When it comes to financial planning, you may feel frustrated whenever your advisor starts speaking in tongues. There are a lot of finance terms out there that regular people don’t really understand, yet feel embarrassed asking about.
It’s a common problem, and there’s no reason to feel ashamed if money jargon makes your head spin. It’s your advisor’s job to ensure you understand the fundamentals of finance when discussing your investment plans and money goals.
Seven Popular Finance Terms, Defined
That said, it certainly doesn’t hurt to take a moment to educate yourself about these less-than-obvious finance terms. Let’s break down seven examples of financial jargon advisors often use in the simplest terms:
- Annuity
- Diversification
- Fiduciary
- Liquidity
- Index funds
- emerging markets
- amortization
Confusing Finance Terms #1: Annuity
An annuity is an insurance product that pays routine income amounts in the future. Individuals make an investment in the annuity, and it then makes payouts on a future date or series of dates. The annuity income you receive can be paid out monthly, quarterly, annually or even in a lump-sum amount.
You can receive payments for the rest of your life, or for a certain number of years. How much you receive depends on whether you purchase a fixed annuity or a variable annuity. A variable annuity provides a payout stream determined by how your annuity’s underlying investments perform financially.
Confusing Finance Terms #2: Diversification
When it comes to understanding how diversification works, we call it the “many eggs, many baskets” strategy. Industry experts define diversification as a risk management technique that puts a variety of different investments into a single portfolio. The thinking behind this strategy is that many different kinds of investments provide higher overall returns. Even more importantly, diversification means lower risk than any individual investment found within the portfolio, on average.
For example: If you only have stock in one company and it goes bankrupt, you’ll lose everything you invested. If you’ve diversified your holdings in many different companies (better yet, several unique industries), your money’s generally safer.
Confusing Finance Terms #3: Fiduciary
This is an important one, so read carefully. A fiduciary manages another person’s assets — and has a legal and ethical obligation to put the other party’s interests first. For advisors, this means helping clients make decisions in their own best interest, regardless of how the advisor may benefit.
Not all financial advisors are fiduciaries, so be sure to ask each new prospective planner about his or her status.
Confusing Finance Terms #4: Liquidity
Liquidity refers to how easily you can convert your financial assets into cash. Cash is, by definition, the most liquid asset you can own, because it’s easily exchanged for goods and services. Cash is what every other asset is else is compared to. Property is one of the least liquid assets because it can take you weeks or often months to convert it to cash.
Confusing Finance Terms #5: Index Funds
Index funds are in the news lately, so it’s a good time to ask: What exactly are they? CNN Money explains it pretty clearly. Thousands of individual stocks are traded every day, so many indexes are set up to track how particular stock market areas perform. One common fund is the Standard & Poor’s 500 (more commonly known as the S&P 500). It represents a broad cross-section of 500 large, publicly traded American companies.
An index fund invests in the entire cross-section of companies. So, an S&P 500 index fund buys all the company stocks listed within the S&P 500 index. The reason these investment products get so much attention is that many out-perform other, more curated mutual funds. Index funds also incur much lower investment fees because investors aren’t paying someone to choose what’s in them. Win-win!
Confusing Finance Terms #6: Emerging Markets
Emerging markets include nations with lower than average per-capita income and which are investing in higher production capacity infrastructure. These markets experience rapid growth and a higher-than-average return for investors. Of course, as with any investment opportunity that promises unusually high returns, you’ll take some serious risk investing.
Confusing Finance Terms #7: Amortization
If you make monthly mortgage payments, you’re paying off your home using amortization. Amortization involves paying off your debt with a fixed repayment schedule in regular installments over a predetermined time period.
