FINANCIAL ABCs
DEBT Amortization Amortization is the paying off of debt with a fixed repayment schedule in regular installments over a period of time, e.g., with a mortgage or a car loan. Annual Percentage Rate (APR) An annual percentage rate (APR) is the annual rate charged for borrowing money or earned on an investment and is expressed as a percentage that represents the actual yearly cost of funds over the term of a loan. Bankruptcy Bankruptcy is a legal, court-directed process that a company or a person undertakes when they are no longer able to meet their debt obligations. Bankruptcy remains on an individual s credit report for several years and can significantly limit access to credit. Credit Report A credit report is a detailed report of an individual s credit history. Credit bureaus collect information and create credit reports based on that information, and lenders use the reports along with other details to determine loan applicants creditworthiness. In the United States, there are three major credit reporting bureaus: Equifax, Experian and TransUnion. Credit Score A credit score is a statistical number that depicts a person s creditworthiness. Lenders use a credit score to evaluate the probability that a person repays his/her debts. Companies generate a credit score for each person with a Social Security number using data from the person s previous credit history. The higher the score, the more financially trustworthy a person is considered to be. Interest Interest is the amount charged for borrowing money, typically expressed as annual percentage rate. Alternatively, it is what investors in bonds (debt securities) earn. Liabilities A liability is a company s (or individual s) financial debt or obligations that arise during the course of its business operations. 2
ECONOMY Consumer Confidence A gauge of how optimistic or pessimistic consumers are with respect to the economy in the near future. Consumer Price Index (CPI) The consumer price index (CPI) is a measure of price inflation that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. Deflation Deflation is the opposite of inflation, or a drop in the prices of goods or services over a period of time. Federal Reserve The Federal Reserve, or Fed, is the central bank of the U.S. government created by Congress to provide a more stable monetary and financial system. Gross Domestic Product (GDP) Gross domestic product (GDP) is the monetary value of all finished goods and services produced within a country s borders in a specific time period. Inflation Inflation is the rate at which the general level of prices for goods and services is rising. The Consumer Price Index (CPI) is a measure of inflation in the U.S. Profit and Loss (P&L) A profit and loss financial statement (P&L) summarizes the revenues, costs and expenses incurred during a specific period of time, usually a fiscal quarter or year. Recession A recession is a significant decline in activity across the economy lasting longer than a few months. Typically, it is the period in which economic growth (GDP) declines for two consecutive quarters. HOME OWNERSHIP Adjustable-Rate Mortgage (ARM) An adjustable-rate mortgage (ARM) is a type of mortgage in which the interest rate applied on the outstanding balance varies throughout the life of the loan. Normally, the initial interest rate is fixed for a period of time, after which 3
it resets periodically, often every year or even monthly. The interest rate resets based on a benchmark or index plus an additional spread, called an ARM margin. Mortgage A mortgage is debt owed on specific property, on the basis that the property is used as collateral to ensure that payment is eventually made in full. The borrower typically is obligated to pay back the mortgage with a predetermined set of payments. Principal Principal most commonly refers to the original sum of money borrowed in a loan or put into an investment. It also refers to the face value of a bond. Private Mortgage Insurance (PMI) Private mortgage insurance (PMI) is a special type of insurance policy, provided by private insurers, to protect a lender against loss if a borrower defaults on a mortgage. Most lenders require PMI when a homebuyer makes a down payment of less than 20 percent of the home s purchase price. SAVINGS, INVESTMENTS & RETIREMENT 401(k) Plan A 401(k) plan is a qualified employer-established plan to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pre-tax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees. Earnings in a 401(k) plan accrue on a tax-deferred basis on behalf of the employees. Actively-Managed Funds Actively-managed funds use one or more managers to actively manage a fund s portfolio. Unlike with index funds, which are intended to match the returns of a specific market index, active managers rely on analytical research, forecasts and their own judgment and experience in making investment decisions on which securities to buy, hold and sell. Annuity An annuity is a contractual financial product sold by financial institutions that is designed to give out a stream of payments to the individual purchaser of the annuity beginning at a specified time or 4
under predetermined conditions (such as at retirement). The period of time when an annuity is being funded by the purchaser and before payouts begin is referred to as the accumulation phase. Once payments commence, the contract is in the annuitization phase. Asset An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. An asset can be thought of as something that in the future will generate cash flow or reduce expenses. Asset Allocation Asset allocation is an investment strategy that aims to balance the investments in a portfolio according to an individual s goals, risk tolerance and investment horizon. The three main asset classes used in an asset allocation investment strategy include equities, fixed-income and cash or short-term investments. Balance Sheet A balance sheet is a financial statement that summarizes a company s assets, liabilities and shareholders equity at a specific point in time. Bear Market A bear market is a condition in which the value of a securities market (such as the New York Stock Exchange or the S&P 500 Index) falls, typically by at least 20 percent, and widespread pessimism causes the stock market s downward spiral to be self-sustaining. Bond A bond is a debt security through which an investor loans money to an entity (typically corporate or governmental), which borrows the funds for a defined period of time at a variable or fixed interest rate. Broker A broker is an individual or firm that charges a fee or commission for executing buy and sell orders for securities submitted by an investor. Budget A budget is an estimation of revenue and expenses over a specified future period of time typically for a year. Budgets are developed for a person, a family, a group of people, a business, a government, a country, a multinational organization or just about anything else that makes and spends money. 5
Bull Market A bull market is essentially the opposite of a bear market, in which the value of a securities market (such as the New York Stock Exchange or the S&P 500 Index) rises, typically by at least 20 percent, after a previous bear market (i.e., decline of at least 20 percent). Capital Capital refers to financial assets or the financial value of assets, such as funds held in deposit accounts, as well as the tangible or physical assets held by a company or individual. Capital Gains and Losses A long-term capital gain or loss is a gain or loss from a qualifying investment owned typically for longer than 12 months before it was sold. The amount of an asset sale that counts toward a capital gain or loss is the difference between the sale value and the purchase value, or, simply, the amount of money the investor gained or lost when they sold the asset. Closed-End Fund A closed-end fund is a pooled investment fund, such as a mutual fund, with a manager overseeing a fixed amount of capital raised from contributions from investors or through an initial public offering (IPO). The fund is then structured, listed and traded like a stock on a stock exchange. Unlike an open-end fund, which has no set limit on the amount of capital invested, a closed-end fund is managed with a fixed amount of capital. Compound Interest Compound interest is interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan. With compound interest, an investor is earning interest on interest, allowing an investment to grow at a faster rate. Defined-Benefit Plan A defined-benefit plan, also known as a pension, is a retirement plan that an employer sponsors where employee benefits are computed using a formula that considers factors such as length of employment and salary history. At retirement, the individual typically receives a periodic payment for the remainder of his or her lifetime. Defined-Contribution Plan A definedcontribution plan, such as a 401(k) plan, is a retirement savings plan in which a certain amount or percentage of money is set aside 6
each year by a company for the benefit of each of its employees. The employee also contributes to the plan and typically selects the investments in the plan from a predetermined list of investments established by the employer. The defined-contribution plan places restrictions that control when and how each employee can withdraw these funds without penalties. Diversification A risk-management technique that mixes a wider range of investments within a portfolio to lower the risk of major losses and high market volatility versus investing in a more limited number of investments. Dividends A dividend is a distribution of a portion of a company s earnings, decided by the board of directors, to a class of its shareholders. Dividends are typically issued as cash payments or shares of stock. Dollar-Cost Averaging (DCA) Dollar-cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. As a result, more shares are purchased by the investor when prices are lower and fewer shares when prices are higher. DCA has the effect of lowering the average share cost over time, increasing the opportunity to profit. Dow Jones Industrial Average (DJIA) The Dow Jones Industrial Average (DJIA) is a priceweighted average of 30 significant stocks of American companies traded on the New York Stock Exchange and the NASDAQ. Equity Equity represents an ownership interest in an asset or company. Essentially, it is the value of an asset less the amount of all liabilities on that asset. Expense Ratio The expense ratio is a measure of what it costs an investment company to manage a mutual fund or other asset. It is typically expressed as a percentage of assets charged to the fund each year for investment-related expenses. Futures Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such as a physical 7
commodity or a financial instrument, at a specified future date and price. Hedge Fund Rather than a specific asset, hedge funds are alternative investment strategies using pooled funds to earn active return, or alpha, for their investors. Hedge funds may be aggressively managed or make use of derivatives and leverage in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark) or managing risk. Index Fund (Passively-Managed Fund) The opposite of actively-managed funds, index funds are intended to match the returns of a specific market index. Individual Retirement Account (IRA) A traditional individual retirement account (IRA) allows individuals to direct pre-tax income toward investments that grow on a taxdeferred basis. Capital gains, dividend income and interest income are not taxed until they are withdrawn from an IRA account. Municipal Bond A municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures, including the construction of highways, bridges or schools. Municipal bonds are exempt from federal taxes and, in some cases, may also be exempt from most state and local taxes. Mutual Fund A mutual fund is an investment vehicle made up of a pool of funds from many investors for the purpose of investing in securities such as stocks, bonds, money market investments and similar assets. NASDAQ Index A global electronic exchange for buying and selling securities, as well as a benchmark index for U.S. technology stocks. Net Asset Value (NAV) Net asset value (NAV) is the value per share of a mutual fund or an exchange-traded fund (ETF) on a specific date or time. Net Worth Net worth is the amount by which assets exceed liabilities, and it represents a measure of how much an entity is worth. 8
New York Stock Exchange (NYSE) The New York Stock Exchange (NYSE), located in New York City, is the largest equities-based exchange in the world, based on total market capitalization of its listed securities. No-Load Mutual Fund A no-load fund is a mutual fund in which shares are sold without a commission or sales charge. This is the opposite of a load fund, which charges a commission at the time of the fund s purchase, at the time of its sale, or as a level load for as long as the investor holds the fund. Open-End Fund An open-end fund is a type of mutual fund that does not have restrictions on the amount of shares the fund can issue. The majority of mutual funds are open-end. Options An option is a financial derivative that represents a contract sold by one party (the option writer) to another party (the option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date). Portfolio A portfolio is a grouping or collection of financial assets such as stocks, bonds and cash equivalents. Portfolios may be held directly by investors and/or managed by financial professionals. Premium Premium has multiple meanings in investments and finance: The specified amount of payment required periodically by an insurer to provide coverage under a given insurance plan for a defined period of time. The difference between the higher price paid for a fixed-income security and the security s face amount at issue. The cost to buy an option, giving the holder the right, but not the obligation, to buy or sell the underlying financial instrument at a specified price. Roth IRA A Roth IRA is an individual retirement account that is funded with aftertax dollars and for which qualified distributions are tax-free. 9
S&P 500 Index (S&P 500) The Standard & Poor s 500 Index (S&P 500) is an index of 500 of the largest U.S. stocks weighted by market capitalization and recognized as an indicator of the U.S. stock market. Standard Deviation In finance, standard deviation is a statistical measurement of the volatility or risk of an investment. The greater the standard deviation of a security, the greater the variance between each price and the mean, indicating a larger price range. For example, a volatile stock has a high standard deviation, while the standard deviation of a government security is relatively low. Stock A stock is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation s assets and earnings. Term Life Insurance Term life insurance is a type of life insurance with a limited coverage period. Once that period or term is reached, the policyholder must decide to renew or let the coverage lapse. This type of insurance policy contrasts with permanent life insurance, which is intended to provide lifelong protection. Total Return Total return, when measuring investment performance, is the actual rate of return (capital gains plus dividends and/or interest income) of an investment or a pool of investments over a given evaluation period. Treasury Securities Treasury debt securities are issued by the U.S. government and include: Treasury Bills which have maturities of less than one year. Treasury Notes which have maturities of one to ten years. Treasury Bonds which have maturities of more than ten years. Volatility Volatility is a statistical measure of the dispersion of returns for a given security or market index. Commonly, the higher the volatility, the riskier the security. Yield The yield is the income return on an investment, such as the interest or dividends received from holding a particular security. The yield is usually expressed as an annual percentage rate based on the investment s cost, current market value or face value. 10
TAXES Itemized Deduction An amount a taxpayer is allowed to reduce taxable adjusted gross income for money spent on certain goods and services throughout the year. The specific deductions that are allowed are outlined by the Internal Revenue Service and include expenses such as mortgage interest, state and local taxes, gifts and medical expenses. Standard Deduction A specific portion of income that is not subject to tax and can be used to reduce a taxpayer s tax bill. A standard deduction can only be used if the taxpayer does not choose the itemized deduction method of calculating taxable income. Tax-Deferred Tax-deferred refers to investment earnings that are not taxed until specific, predetermined thresholds are reached. The most common types of tax-deferred investments include individual retirement accounts (IRAs) and 401(k) plans, which are not taxed until investments are withdrawn. Tax-Exempt Tax-exempt refers to income earnings or transactions that are free from all tax at the federal, state or local level. While a tax deduction refers to an amount that reduces a tax liability, a tax-exempt item is excluded from any tax calculations. *This information is for general information, education and reference purposes only. It is not meant to provide, or take the place of, specific legal, tax or investment advice. 11