Glossary
401(k) - Also known as a defined contribution plan, a type of retirement plan offered by employers to their employees. Money taken out of your paycheck is typically invested in stock or bond funds, where it grows untaxed until you retire, at which point you pay taxes on it. (In a special type called a Roth 401(k), the money is taxed at the beginning but then grows tax-free forever.) Typically, your employer will allow you to choose your mix of funds and, often, will match your contribution up to a certain level. An excellent deal.
Bond - Essentially an IOU. When you buy a bond, you are lending money to its issuer - either a company or the government, federal, state, or municipal, which agrees to pay it back with interest on a certain date, called the maturity date. Bonds are less safe than bank accounts or money market funds but generally safer than stocks.
Brokerage firm - A company that handles your stock trading. When you want to buy or sell shares of a stock, you contact your broker and he or she arranges it. The brokerage firm also provides you with statements that you'll need at tax time. Brokerage firms focus on individual stocks and bonds. Some brokerage firms offer mutual funds, but you'll generally pay than you would at a low-cost mutual fund company.
Cash flow - What's left at the end of the month after you've paid all your bills and done all your spending. To find your cash flow, add up all of your expenses for a month and subtract that number from your monthly income. Knowing your cash flow is key to setting a monthly savings goal.
Closing costs - The additional costs typically involved in purchasing a piece of real estate. Closing costs, which usually amount to about 1% to 4% of the total price, include fees for inspections, appraisals, title insurance, credit checks, land surveys and legal services.
Compounding - Occurs when earnings from an investment are added back into the investment and used to generate further earnings. For example, on bank accounts that pay interest, the interest is typically added to the balance of the account each day, which means that the next day's interest is calculated on a slightly higher amount. Likewise, if you leave your money in a mutual fund, rather than periodically withdrawing earnings on it, it will grow significantly faster. Compounding is the key to the success of long-term investments.
Credit (tax) - An item you can list on your tax return that directly reduces the amount of tax you owe. You can get a credit for having children, buying environmentally friendly cars or appliances, enrolling in college, or even simply having a low income. Some credits are even "refundable," which means that if the value of your credits is greater than the amount of tax you have to pay the IRS in a given year, you'll get a refund for the difference. Because of this, tax credits are even more highly sought than deductions.
Credit score - A rating assigned to you by three major credit bureaus that indicates how likely you are to pay back a loan on time. Your credit score is based on your credit report, a detailed list of all of your past transactions with creditors, like the credit card payment you missed five years ago. Information on your credit reports generally remains there for seven years. Bankruptcies remain for ten. Get your credit reports for free at annualcreditreport.com and buy your scores for about $16 apiece at myfico.com.
Deduction - Any expense that you can "write off" on your tax return in order to lower your taxable income and ultimately the amount of tax you pay. Some common deductions include moving bills, student loan interest, sales and state income tax, unreimbursed medical costs, charitable contributions, childcare costs, mortgage interest, and various business-related expenses. The IRS gives you a choice of adding up your deductions (a process called itemizing) or simply taking the "standard" deduction.
Debt - Money you've borrowed from a lender. In addition to paying back the money borrowed, you almost always have to pay interest. The rate of interest being charged on your debt affects how you should approach paying it off. Credit card debts generally carry the highest rates (sometimes over 30%) and should be paid off first. Debts with lower rates, like most student loans (5-10%), can be paid off more slowly, even while saving.
Expense ratio - The annual fee a mutual fund company charges its customers, expressed as a percentage of your investment. The current average expense ratio for stock funds is 1.4%, which means that the fund takes 1.4% of your investment each year. Index funds, on the other hand, can have much lower expense ratios - the Vanguard 500 Index fund, for example, charges only 0.15%. The difference this makes to your investment is considerable: $10,000 held for 10 years in a fund with a growth rate of 8% and an expense ratio of 1.4% will grow to $17,775, while the same investment in a fund with the same growth rate but an expense ratio of 0.15% will grow to $19,741.
Gross income - The amount of money you earn before it is reduced by federal and state taxes, FICA, and any other automatic payouts.
Growth fund - A mutual fund generally consisting of stocks chosen for their strong growth potential. These are generally mid-sized or large companies whose stock prices appear to be growing rapidly. Gains may be greater than average when the market is doing well, and losses may be similarly great when the market falls. Growth funds make for a relatively aggressive investment, which is to say they are more of a gamble than other funds, but may pay off over the long haul.
Health maintenance organization (HMO) - A popular type of health insurance. HMO members are given a list of physicians who participate in the plan; as long as you stay on the list, the HMO will cover some or all of the cost of treating an illness or injury. Members often make a relatively small fixed payment (called a co-payment) per doctor's office visit.
Index - An index is a group of stocks that are bunched together and watched closely as an indicator of the performance of the market. For example, Standard & Poor's 500 (the S&P 500) is a collection of stocks in large, established companies.
Index fund - An index fund is a mutual fund that buys only the stocks in a particular index, unlike most funds, whose stocks are chosen by a highly-paid fund manager. Because you are not paying a manager, index funds are less expensive. Surprisingly, index funds, on average, have actually outperformed other funds over the past twenty years.
Inflation - How fast prices are increasing over time. Inflation erodes the buying power of money across long periods. At the average historical inflation rate (3%), it will take $1,356 in ten years to buy what $1,000 will buy today. Because of this, it's important to try to invest in accounts that will return enough to at least keep up with inflation.
Interest - The fee a lender charges in exchange for lending you money. This fee is calculated as an agreed-upon percentage of the amount of the loan per year (the "interest rate"). Interest rates vary between 0% and 20% or more, depending on the type of loan, the particular lender, and, often, on your credit score. Interest can also be paid to you, as in the case of bonds and certain bank accounts.
Investment - Like savings but, instead of putting your money under the mattress or in a bank account, you use it to buy something that is expected to be worth more in the future, like a mutual fund or stock in a company. When you invest your money responsibly and let it grow untouched, the results can be astounding: if you invest $1,000 a year for ten years in a tax-favored retirement account and let it grow at 8% for thirty more, you'll end up with $168,627.
IRA (Individual Retirement Account) - This tax-favored investment comes in two types: traditional and Roth. In a traditional IRA, you contribute money tax-deferred, which means it is taxed only when you withdraw it upon retirement. In a Roth IRA, you pay taxes upfront on the money you contribute, after which it is never taxed again. For a number of reasons, Roth IRAs are often better for younger people.
Itemizing - The process of adding up all your deductions on your tax return in case they add up to more than the standard deduction. It's definitely worth itemizing to see whether you could lower your tax bill.
Large-cap fund - A mutual fund consisting of stocks in large companies whose total stock is worth roughly $8 billion or more, though each fund has its own policy about where to draw the line. Large-cap funds are generally considered the safest stock investments and are often the best performing as well.
Load - Some mutual fund companies charge you an additional commission above standard expenses. This charge, called a load, is a one-time fee taken off the top of your investment and given directly to the broker. Load funds do not generally do any better than no-load funds, so steer clear of loads.
Market capitalization - The total dollar value of all the stock that exists for a particular company, obtained by multiplying the total number of shares by the current share price.
Mid-cap fund - A mutual fund consisting of stocks in mid-sized companies whose total stock is worth roughly between $1 billion and $8 billion, though each fund has its own policy about where to draw the lines.
Money market fund - Nearly as safe as bank accounts but with generally higher returns, these funds consist of an ever-changing collection of very short-term loans to large, stable companies or governments. Also called "money funds."
Mortgage - A loan taken out to buy real estate. The loan is guaranteed by the real estate, which means that until you pay off your mortgage, your bank owns your house.
Municipal fund - A mutual fund consisting of bonds issued by city, town, and state governments.
Mutual fund - Mutual funds are investments that pool together the money of many investors and invest it in a variety of stocks, bonds, and money market securities. By owning a stake in a wide variety of investments, individual investors are protected from the possible ill fate of any particular investment. Take, for example, our friends Mike and Sam, who watched their money shrink after buying individual stocks. Had they instead invested in a mutual fund, they would have weathered the market's drop with only a modest loss. Unless you have enough money - and time - to invest in many different stocks, your stock investment should all be in mutual funds.
Net income - The amount of money you've earned after paying federal and state taxes, FICA, and any other automatic payouts. Your "take-home" pay.
No-load fund - A mutual fund which charges you only the annual expense fee and no additional commission on your investment. There are plenty of quality no-load mutual funds out there.
Pension (defined benefit plan) - The old-fashioned retirement plan, increasingly replaced by defined contribution plans like 401(k) plans. Under this type of plan, an employee would stay with a company for decades, and upon retirement begin to receive a steady retirement paycheck based on their length of service.
Prospectus - An informational document available for free from any mutual fund company. Includes basic information about a fund, including its investment strategy, its past performance, and its expenses, which are passed on to you. Read it before you invest in the fund.
Retirement - The point in life at which you stop working. This is also the point at which you are entitled to withdraw money from your 401(k) or IRA. Generally, you must be at least 59.5 years old before you can declare yourself retired and withdraw your money without penalty; however, the rules are different for each type of retirement investment.
Securities - A broad term that refers generally to stocks, bonds, and money market instruments. ("Instrument" is just a fancy word for any form of investment, like a stock or a bond.)
Small-cap fund - A mutual fund consisting of stocks in smaller, younger companies whose total stock is worth roughly $1 billion or less, though each fund has its own policy about where to draw the line. Small-cap funds are generally considered riskier investments than other funds, but many advisors recommend keeping them as a small portion of your stock investment.
Stock - Stock is ownership of a company. It is sold in "shares" because its owner owns a share of the company. The price of a company's stock fluctuates according to its supply and demand on the open market and generally reflects the company's current prospects. It is advisable to invest in a wide array of stocks so as not to have too many eggs in too few baskets. (see mutual fund)
Tax-favored - A tax-favored investment is one which shelters your money from taxes, minimizing the tax you pay. Typically this is done in one of two ways: either by deferring taxation until you withdraw the money (as in a 401(k) or traditional IRA) or by letting money which has already been taxed grow without ever being taxed again (Roth 401(k) or Roth IRA).
Value fund - A mutual fund consisting of "value stocks," stocks that have fallen out of favor with the stock market and are considered under-priced when you look at the company's past and potential earnings. Basically, a value fund manager is looking for what are considered "good buys." Sort of like a bargain hunter combing designer outlets.
Still looking?
If you can't find the word you're looking for here, check these more complete financial glossaries:
The Yahoo! Finance glossary - This is one of the most complete financial glossaries anywhere, with thousands of terms concisely defined.
The Investopedia - Another great glossary of investment terms and acronyms. It's aimed at slightly more financially sophisticated people, but the definitions are clear and easy to understand.