Demystifying Finance: A Simple Guide to Key Terms
Ever been in a financial conversation where it feels like everyone is speaking another language? You're not alone. Here's a down-to-earth breakdown of some financial terms that might not be in everyone's day-to-day vocabulary.
Stock & Bond
Stock: Imagine stocks as slices of a company’s pie—owning one means you own part of that company. It's a chance for high returns, though there is a risk involved.
Bond: Bonds are like IOUs from companies or governments. Buying one means lending your money with the promise of receiving interest over time, depending on the stability of the issuer.
Bond Ladder & Maturity
Maturity: This signifies when a bond’s original investment is repaid to the investor, marking the end of the bond’s term.
Bond Ladder: A strategy of investing in bonds with staggered maturity dates to mitigate interest rate risk and ensure a cash flow that matches the investors's needs.
Interest & Dividend
Interest: This is the money you earn when lending or the cost incurred when borrowing.
Dividend: A share of a company's profits paid to shareholders, usually in cash or additional shares.
Mutual Fund & ETF
Mutual Fund: This pooled investment uses collected funds to buy a mix of securities, such as stocks and bonds, and trades once daily.
ETF: Exchange-traded funds are similar to mutual funds but trade like stocks.
Risk & Return
Risk: The unpredictability of an investment's returns.
Return: The percentage gain or loss on an investment, generally higher as the risk increases.
Time Horizon & Liquidity
Time Horizon: The period you plan to invest before you need the money. Most of the time, you will have many goals with many investment horizons.
Liquidity: The ease with which an asset can be converted into cash without affecting its value.
Net vs Gross & Net Worth
Net vs Gross: 'Gross' is the total before deductions, while 'net' is what's left after deductions.
Net Worth: Your total assets minus your liabilities—a snapshot of financial health.
Equity & Liability
Equity: Ownership in a company or the value of an asset after liabilities are deducted.
Liability: Financial obligations like loans and credit card debt.
Interest & Compound Interest
Interest: A repeat for emphasis—it's the charge for borrowing or reward for lending funds.
Compound Interest: Earning interest on interest is a powerful concept! Use the Rule of 72: Divide 72 by the interest rate to estimate how long it'll take to double your investment.
Capital Gain & Cost Basis
Capital Gain: Profit made from selling an investment above its purchase price.
Cost Basis: The original purchase price used to calculate the capital gain.
Now that you're armed with this knowledge, you next conversation about finance should be easier to navigate! I'm always here to demystify other terms or answer questions. Happy investing!