By Jamie Englert
Managing your finances may seem like a dizzying mass of numbers. But you can also think of personal finance in terms of letters, as in the initials of some important personal finance terms to know. From bonds to life insurance to yield, below are some of the A to Z finance terms it’s worth knowing.
The annual percentage rate is the actual rate you pay on money you borrow or the actual return you earn on money you invest calculated out over a year. This differs slightly from the interest rate. For example, with a mortgage, the APR includes fees you have to pay for the loan. With a credit card, the APR accounts for the fact that the interest may be compounded daily, which will lead to a slightly higher rate than simple interest.
Essentially, you want a higher APR for your bank accounts or money you lend but the lowest for your own credit products. Just a one point APR difference can mean thousands of dollars over the life of a long-term loan, such as a mortgage.
Bonds are an investment that is essentially a loan to a company or government entity. Unlike stocks, bonds don’t give you an equity investment in a company; you instead get a promise to pay back your investment plus interest.
Bonds are usually less risky than stocks but their returns are also lower over the long-term. Cost is a heavier factor, with high-cost bonds poses more risk than lower cost vehicles. Examine your risk tolerance and current finances to decide whether you can weather a bond.
Your credit score is essentially a numerical rating of how you manage the money you borrow. Lenders, landlords, insurance companies and even some employers use your credit score to assess the risk of doing business with you. Check your credit score annually and dispute any incorrect entries on your credit report. Make paying on time and in full a priority to improve your score and increase the availability and quality of credit items offered to you.
Whenever you borrow money, whether it’s for a mortgage, car loan or a credit card balance, it creates a debt until the loan is paid off. The longer you carry debt, the more you will pay in finance charges. Accumulating large amounts of debt can lower your credit score and also put you in a financial bind. While there may be times when you want to take on debt, such as for a purchase of a house or to finance college, in most cases you want to avoid it whenever possible. Becoming debt free should be a top financial goal.
Most financial experts recommend that in addition to any money you save for retirement or for your kids’ education, you also save money for an emergency fund. This is money you keep in an easily accessible taxable account, such as a savings or money market account. The money is there to help you through an emergency, such as a job loss, major repairs to your house or a major medical crisis.
A good rule of thumb is to save enough to cover at least six months’ worth of your household expenses. Having an emergency fund prevents you from having to run up huge credit card debts or borrowing from tax-deferred retirement accounts.
FICO is the credit score most widely used by lenders and others. It ranges anywhere from 300 to 850, with an average score around 635. To calculate your score, FICO puts the most emphasis on your payment history, attributing 35 percent of your score to that factor. How much debt you have makes up 30 percent of your score. The length of your credit history makes up 15 percent of your score, while the types of credit you have and the amount of new credit you have each account for 10 percent.
An easy way to boost your credit score is to take out a small amount of credit and pay it off over a short period of time, this proves to lenders you are capable of paying your debts on time and will raise your score.
A growth stock is one that has a high potential for growth. That usually means it is a young company or one that has just produced a breakout product. Along with the high potential for growth, however, comes a high risk. Growth stocks often have unstable histories and products. If you want to mitigate some of the risk, you can invest in a growth-oriented mutual fund instead.
Review growth stock company information thoroughly before investing. If you don’t have a high tolerance for risk, a growth stock isn’t the best choice for you.
This is the amount of money your home is worth minus whatever you owe on a mortgage. For example, if your home is worth $200,000 and you owe $140,000 on your mortgage, then you have $60,000 in equity. If you could sell your home for $200,000, you would get $60,000 in cash after paying off your mortgage. You can also borrow against your equity with a home equity loan or home equity line of credit.
While home equity loans carry a lower interest rate than personal loans that are not secured by property, you can lose your home in foreclosure if you can’t pay. Assess your finances to determine whether a home equity loan is worth the risk.
An index fund is one of the simplest ways to invest in the stock market. Instead of investing in a particular industry or size of stock, an index fund simply seeks to replicate the performance of a stock index, such as the S&P 500 or Russell 2000.
Since index funds aren’t actively managed, they tend to have lower expenses than many other mutual funds. However, passive management means less human input, so guard yourself accordingly.
A jumbo mortgage is a mortgage that exceeds the conforming loan limits set by Fannie Mae and Freddie Mac. For most of the country, the conforming loan limit is $417,000, although it is as high as $625,500 in some parts of the country.
Because of the risk involved with a jumbo loan, it’s interest rate is usually higher than that of a conventional loan. Try saving for a larger down payment or scaling down your housing price range to avoid a jumbo loan. If you must have one, get multiple quotes to ensure you’re getting the best rate.
A Keogh plan is a tax-deferred retirement plan that’s available to small companies and the self-employed. The plan can be set up as either a traditional defined-benefit pension plan or a defined-contribution plan. Contributions to the plan are tax-deductible up to 25 percent of annual income or net profits, up to a maximum of $51,000 as of 2013.
While saving for retirement is always a good idea, consider a SEP IRA over a Keogh plan. The contribution maximums are the same but the SEP IRA requires less paperwork.
If you’ve got a spouse, kids or assets you want to protect, you have a need for life insurance. Many people, especially those who are young and not married, think they don’t need life insurance. But even a small policy is a good idea to cover burial and funeral expenses in the event of your death.
There are basically two types of life insurance, term and whole. Though there are many variations of whole life, the policy is generally in force for as long as you pay the premiums and builds a cash value which you can borrow against or take in lieu of death benefits.
Term life insurance gets you a set amount of insurance at a set premium for a certain period of time. Term has no cash value and if you live through the term, you get nothing. However, the big advantage to term insurance is that you can get a large amount of insurance for very little money, so consider term if you have a family.
A matching contribution, also called an employer match, is the amount an employer contributes to a retirement plan such as a 401(k). While some employers put contributions into a plan regardless of whether you contribute or not, most “match” a certain amount contributed by the employee. For example, your employer might contribute 50 cents on the dollar for the first 6 percent of your contributions, which means if you put 6 percent of your pay into your 401(k), your employer will contribute 3 percent. If your employer offers matching contributions, it’s important you contribute the minimum necessary to get the full match.
Your net worth is a measurement of how much cash you could generate if you needed to. To calculate net worth, you simply subtract your liabilities from your assets. Assets include any money you have saved up or invested, equity in a home or car, any ownership in a business and the value of your property. Liabilities are generally any loan commitments you have, such as a mortgage, car loan and credit card balances.
For example, if you have a house worth $200,000, a car worth $10,000, savings and investments of $50,000 and personal property worth $15,000, you have $275,000 in assets. If you owe $140,000 on your mortgage, $5,000 on your car loan and $5,000 on credit cards, your liabilities are $150,000. That would leave you with a net worth of $125,000.
Calculate your net worth to see how healthy your finances are. If you’re carry little or no net worth, you must work on lowering your debts.
When discussing loans and investments, principal is the amount you borrow or invest, not counting any interest. Some investments guarantee that your principal will be protected; meaning you can only gain money, not lose it. With many loans, you may have the option to pay back your principal faster than your payment schedule, which will reduce the amount of interest you pay.
A qualified dividend is a distribution from a stock or other investment that qualifies for the lower capital gains rate. For a dividend to be qualified, it must be paid by an American corporation or a qualifying foreign corporation. You must also hold the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. Reinvest dividends instead of pocketing the money to postpone tax payments.
When you invest, you are hopefully following a strategy or philosophy. For example, when you are investing for retirement, the strategy often involves being more aggressive in younger years and then becoming more conservative in later years. Rebalancing involves adjusting your investment portfolio on a regular basis to keep certain investments from becoming too large based on performance. For example, if international stocks have a really great year, you may need to sell off some of your international holdings to keep them from becoming too large a part of your portfolio.
If you work for yourself or as a contractor, you are responsible for paying the taxes that an employer normally picks up for its employees. This is called the self-employment tax and consists of Social Security and Medicare taxes. You are responsible for the full amount, which is 15.3 percent in 2013. This tax is in addition to the income taxes you owe on your earnings.
To comply with IRS rules, you can make quarterly payments of your estimated taxes throughout the tax year. Form 1040-ES provides a worksheet for individuals who need to calculate estimate taxes and you can register with the IRS electronic system to make the payments.
A timeshare is a fractional ownership in a piece of property, often real estate. You usually pay a one-time fee plus ongoing monthly or annual maintenance fees. The ownership may be perpetual or it may be for a certain period of time. In return, you get a certain amount of usage of the property. Being part of a timeshare does not give you any actual ownership rights to the physical property, however.
Timeshares are depreciating assets and your interest in them can be hard to sell. Even when you’re able to sell, it’s often at a huge loss. While they usually seem appealing when first introduced to them, they have a lot of pitfalls and should be avoided by most. Weigh the costs and fees and the resort’s state before you consider purchasing a timeshare.
When property you used to secure a loan is worth less than what’s remaining on the loan balance, you are said to be underwater. A more technical term for this situation is negative equity. Though this term is commonly used when referring to home ownership, it can apply to any secured loan if the value of the collateral falls below the balance remaining on the loan.
The federal government’s Making Home Affordable program offers loan modification options to those with underwater home loans. Contact the organizers to learn if you qualify for help on your underwater mortgage.
Vesting is the process by which you fully earn an employment incentive or benefit. For example, many companies require a person to work for a few years before becoming fully vested in company contributions to a 401(k) or other retirement plan. If the person leaves before reaching the full vesting level, he forfeits some of those contributions. Confirm the vesting time in your company with your new employer and make sure you have full access to benefits with the time comes.
The Internal Revenue Service offers tax breaks on retirement accounts such as IRAs and 401(k)s to encourage people to save for retirement. As an additional incentive, it levies a 10 percent tax penalty if you take money out of these accounts before age 59 1/2. This is called a withdrawal penalty and it is in addition to any regular income taxes that are due on the money. To account for hardships and other situations that might require you to tap these savings, there are some specific exemptions to the withdrawal penalty.
In neoclassic economics, businesses and individuals must maximize efficiency to succeed when competition is perfect. However, in real life, competition is almost always imperfect and x efficiency measures the level of efficiency in such markets.
Yield is the income that an investment pays. With a stock or mutual funds, it’s any dividends they pay. With bonds, it is the interest they return. You can figure out the yield by dividing the payout by the price of the investment. For example, a stock with a price of $20 that pays a $1 annual dividend has a yield of 5 percent.
Use yield to assess potential returns on your investments. Don’t become blinded by a high yield, as a higher yield usually means increased risk.
Zero percent balance transfer
People with good credit scores often get balance transfer offers with an initial period of no interest, sometimes as long as 18 or 21 months. Such offers provide a good way to consolidate credit card debt and save on finance charges. However, they usually come with a fee that is a percentage of the balance being transferred and once the zero percent offer is up, the interest rate will revert to something much higher.
Balance the fees against how much you’ll save in interest if you consolidate your debt balances on one card. You must be able to pay the card off before the initial interest period ends to receive the full benefits of this maneuver.
Jamie Englert is the Editorial Manager at Car Finance 247, a leading car finance broker. He has a passion for digital and loves nothing more than grabbing a great deal.
(Photo courtesy of Martin Abegglen)