People use them on TV and in every day conversation. So when we aren’t exactly sure of what some commonly used financial terms mean, we might be too embarrassed to ask! Remaining in the dark about common financial terms can at best curb our ability to converse about such matters, and at worst lead to incorrect financial decisions. No more delay; it’s time to dive in with a dictionary of these common financial terms (or at least you can brush up).
401(k): a type of employer-provided retirement savings account taking its name from section 401(k) of the tax code. There are contribution limits depending on the year and the age of the employee, and contributions are tax-free, meaning you don’t pay income taxes on the money contributed. Employers submit them for employees from their paychecks and will often offer a matching contribution.
Traditional IRA (Individual Retirement Account): a retirement account where money is contributed tax free, but taxed when the money is taken out at retirement. An IRA has annual limits on contributions depending on the year and the age of the person.
Roth IRA: a retirement account where contributed money is taxed, but when the money is taken out at retirement it is not taxed. An IRA has annual limits on contributions depending on the year and the age and income of the person.
Stocks: In short, stocks are pieces of ownership in a company. When a company wants to raise money it issues stocks in which the purchaser pays for a piece of ownership in that company. Public stocks are sold and purchased on stock exchanges at prices based on what everyone believes that share of ownership is worth at that time.
Dividends: Dividends are monies paid out by companies to their stock holders.
Asset: Anything that makes you money or has the potential to make you money.
Interest: In short, interest is the price you pay to use someone else’s money or the price someone pays you to use your money. When you receive interest on an investment account, the company using your money through your investment is paying you that interest in return for letting them borrow your money. When you pay interest, you are paying for the use of their money.
Wall Street Stock Exchange: the most prominent stock exchange in the U.S. in New York City on Wall Street. Stocks are bought and sold here.
Mutual Fund: An investment where lots of small investors pool their money and a manager invests that money into different financial assets. The rewards and losses are divided in proportion to each investors share.
Bonds: When an institution needs money, they sell bonds and promise the owner the money back at the end of the bond period as well as interest in the interim.
Capital Gains: A capital gain is what results when you sell an investment for more than you paid for it.
Inflation: The general rise in prices over a time. It means your money is worth less because it buys less. (Note: Inflation in moderation is not always a bad thing.)
Net vs. Gross: Gross means before anything is taken out, while net means what is actually received or paid after necessary subtractions are taken out.
Rollover: This usually means transferring the money from one type of financial account into another similar type of account. Different tax consequences may result, depending on the exact situation.
Compound Interest: Compounding interest is when interest is assessed on previous interest that has become part of the balance.
To educate yourself about common political financial terms, see our post Money and Politics.