It would be wisest to begin with some basic Personal Finance vocabulary. As you can see by now, the financial world is full of cryptic terminology, foreign words, and acronyms… We in the banking business LOVE acronyms. By learning some of these words (or at the very least coming back to the list for reference if you forget) you increase the chances of being able to apply that which we are going to discuss! So let’s go down a short list of important terms…
Annual Fee – A fee charged by credit card companies, yearly, for the use of their card.
Annuity - A series of regular payments, usually from an insurance company, guaranteed to continue for a specific time, usually the annuitant's lifetime, in exchange for a single payment or a series of payments to the company.
Amortization - Gradual repayment of a loan in equal (or nearly equal) installments which include portions of interest and principal amounts.
Asset - Something you own. An asset can be property, such as your home or a company's warehouse, a diamond ring or a piece of manufacturing machinery; securities; debts owed to you; or cash.
Liability – Something you owe to another party. Liabilities include all debt.
Net Worth- The measure of your actual worth once you deduct liabilities (Assets – Liabilities = Net Worth)
Bank (US definition) – An organization, usually a corporation, chartered by a state or federal government, which does most or all of the following: receives demand deposits and time deposits, honors instruments drawn on them, and pays interest on them; discounts notes, makes loans, and invests in securities; collects checks, drafts, and notes; certifies depositor's checks; and issues drafts and cashier's checks.
Credit Union (US definition) - A non-profit financial institution that is owned and operated entirely by its members. Credit unions provide financial services for their members, including savings and lending. Large organizations and companies may organize credit unions for their members and employees, respectively. To join a credit union, a person must ordinarily belong to a participating organization, such as a college alumni association or labor union. When a person deposits money in a credit union, he/she becomes a member of the union because the deposit is considered partial ownership in the credit union.
Federal Deposit Insurance Corporation – The FDIC insures all commercial bank deposits up to a certain amount. It used to be $100,000 per person (there are easy ways around this) but with the onslaught of the financial crisis and the fear of bank runs, the government raised FDIC limits last year.
National Credit Union Administration – This is the credit union counterpart to the FDIC, they also raised the limit on individual account insurance.
Credit Card – A secured or unsecured revolving line of credit with a limit and a percentage rate.
Charge Card – Not to be confused with a credit card, a charge card is paid off in full by the end of the period. American Express Green/Gold/Platinum are examples of a charge card. There is no interest rate, because there is never an outstanding balance.
Bond – An interest-bearing security that obligates the issuer to pay a specified amount of interest for a specified time, usually several years, and then repay the bondholder the face amount of the bond. They are issued by governments, companies, as well as the treasury.
Security - Financing or investment instrument (which may or may not be a negotiable instrument) issued by a firm or government agency which denotes an ownership interest and provides evidence of a debt, a right to share in the earnings of the issuer, or a right in the distribution of a property. Securities include bonds, debentures, notes, options, shares (stocks), and warrants but not insurance policies, and may be traded in financial markets such as stock exchanges.
Mortgage-Backed Security – Securities created by bundling consumer and commercial mortgages. A fairly new investment vehicle, and one of the big reasons for the financial mess we are in today.
Common Stock – A share of stock in a company with voting rights which may or may not pay dividends out. Common stock offers voting privileges, but it’s right to reclaim assets when the company goes bankrupt fall near the bottom of the food chain meaning they get repaid after bondholders and preferred stock holders (If there is anything left).
Preferred Stock – A share of stock in a company that pays out a fixed amount of interest to its holders instead of dividends. Preferred shares sometimes carry voting rights, and other times they do not. No dividends can be declared for the common stockholders untill the payment of interest has been made to Preferred stockholders.
Mutual Fund – A pool of investments managed by a firm that has a specific investment objective. Mutual funds are a common way to invest for people who do not know a lot about investing other than what they are looking to invest in. Most of us with 401k plans are familiar with mutual funds.
Dividend – A portion of the company’s retained earnings paid out to its common shareholders (usually) quarterly. Companies do not have to pay dividends, and in today’s economy many do not.
Dividend Reinvestment Plan – A Dividend Reinvestment Plan or DRIP takes the dividends paid out by the company and automatically reinvests it for you in additional shares. These are GREAT programs for people investing in companies that pay dividends.
Dollar-Cost Averaging – The practice of buying shares in a company on a regular basis regardless of price fluctuations with the hope that over time your entire lot of shares will have cost you less. For example, if you buy 100 shares of something at $100 a piece, then buy 100 more a week later when the price is $50 a piece, you have brought your cost per share down to $7.50, bringing down your break-even point and the point at which you begin earning a profit!
Cash flow – Cash flow is basically the incoming and outgoing money in your home. A good way to analyze your spending.
Certificate of Deposit – a certificate of deposit, or CD, is a time-instrument that promises a certain interest percentage on deposited funds for a certain period of time. Typically the longer the term, the higher the interest rate you are paid for keeping the money in the bank. Unlike checking and savings accounts, CD’s cannot be withdrawn until maturity without penalty.
Credit - An arrangement for deferred payment of a loan or purchase
Debt to Income Ratio – A figure that calculates how much of a person's income is spent paying his or her debts. The higher one's debt to income ratio, the more of their monthly income that is solely devoted to paying back debts. DTI is important to manage, because it is something often considered by institutions when they evaluate loan creditworthiness; institutions conclude that if a person's DTI is too high, they might not be able to pay back their debts very easily, and the institution will be less inclined to make the loan
Due Diligence – The homework that goes into making ANY investment decision. An essential step in not going broke.
Equity - Ownership interest in a corporation in the form of common stock or preferred stock. It also refers to total assets minus total liabilities, in which case it is also referred to as shareholder's equity or net worth or book value. In real estate, it is the difference between what a property is worth and what the owner owes against that property (i.e. the difference between the house value and the remaining mortgage or loan payments on a house). In the context of a futures trading account, it is the value of the securities in the account, assuming that the account is liquidated at the going price. In the context of a brokerage account, it is the net value of the account, i.e. the value of securities in the account less any margin requirements.
Federal Housing Administration – Or, FHA as it is often abbreviated, is a government agency whose primary purpose is to insure residential mortgage loans.
Finance Charges – The COST of credit to the debtor.
401K – Workplace sponsored retirement plan. The 401k is a pre-tax account, in that funds go into it before taxes are deducted, thereby lowering your taxable income. Most companies have some sort of match to encourage participation.
403b – Similar to a 401k, except it is for non-for-profit organizations.
SEP IRA - A retirement program for self-employed people or owners of companies with less than 25 employees, allowing them to defer taxes on investments intended for retirement. This plan allows employers to contribute on behalf of eligible employees, and all contributions are tax-deductible as a business expense and can be integrated with Social Security contributions. In addition, there is no minimum contribution requirement.
Traditional IRA - A Traditional IRA is an individual retirement account (IRA) in the United States. The IRA is held at a custodian institution such as a bank or brokerage, and may be invested in anything that the custodian allows (for instance, a bank may allow certificates of deposit, and a brokerage may allow stocks and mutual funds). Unlike the Roth IRA, the only criterion for being eligible to contribute to a Traditional IRA is sufficient income to make the contribution. However, the best provision of a Traditional IRA — the tax-deductibility of contributions — has strict eligibility requirements based on income, filing status, and availability of other retirement plans (mandated by the Internal Revenue Service). Transactions in the account, including interest, dividends, and capital gains, are not subject to tax while still in the account, but upon withdrawal from the account, withdrawals are subject to federal income tax
Roth IRA - In contrast to a traditional IRA, contributions to a Roth IRA are not tax-deductible. Withdrawals are generally tax-free, but not always and not without certain stipulations (i.e., tax free when the account has been opened for at least 5 years for principal withdrawals and the owner's age is at least 59 ½ for withdrawals on the growth portion above principal). An advantage of the Roth IRA over a traditional IRA is that there are fewer withdrawal restrictions and requirements. Transactions inside the Roth IRA account (including capital gains, dividends, and interest) do not incur a current tax liability.
Flexible Spending Account - A benefit offered to an employee by an employer which allows a fixed amount of pre-tax wages to be set aside for qualified expenses. Qualified expenses may include child care or uncovered medical expenses. The amount set aside must be determined in advance and employees lose any unused dollars in the account at year-end.
Futures - A standardized, transferable, exchange-traded contract that requires delivery of a commodity, bond, currency, or stock index, at a specified price, on a specified future date. Unlike options, futures convey an obligation to buy. For example, I buy futures Microsoft June-2012 futures at $50.00 a share, because I think Microsoft is going to do really well and fly above that. At that time, I am obligated to buy that number of shares at $50.00 regardless of whether they are at $1.00 or $100.00. Used by many hedge funds, producers of goods, and farmers, to hedge against losses.
Options – An option is similar to a future, except that it represents an OPTION to buy or sell at the time of maturity, not an obligation. At maturity, the holder of the option can exercise it if it is advantageous, or let it lapse and have lost only the cost he paid for the futures contract itself.
Rollover – A rollover is a move from one IRS approved retirement account to another. It is tax/interest free and is most typically done when one changes jobs or investment companies.
Short Sell – Investing on the belief that a security is going to go down in value. To ‘short’ a stock, one borrows the shares from the brokerage on credit at the going price and in doing so puts themselves under obligation to give them back the borrowed NUMBER of shares. In other words, if IBM is trading at $20.00 a share, and I short 100 shares, they will GIVE me $2000.00 and I will be obliged to give them back 100 shares of IBM at a later time. If six months from now, IBM is at a dollar, I would buy a hundred shares to “Cover my short”, pay back my obligation, and be left with a $1900.00 profit (MINUS the interest paid to the brokerage who lent you the shares). It’s also a great way to lose your ass on Wall Street.
Spread – The spread is the difference between the BID and ASK prices for a stock.
Split – A split effectively increases the amount of shares out in the market and lowers the price. This is sometimes done by a company when their shares are becoming too pricy. If a company declares a 2-1 stock split, each share owned by an individual or institution will become 2, and the price of each share will be halved thereby reaching equilibrium.
Treasury Bill - A negotiable debt obligation issued by the U.S. government and backed by its full faith and credit, having a maturity of one year or less. Exempt from state and local taxes.
Treasury Bond - A negotiable, coupon-bearing debt obligation issued by the U.S. government and backed by its full faith and credit, having a maturity of more than 7 years. Interest is paid semi-annually. Treasury bonds are exempt from state and local taxes. These securities have the longest maturity of any bond issued by the U.S. Treasury, from 10 to 30 years. The 30-year bond is also called the "long bond." Denominations range from $1000 to $1 million.
Treasury Note - A negotiable debt obligation issued by the U.S. government and backed by its full faith and credit, having a maturity of between 1 and 7 years. also called U.S. Treasury Note.
Interest - The fee charged by a lender to a borrower for the use of borrowed money, usually expressed as an annual percentage of the principal; the rate is dependent upon the time value of money, the credit risk of the borrower, and the inflation rate. Here, interest per year divided by principal amount, expressed as a percentage. also called interest rate.
Demand Deposit Account – An account which allows access to funds on demand, unlike a CD or certain types of money market accounts. Also known as a “DDA” in banking circles, most of you would be familiar with it as a “Checking account”
Savings Account – Interest bearing accounts at a bank, does not carry check writing privileges.
Money Market Account – A money market account is like a savings account, except that it tends to pay higher rates of interest. It is also governed by several rules and has withdraw limits.
Liquidity - The ability of an asset to be converted into cash quickly and without any price discount. For example, the money you have in your bank account is much more liquid than a house, which may take a long time to sell, or a stock whose value may be below its cost and not worth selling.
Mortgage - A loan to finance the purchase of real estate, usually with specified payment periods and interest rates. The borrower (mortgagor) gives the lender (mortgagee) a lien on the property as collateral for the loan.
Adjustable-Rate Mortgage – A mortgage with an interest rate that may change, usually in response to changes in the Treasury Bill rate or the prime rate. The purpose of the interest rate adjustment is primarily to bring the interest rate on the mortgage in line with market rates. The mortgage holder is protected by a maximum interest rate (called a ceiling), which might be reset annually. ARMs usually start with better rates than fixed rate mortgages, in order to compensate the borrower for the additional risk that future interest rate fluctuations will create.
Point - For loans, 1% of the loan amount. By charging a borrower points, a lender effectively increases the yield on the loan above the amount of the stated interest rate. Borrowers can offer to pay a lender points as a method to reduce the interest rate on the loan, thus obtaining a lower monthly payment in exchange for this up-front payment. For each point purchased, the loan rate is typically reduced by 1/8%. For stocks, $1 per share. For bonds, 1% of the face value (usually $10, 1% of $1000).
Prime Rate - The interest rate that commercial banks charge their most creditworthy borrowers, such as large corporations. The prime rate is a lagging indicator (An economic indicator that changes after the overall economy has changed). Also called prime.
Refinance - Revising a payment schedule to reduce monthly payments or to modify interest charges. In banking, extending the maturity date or increasing the amount of existing debt, or both. With bonds, retiring existing bonded debt by issuing new securities to reduce the interest rate, or to extend the maturity date, or both.
Ok, ok, so maybe the list wasn’t so short… But this is important damn it! We will be using many more terms than this from here on out, this is just a list of the most basic. Many of them are very basic, I do not mean to make fun, I only include them because I want to make SURE that everyone knows what they are!
In our next exciting installment… We open our first bank account.
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