You don’t have to be a finance whiz to manage your money well. But to truly have a handle on your finances and meet your goals, you need to amass some basic financial knowledge.
The more you understand, the more successful you’ll be — even if you’re paying a financial planner to help you. Here are 10 often misunderstood finance terms and what they mean.
IRA: An Individual Retirement Account, or IRA, is an account that allows you to save for retirement with tax-free growth or on a tax-deferred basis. With a traditional IRA, earnings are tax-deferred, meaning you don’t pay taxes on contributions until you withdraw. In a Roth IRA, contributions are made after taxes are paid, so growth is tax free. A SIMPLE IRA (Savings Incentive Match Plan for Employees) is sponsored by a small employer and allows for contributions from both employer and employee.
401(k): A 401(k) plan is an employer-sponsored retirement plan that allows for contributions from both employee and employer. In many cases, employers offer a matching contribution up to a certain percentage of the employee’s salary. A 403(b) is a similar, employer-sponsored plan for nonprofit and government employers.
Annuity: An annuity is an insurance product that pays income to the owner and is sometimes used as part of a retirement strategy. When you purchase an annuity, you make an investment in it and it makes payments to you on a future date or dates, such as on a monthly, quarterly, or annual basis.
Mutual fund: A mutual fund is an investment vehicle that pools funds from many investors and uses them to purchase stocks, bonds, and money market instruments. The fund is managed by a professional money manager and each investor can sell his or her shares at will.
ETF: An ETF, or exchange-traded fund, is an investment fund that holds assets such as stocks, commodities, and bonds. An ETF can be an attractive investment because of its low costs, tax efficiency, and stock-like features. (Here’s how it differs from a mutual fund.)
REIT: A REIT, or real estate investment trust, is a security that trades on the major exchanges like a stock but is invested in real estate, either through properties or mortgages.
Active management and passive management: Also known as active investing, active management is a portfolio management strategy in which the manager makes specific investments with the goal of outperforming an investment benchmark index. In passive management, investors expect a return that mirrors the investment weighting and returns of a benchmark index. Passively managed funds are often invested in an index fund.
Credit report: A credit report is a detailed report of your entire credit history, which includes your personal data, a summary of your credit history, and details of any accounts turned over to a credit agency. A credit report also includes your credit score, a three-digit number calculated from your credit history and used by lenders to determine your creditworthiness.
Liquidity: Liquidity refers to the ability to convert an asset to cash quickly. For instance, blue chip stocks and money market securities can be quickly sold and converted into liquid cash.
Returns: The return is your profit on an investment. It includes any change in value, including interest or dividends, that the investor may receive from the investment.