I am using the occasion of Financial Literacy Month to define the most frequently asked financial words or terms that I find myself defining for readers, listeners and viewers. I will use the letters of the alphabet to help and if I miss something you would like defined, just shoot me a note and I will add to the Jill on Money Financial Glossary. I’ll complete the alphabet later this month.
Asset Allocation: The process of dividing an investment portfolio among different categories, such as stocks, bonds, commodities and cash. The mix depends on a variety of factors, such as your time horizon and risk tolerance.
Basis Point: This measure is often used in the describing price movements in the bond market. One basis point is equal to one one-hundredth of a percentage point, so 1% = 100 basis points. The abbreviation for the plural is "bips."
Compound Interest: The application of interest to both principal (for either a deposit or a loan) and to the accumulated interest that adds up over the term. The magic of compound interest helps many reach their goals more quickly. That’s why if you are 25 and save $500/month at a 6 percent rate, you can accumulate over $1 million. Check out this fun compound interest tool.
Dollar Cost Averaging (DCA): The process of putting a certain percentage (or fixed dollar amount) of money to work at regular intervals. You are dollar cost averaging when you contribute a certain percentage from your paycheck into an employer-sponsored retirement plan.
Exchange Traded Fund (ETF): A pooled investment, similar to an open-end mutual fund, but one that trades more like a stock, because you can sell it at any point during the trading day. The first ETF in the United States was launched in 1993.
Fiduciary Standard: A standard of care that requires professionals to put a client’s best interests first. Financial pros with designations like CFP, CFA, CPA-PFS, or CPA, operate under the fiduciary responsibility. However, many others are able to sell products that are merely “suitable” for their clients, but that might not be in the client’s best interests.
Growth Mutual Fund: Managers of growth funds attempt to invest in companies that are expected to grow faster than other companies in their sectors or industries. Growth funds are often compared with value funds, whose managers scour the universe for companies whose stock prices may not reflect the “true value,” or at least what the manager believes is true value of the company.
Health Savings Account (HSA): Accounts that are paired with high-deductible health insurance plans (HDHP), which offer lower premiums. HSAs allow you to set aside pre-tax money to pay for unreimbursed medical and health care costs. For 2019, you can contribute $3,500 for an individual and $7,000 for a family, with a catch up contribution of $1,000 for adults who are over 55.
Inflation: When the prices of goods and services rise and as a result, every dollar you spend in the economy purchases less. Inflation over the past thirty years has been relatively low, but it still adds up: today you need $2,078.75 in cash to buy what $1,000 could buy 20 years ago.
Junk Bond: A fixed income asset that carries a low credit rating and therefore has a higher risk of default. Also called “high yield” or “non-investment-grade” bond.
K-1: Not a lot of “K” words in the financial world, but this one refers to a tax document that reports partnership information to the IRS.
Liquidity: The ability to convert an asset to cash quickly, without having a significant impact on price.