking a new loan amount out from one lender. It can simplify your payments, lower your interest rates, and lower the total amount you pay on your loans over time. However, refinancing your student loans isn’t for everyone.
6. Debt-to-income ratio – This is a metric used by lenders to measure your ability to manage your monthly payments. To calculate this number you would divide your total monthly debt payments by your gross monthly income. The answer will be a decimal, so multiply that by 100 to see the percentage.
7. Bonds – Sometimes called “fixed-income securities,” bonds are investments in debt. These can be a company or government bonds. Buying U.S. Savings Bonds, for example, means you are giving the U.S. government a loan which is paid back with a fixed amount of interest over a fixed period of time.
8. ETF – This is one of the most popular personal finance terms among M$M readers, because of what it means in terms of investing. ETF stands for Exchange-Traded Fund, and it is marketable security (something traded on the open stock market) that tracks a stock index or any other bundle of securities, giving you some automatic diversification. Here are some of the top ETF picks for 2020.
9. Diversification – This is an investing term that means you are attempting to mitigate your risk by investing in a variety of securities and markets. Diversification is an important part of your investment strategy (and one of the most valuable personal finance terms for you to know) because it can help you weather a bad market and prepare for retirement.
10. Dividends – When you invest in a company, with stocks or REITs for example, a dividend is an amount you are paid when a company earns a profit or has a surplus of funds.
11. Expense ratio – This is the percentage of the cost of a fund that is used to pay for managerial fees. Securities like ETFs have much lower expense ratios because they require less day-to-day management.
12. Liquidity – This describes how easy it is to get your hands on your money, as in your ability to sell an asset without affecting the price.
13. Micro-investing – These are very small scale investments, and they can refer to anything from spare change investing apps to just investing without much money.
14. Mutual funds – This is a professionally managed portfolio of securities that is owned by the people who buy shares of the fund. Investing in a mutual fund means you own a portion of the portfolio’s holdings. Choosing mutual funds or ETFs both come with their own pros and cons.
15. REIT – This stands for Real Estate Investment Trust, and they allow regular (i.e. not super wealthy) people to invest in income-producing commercial real estate. This is one of the personal finance terms I recently wrote about in my Fundrise Review.
16. ROI – This means “return on investment” and it’s used to explain how profitable the cost of investing may be. To calculate this percentage, divide the return of an investment by the cost of it, then multiply that by 100 to get a percentage. This is one of several personal finance terms that can mean different things depending on the context, as you can think of ROI in terms of a time investment too.
17. Securities – These are tradable financial assets, and they fall into two different categories, debt or equity. Debt securities are bonds, banknotes, etc. Equity securities are stocks, ETFs, mutual funds, etc.
18. Stocks – This is a small piece of a company, and owning a stock (or share) means you are a shareholder in that company. It also means that you have a claim to a portion of a company’s assets and earnings.
19. Volatility – Measured changes in the stock market are described as volatility and can be narrowed down by price, stock, historic, implied, and market. Volatility can be a good thing for some millennial investors.
20. Premium – This is the amount you pay for an insurance policy. You may pay this amount every month, annually, or semi-annually.
21. Term life insurance – Sometimes referred to as pure life insurance, this type of policy guarantees a payout (death benefit) within a specified term.
22. Whole life insurance – This type of life insurance policy doesn’t expire, guaranteeing a death benefit and possible cash accumulation. This is one of the personal finance terms I recently wrote about so you can understand which type of policy is best for you – Term vs. Whole Life Insurance, What’s Best for Millennials?
23. 401(k) – This is an employer-sponsored retirement plan that allows employees to make salary-deferral contributions. Some employers might match your contributions, and when you hear the phrase “leaving money on the table” it can refer to not taking advantage of employer 401(k) matches. Earnings in a 401(k) grow on a tax-deferred basis. There are typically restrictions and penalties regarding when and how money is withdrawn from a 401(k).
24. IRA – This stands for Individualized Retirement Account, which is a tax-advantaged account that is designed to help you save for retirement. There are two different types, Roth and traditional. The earnings on Roth IRAs are tax-free in retirement, but there is no tax deduction to put money in a Roth IRA. Traditional IRAs are a tax-deferred investment, meaning you don’t pay taxes until you withdraw your funds – tax deferment can potentially lead to a greater accumulation of wealth. You’ll want to know the pros and cons of each before deciding if a Roth or traditional IRA is right for you.
Personal finance terms about Banking
25. Interest rate – In terms of lending, this is a percentage of the loan amount that lenders charge you for borrowing money. In banking terms, this is what a bank is willing to pay you for putting your money in the bank.
26. Compound interest – One of the simplest ways to think about compound interest is that you are earning “interest on interest.” It’s reinvesting the interest and adding it to the principal, which is repeated over and over again until you withdraw or close an account. It’s making a sum of money grow at a faster rate, and that rate will depend on the compounding period – daily, monthly, quarterly, semi-annually, annually. It’s a powerful tool investors have for reaching retirement, and to see how it works, you can check out this compound interest calculator.
27. Money market account – This is a hybrid savings/checking account (limited check writing ability) that typically pays a higher interest rate than a regular savings account. These accounts often require a higher minimum account balance.
28. Liabilities – These are debts you owe, like mortgage, car note, student loans, and credit card debt.
29. Assets – These are things you own outright, like stocks, a paid-off mortgage, a paid-off car, etc.
30. Net worth – This is a number you figure by subtracting your liabilities from your assets. Consistently increasing your net worth is a sign of good financial health. This is one of my favorite personal finance terms because it’s something you can track with an app like Personal Capital.
31. Capital gains – This term refers to any profit you’ve realized from selling a capital asset, think real estate, stock, etc. You may pay taxes on capital gains, and that depends on many factors, including the category of long or short term.
Personal finance terms about your income
32. Gross income – This is the amount you make before paying taxes or having any other deductions. You may see it written as AGI, or adjusted gross income, for tax purposes.
33. Net income – Your net income is your take-home pay, or what’s left in your paycheck after all other deductions are made.
Real Estate terms
34. Principal – In terms of loans and borrowing, principal refers to the amount borrowed. In investing terms, it can mean either the amount you invest or the face value of a security.
35. Equity – This is the difference in the market value of an asset, like your home, and the amount you owe (your liability). You build equity as you pay off your mortgage and as your home increases in value.
36. Adjustable rate mortgage – Commonly referred to as ARM, these are mortgages with fluctuating interest rates that are determined by the rates of the larger market. After being seen as pretty risky, adjustable rate mortgages have been on the rise these past few years.
37. Fixed rate mortgage – This is a mortgage with an interest rate that is predetermined and stays the same for the course of your loan. They are typically thought to be safer than ARMs, but there are both pros and cons to each.