Making Sense of Financial Jargon: 15 Key Financial Terms for Planning a Successful Future
When reviewing your personal finances, you may come across a lot of financial jargon. Understanding the relevance of these terms to your financial goals is essential. Personal finance doesn’t have to be complex, and you deserve to have a clear understanding of your financial picture.
Whether you’ve been managing your finances for decades or are just starting out, familiarity with key financial terms is valuable for planning your future. Here is a rundown of some commonly misunderstood terms in the categories of investments, taxes, insurance, retirement planning, and estate planning.
Investments
When navigating the world of investments, you may encounter these terms while reading about investments or reviewing your investment statements:
Asset Class: An asset class refers to a grouping of investments that share similarities with each other, setting them apart from assets in other classes. Assets within a particular asset class have similar characteristics, perform comparably under certain economic conditions, and behave similarly on their respective markets.
Stocks: Stocks represent ownership shares in a company. Investing in stocks allows you to participate in the company’s growth and share in its profits.
Bonds: Bonds are debt instruments issued by governments or corporations. When you invest in bonds, you are essentially lending money to the issuer in exchange for regular interest payments and the return of the principal amount at maturity.
Mutual Funds: Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other assets. They are managed by professional fund managers.
A well-diversified portfolio can help alleviate the impact of poor performance in any one asset class.
Taxes
Taxes play a substantial role in most areas of your finances. Understanding the following terminology will better prepare you for navigating the tax landscape:
Marginal Tax Rate: It is a common misconception that your marginal tax rate (the highest bracket your income puts you in) is what you pay in taxes. You actually pay an average, and this average is called your “effective tax rate.”
Effective Tax Rate: The effective tax rate is typically calculated as an average across all taxes paid, including income taxes, capital gains taxes, and other taxes. It takes into account the total tax liability divided by the taxpayer’s total income. This provides a more comprehensive picture of the overall tax burden on an individual or entity, considering various types of taxes.
For example, if your filing status is single and your taxable income is $150,000, your effective tax rate would be calculated based on the total tax liability divided by your total income.
Retirement Planning
Retirement planning is crucial for ensuring a financially secure future. Understanding the following terms will help you make informed decisions:
401(k): A 401(k) is a retirement savings plan offered by employers. It allows employees to contribute a portion of their salary to a tax-advantaged investment account. Employers may also match a percentage of the employee’s contributions.
IRA: An Individual Retirement Account (IRA) is a tax-advantaged investment account that individuals can contribute to on their own. There are different types of IRAs, including Traditional IRAs and Roth IRAs, each with its own tax advantages.
Required Minimum Distribution (RMD): Once you reach a certain age, typically 72, the IRS requires you to start taking withdrawals from your retirement accounts. These withdrawals are called Required Minimum Distributions (RMDs) and are subject to tax.
Estate Planning
Estate planning involves preparing for the transfer of your assets to your beneficiaries. Understanding the following terms will help you navigate the estate planning process:
Will: A will is a legal document that outlines how you want your assets to be distributed after your death. It also allows you to appoint a guardian for your minor children.
Trust: A trust is a legal entity that holds assets on behalf of beneficiaries. It allows for the management and distribution of assets according to your wishes.
Power of Attorney: A power of attorney is a legal document that grants someone the authority to act on your behalf in financial and legal matters if you become incapacitated.
By familiarizing yourself with these financial terms, you can better understand the complexities of personal finance and make informed decisions for a successful future.
