We understand how difficult it can be to navigate the fancy vocabulary that litters the world of finance. When you hear ‘investment speak’ on your TV you may be reminded of a playful line in the 2015 Oscar-nominated film The Big Short: “Wall Street loves to use confusing terms to make you think only they can do what they do. Or even better, for you to just leave them…alone.” Personal finance shouldn’t be complicated and you deserve to have a clear understanding of your finances.
Knowing frequently used financial terms can equip you with the tools you need to make informed financial decisions. We think it’s about time you had clear explanations of some commonly used finance terms. Whether you’ve been investing for decades or are just starting out, being familiar with these terms can be helpful in planning your future.
Common Finance Terms You Should Know
1099
An IRS tax form that provides information about many different types of income a taxpayer can receive in addition to compensation from an employer. For example, investment income is included on a taxpayer’s Form 1099 if their investments earned dividends and interest in a given year. This is a common form we annually provide to our clients’ CPAs during tax season.
Asset Class
A broad category of similar financial investments. The three most common types of asset classes are:
- Stocks – Stock is an investment that represents ownership of a company. When you buy stock, you purchase a share (or shares) in a company. The goal for companies is to raise money to continue operations and expand their business; the goal for investors is to support companies that will grow in value and eventually earn the investor money when the shares are sold.
- Bonds – A bond is a type of debt security similar to a loan. When you buy a bond, you loan money to a company or government who has promised to pay it back at a certain time. Bonds are fixed-income securities because they pay their investors interest (either variable or fixed) along the way.
Bonds are used by corporations and governments to help fund their ventures and are often publicly traded. Bond prices vary depending on many factors. These include the time it takes to mature (i.e. when the bondholder receives the face value of the bond), the credit quality of the bond issuer — meaning the likelihood that the bond issuer will repay the loan, and prevailing interest rates at the time you are buying the bond.
Bonds that pay higher interests to investors often have lower credit ratings, meaning a higher chance of default and longer maturity time frames. These types of bonds are known as high-yield bonds. You might also hear them called “junk bonds.” The highest quality bonds have good credit ratings and are known as investment grade, and these are backed by the U.S. government or very stable companies.
In general, bonds are a safer form of investing but they generate lower returns compared to the stock market over the long term.
- Cash – Cash was an English word that originally meant ‘money box’. Today, cash refers to legal tender (meaning any type of currency or coins) for use in purchasing services, buying goods, or paying off debt. How much cash to keep on hand (versus stocks and bonds) is a good question to discuss with your financial advisor.
Basis Point
A unit of measure for percentages in finance. One basis point equals 1/100th of a percentage point. For example, if you hear that a stock’s value increased by 80 basis points, that means its price rose by 0.80%.
Capital Gains
A capital gain is the increase in your investment’s value. For example, if you invested $1,000 in the stock market and it grew to $1,500, you would have a capital gain of $500. If you sold that investment, you would have a realized capital gain of $500. A realized capital gain happens when an asset is sold at a profit.
Capital Gains Tax
When you sell an investment at a capital gain (i.e. profit), then your capital gain is taxed. For example, if you bought a stock 5 years ago for $90 and sold it today for $100, you would pay long-term capital gains tax on the $10 profit ($100 FMV (fair market value) – $90 cost = $10 capital gain). Capital gains tax applies to certain accounts. If that investment was in a non-retirement account and you held it for longer than a year, you would pay taxes on this gain at the capital gains rate (0%, 15%, or 20%) and the equivalent state tax rate. Holding an investment for longer than one year before selling it qualifies for federal long term capital gains treatment. If that investment was in a retirement account, then you would not pay taxes on the gain (this is why retirement accounts are called tax-free growth accounts).
Cost Basis
The purchase price for an investment. Investors pay taxes when they sell an asset at a profit, and only pay taxes on the gain, which is the positive difference between its current selling price and the original purchase price.
Equity
This refers to a degree of ownership in an asset, such as a stock of a publicly traded company. Many times, financial advisors will refer to stocks as “equities” as a result.
Fiduciary
In our industry, a fiduciary is a trusted advisor who is legally obligated to place their client’s best interests above their own. Abacus advisors are all fee-only fiduciaries. We don’t earn money by trying to sell clients unnecessary investments or products that enrich our company. Our only concern is what is best for our clients. If your financial advisor is not a fiduciary, they are allowed to give you advice or sell you a product that doesn’t necessarily benefit you, but enriches their own bottom line.
Fixed Income
This is an investment that pays the investor (or lender) fixed interest payments until maturity; when the investment matures, the investor is repaid the principal amount. Bonds are the most common type of fixed income investment and you might hear an advisor say “fixed income” when discussing your portfolio.
Index Fund
An index fund is a type of mutual fund that invests to track the composition and performance of a particular market index. Let’s say you wanted to track larger market indices like the S&P 500. By investing in an index fund designed to match the S&P 500, you could gain broad market exposure that removes some of the guesswork while keeping costs low (i.e. you don’t face as many operating costs because your portfolio doesn’t change as much, and the fund manager doesn’t have to provide research on the companies in their fund.) Index funds can be used in passive investing, where instead of focusing on timing the market in the short-term, you take a long-term strategic approach towards the market.
Market Capitalization
The fair market value of all outstanding shares of a publicly traded company:
- Large Cap Stock – Shares of publicly traded companies with a market capitalization of $10 billion or more.
- Small Cap Stock – Shares of publicly traded companies with a market capitalization between $300 million and $2 billion.
Why is this important? Large cap stock companies are among the biggest in the world. Small cap stock companies tend to have a shorter track record. When deciding how to grow your investment portfolio (and how much risk you’re comfortable with), McDonald’s may be more stable than Shake Shack but Shake Shack might offer more growth potential (as just one broad example).
Mutual Fund
A mutual fund lets multiple investors pool money together in a basket of securities. Mutual funds are operated by money managers and are a good way to invest in multiple companies at once without having to buy individual shares of each. A mutual fund can be an index fund, which attempts to mimic the composition and performance of a particular market index, or it can have its own strategies and objectives. For instance a mutual fund may target a specific sector of the market (like technology or health care), or they might contain a mix of stocks and bonds to reduce the volatility of their holdings.
Point
Refers to 1% of the outstanding principal on a mortgage loan. For example, a broker could offer to lower the interest rate on a 30-year fixed mortgage by .25% if the homebuyer pays an additional point. On a $200,000 mortgage, a point would cost the homebuyer an additional $2,000 which they could pay up front or add to the loan balance.
REIT (Real Estate Investment Trust)
A type of mutual fund that invests in real estate properties such as apartment buildings, offices, or retail stores. Since traditional real estate investing is highly illiquid, public REITs offer investors diversification by allowing them to invest in real estate while having the liquidity of a mutual fund trading on the stock market.
RMD (Required Minimum Distribution)
A required minimum distribution (RMD) is the amount of money that must be distributed (or withdrawn) from an employer-sponsored retirement plan, such as a 401(k), traditional IRA, SEP account, or SIMPLE individual retirement account (IRA) by the account holder upon reaching retirement age. Under current law, RMDs must begin by April 1 of the year following the year the account holder reaches age 72. Your RMDs are taxed as ordinary income, just like a salary, because the government wants to collect taxes on the money that has been growing tax-free in your account.
An RMD is any amount you must withdraw from a retirement account within a calendar year. Your annual RMD will shift depending on your age, life expectancy, and account balance. RMDs impact your retirement income plan, projected annual tax bill, and retirement lifestyle, making it necessary for you to understand what they are so you can build a plan that works for you.
Russell 3000
A market index that tracks the performance of the 3,000 largest publicly traded U.S. companies. Russell’s objective is to give a total view of the U.S. stock market by covering roughly 98% of all tradable stocks.
S&P 500
A market index that tracks the performance of 500 of the largest publicly traded U.S. companies on the New York Stock Exchange. By following the largest U.S. companies, the S&P 500 provides a window into the overall financial health of the U.S. economy.
Taxable Account
An individual or joint investment account that can hold assets such as stocks, bonds, mutual funds, and REITs. Unlike retirement accounts, you can deposit or withdraw money without incurring penalties. Investors usually need to sell assets within the account when they need cash, and will also pay capital gains tax if they sell any asset at a gain.
TOD (Transfer On Death)
A designation on an investment account that names a beneficiary to receive the assets within the account upon the account holder’s death. TOD generally allows accounts to pass to beneficiaries outside the probate estate, avoiding the time and expense of the probate process. TOD designation is highly recommended to our clients who do not have a living trust. Naming beneficiaries is an important part of fulfilling your post-life wishes and determining your legacy after you’ve gone.
POD (Payable On Death)
A designation on a bank account or certificate of deposit that names a beneficiary to receive the assets within the account upon the account holder’s death. This similarly determines and protects your wishes.
Sustainable Rate of Withdrawal
Also called the Safe Withdrawal Rate (SWR) Method, this is the maximum you can reliably pull from your portfolio, ensure your spending can keep up with inflation, and remain reasonably assured you’re not in danger of depleting your assets.
Always Ask Questions
Knowing commonly used financial jargon is a crucial step in your financial literacy journey. By gaining a clear understanding of key financial terms, you can equip yourself with the knowledge to make well informed financial decisions. Remember, if you’re talking with a financial professional and don’t know what a word, concept, or strategy means, ask them to explain it further. Never hold back your questions; in fact, you should have questions. You deserve to work with someone who will take the time to ensure you have a clear understanding around your finances.
In an industry weighed down with complex language, acronyms, and products, we understand the confusion (and even shame) you may sometimes experience around money. Because we value simplicity and clarity, we believe it’s important to demystify the complexity and break down technical language into easy to understand financial lessons and resources.
We’re dedicated to providing educational content for you to continue learning and expanding your knowledge about finance, investing, and financial planning. It’s our mission to provide everyone with accessible educational content to improve national financial literacy. If you want to continue learning, subscribe to our newsletter and receive news updates, informative articles, and event opportunities aimed at helping you feel empowered around your finances.
Everyone Deserves Quality Financial Advice
You deserve quality financial service that meets your needs. You deserve to have a financial partner who will make money approachable and understandable, and who will answer any questions you have. We want you to feel comfortable and confident next time you approach the wide world of financial jargon. If you’re looking for a financial advisor to support you and your unique needs, schedule a call and ask about our approach to financial planning.
Disclosure: Abacus Wealth Partners, LLC (Abacus) is an SEC registered investment adviser with its principal place of business in the State of California. Abacus may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements. This brochure is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Abacus with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Abacus, please contact us or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).
This is not an offer to sell any type of security, and there is no investment currently available through Abacus. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell this security. This newsletter contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Information was based on sources we deem to be reliable, but we make no representations as to its accuracy. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.
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