The world of finance can be intimidating, especially when professionals start talking about financial jargon that you don’t understand. While you don’t have to be an expert, it’s important to build a strong foundation of financial literacy so you can make informed decisions about your financial future. Read on to learn more about financial literacy and discover 24 financial terms everyone should know.
What is financial literacy?
Financial literacy is more than just recognizing common financial terms, it’s about understanding and applying financial skills like personal finance management and budgeting. When you are financially literate, you’re in the driver’s seat of your financial future.
The more comfortable you are managing your financial resources, the more confident you’ll feel to make strategic financial and investing decisions. Furthermore, those who are financially literate are also less likely to fall for scams, overspend, and make risky decisions.
24 Finance & Investment Terms Everyone Should Know
To improve your financial literacy, we gathered 23 financial and investment terms that everyone should know.
Also referred to as ‘alternatives’, this type of investment doesn’t fall into one of the conventional investment categories like stocks, bonds, or cash. The most common types of alternative investments include private equity, hedge funds, real estate, and natural resources.
An asset is a resource with economic value that will provide future value to you or your business. Assets include things like cash, real estate, or stocks. There are different types of asset classes, including:
- Current assets: These are short-term assets that can be converted into cash within a year. Current assets include accounts receivable, stock inventory, and other liquid assets.
- Fixed assets: Fixed assets are tangible resources that cannot be immediately turned into cash. A company will purchase fixed assets to aid in business operations such as software, furniture, and vehicles.
- Financial assets: Examples include stocks, corporate bonds, and equity.
- Intangible assets: These are assets that you can’t physically touch. Patents, trademarks, and copyrights are examples of intangible assets.
3. Asset Allocation
Asset allocation is how you distribute your money across various investment types, such as bonds, stocks, cash, and alternative investments.
4. Annual Percentage Rate (APR)
The annual percentage rate (APR) is the interest charged on a loan. The APR includes any fees or costs associated with the loan, but it does not recognize compound interest.
5. Annual Percentage Yield (APY)
The annual percentage yield (APY) is the real rate of return earned on an investment in one year, if the interest is compounded. The high the APY, the faster your money grows.
6. Average Annual Return (AAR)
The average annual return (AAR) is a percentage that represents an investment or fund’s historical average return. An investment’s AAR measures its long-term performance over 3, 5, or 10+ years. The 3 components contributing to the AAR are share price appreciation, capital gains, and dividends.
Bonds are fixed-income investments that governments and businesses typically issue to raise money. Think of a bond as an I.O.U. between the lender and borrower. It includes the details of the loan and its respective payments. Bonds have maturity dates which is when the principal amount must be repaid back in full. The interest payment, also called the coupon, is included in the return to the bondholder.
8. Capital Gain
Capital gain is the profit made from the sale of property or an investment. It represents the difference between how much an asset is currently worth and how much it was worth when it was purchased.
9. Compound Interest
Compound interest is the interest you earn on interest. Simple interest is calculated only on the principal amount, while compound interest is calculated both on the initial principal and the accumulated interest.
A contract is an agreement between two or more parties that is enforceable by law. A debt instrument, for example, is defined by contractual terms and will specify the interest rate, payment schedule, and maturity date.
11. Debt Instrument
A debt instrument is a financial tool used to raise capital or generate investment income. Any vehicle classified as debt is considered a debt instrument, including government bonds, leases, promissory notes, mortgages, and credit cards.
Diversification is a savvy investment strategy that allocates capital across various investments and/or other asset classes to increase returns and minimize overall risk to your portfolio.
Inflation is the rate of increase in prices of goods and services over a period of time. It’s the decrease in the purchasing power of money, which simply means that items cost more. Inflation is a broad measure, such as the increase in the cost of living.
Interest is the cost of borrowing money or the return earned on an investment if it’s a debt instrument. The three types of interest are simple, compounding, and accrued.
15. Internal Rate of Return (IRR)
The internal rate of return (IRR) is the annual growth rate that an investment is anticipated to accrue. Simply put, it measures the profitability of a potential investment.
16. Investment Portfolio
An investment portfolio is a collection of all of the assets you own across various accounts, whether it be bonds, stocks, cash, or alternatives.
A lender is a person or company that provides loans to another company or individual. A lender could be a bank, credit union, insurance company, or individual.
Liquidity refers to how quickly you can turn an asset into cash. Essentially, liquidity means you can get your money whenever needed. Your emergency fund, for example, is liquid because you can tap into the funds whenever an emergency arises.
19. Market-Based Investment
A market-based investment is a debt security or bond that is linked to the performance of another asset or asset.
A return is the money made or lost in an investment. It’s the change in the price of an asset or investment over time represented by a price or percentage change.
A security is a convertible, negotiable financial instrument representing ownership and holding monetary value, such as stocks, bonds, and promissory notes. Currency, checks, or an insurance policy is not considered a security.
Stock is a type of security representing a claim on a company’s assets and earnings. When you purchase stock, you hold a share of ownership of a company.
23. Stock Market
The stock market, or equity market, is where investors buy and sell shares of stock and other financial securities that are publicly held.
Volatility is the risk of an investment or asset. A volatile market is filled with uncertainty and can be subject to frequent (and significant) changes.
This material is intended for informational purposes only and should not be construed as legal or tax advice. Information here is not intended to replace the advice of your investment advisor or financial advisor. This information is not an offer or a solicitation to buy or sell securities. This information may have been compiled from third-party sources and is believed to be reliable. All investing involves risk, including the loss of principal.