Definitions in personal finance and investment: Common terms in finance and banking
Since this is Financial Literacy Month, I bring you a series of personal finance and banking terms that everyone should know.
They’re terms and phrases we hear on TV, the radio, or read about on the news, and at some point in life, they can be instrumental in helping you make informed decisions about what you want to do with your money.
401(k)
This is a retirement plan that companies offer their employees, which allows the employees to make pretax deductions from their salaries, and invest them according to the wishes of each employee.
Diversification
In Investments, diversification refers to the act of investing in a variety of options, allowing the consumer to obtain the best rate of return while respecting the amount of risk he/she wishes to take. He/she invests a combination of financial products, bonds and stocks with greater or lesser risk; each investment’s individual performance determines the overall return on investment.
Bear and bull markets
These terms refer to the state of the stock market. When the market is down, incurring a loss of over 20% of its value over a period of 2 months, we call it a bear market (the bear that burrows down during adverse times). Alternatively, when the stock market is rising more rapidly than usual, which shows investor confidence regarding the future of the economy, it’s a bull market (the one that charges ahead, full speed).
Adjustable rate mortgages
Here’s a blog article that I wrote explaining what they are.
The prime rate
This is the interest rate that the Federal Reserve charges banks for overnight loans when banks can’t meet their lawful liquidity reserves. Because this rate is decided by the central bank, it’s considered a standard and many financial institutions use it to base their own loan rates on it.
Escrow
A secured savings account in the guardianship of a third party, that has the purpose of securing the relationship between two people, institutions, or a person and a financial institution. In real estate lending, an escrow accounts are part of the mortgage process. Every month, an agreed portion of the mortgage payment that the borrower pays goes into an escrow account; that account’s balance pays pre-agreed expenses, such as property taxes and certain types of insurance.
Term life and whole life insurance
Term life insurance is one that offers coverage during a limited, specific time period. Whole life insurance covers a person during his/her whole life and stays until his/her death. To understand the difference of purpose between one and the other, please read this article on the subject of insurance.
Annuity
A retirement investment product that has the goal of providing the investor with a fixed income for life at the time of her/his retirement.
Bankruptcy
The legal process by which a person or company states his/her/its inability to pay debts and obligations. Depending on the type of filing, the person/company selects, the court forgives part or all the debt. Bankruptcy is a last-resort prospect, because it has very long-term financial consequences.
IRA (individual retirement account)
An account that allows a person to make tax-deductible deposits and accrue dividends until his/her retirement; at that time, she/he will have to pay taxes on any withdrawals made. They’re very safe investments. However, you should only consider them if you’re a U.S. citizen or permanent resident planning to retire in the US, because otherwise the deposits won’t be tax-deductible.