Listening to financial professionals can often feel like hearing a foreign language. The terms used and their perceived complexity keep many interested people standing on the sidelines — but these terms are usually a lot more straightforward than you think. Below, we’ve compiled a list of financial terms everyone should know. You’ll probably be vaguely familiar with most of them, but it’s important to really understand what they mean and how they can impact your personal financial decisions.
We’ve all heard this phrase referring to athletes or celebrities, but few know how it’s calculated and how to use it for their own financial benefit. Net worth is calculated by subtracting your liabilities from your assets. Include all bank accounts, investments, home values and even vehicle values when calculating assets. All debt, including the balances on your mortgage, credit cards and student loans, factors into your liabilities. By figuring out your net worth, you’ll get an overall picture of your financial health and can make changes to your goals accordingly.
As personal investing continues to grow in popularity, more and more people manage their own portfolios without the help of professionals. But amateur investors can easily overlook asset allocation principles such as diversification. Professional traders and amateurs alike should familiarize themselves with the rebalancing process to maintain their desired investment strategy. Rebalancing keeps asset allocation at your predetermined levels by buying or selling different investment vehicles such as stocks and bonds (see below). As markets swing, your allocation can quickly go haywire, so look to rebalance your portfolio at least twice a year.
We’ve all heard the word, and have probably been gifted one at some point, but few know the details behind the transaction that takes place when purchasing a bond. When you buy a bond, you essentially become a lender, typically to the government, although there are corporate bonds, as well. You’ll receive periodic interest payments, and the full amount of the bond will be returned to you at maturity. Bonds continue to be viewed as one of the safest ways to invest, although the returns are typically smaller than other investment options.
The simplest way to view compound interest is to think of it like interest stacked on top of interest. When saving or investing, compound interest will help your money pile up faster. For example, you may receive interest for any deposits into an account that’s already accruing interest on the balance. Compound interest should also be looked at closely when dealing with debt. You may be paying interest at the outset of a loan, plus any added to the balance through the course of your loan. It truly is a double-edged sword.
One of the most popular financial terms around tax season, capital gains refers to the increase in an asset’s value compared to its original purchase price. Capital gains are not realized until you sell an investment, and the tax rate varies depending on how long you’ve been holding that asset. Long-term capital gains refer to assets held for more than one year. These gains are taxed more favorably than regular income and short-term gains. Any capital gains increase your tax liability, and capital losses lower them, so be sure to keep a detailed log of your trading if you’re going at it alone.
By increasing your understanding of the language of finance, you’ll be better equipped to put your money to work and start reaching your financial goals. Whether you’re trying to maximize your gains using compound interest or looking to lower your tax liability by holding onto an asset long term, expanding your knowledge will only help you make sound financial decisions. The further you dig, the more resources you’ll discover to enable your money to grow.
Finances FYI is presented by 1st Security Bank.
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