Financial literacy is important for everyone, regardless of their career or their age. Whether you’re new to investing or have been doing it for a while, it’s always important to brush up on commonly-used financial terms, like these.
7 Top Financial Literacy Terms
1. Asset Allocation
Asset allocation is the effective balancing of risk and reward by developing a portfolio according to an individual’s goals, risk tolerance and investment horizon.
This portfolio will consist of different assets, such as equities, fixed income investments and cash equivalents. A certain amount of money is allocated to each asset, hence the name.
No list of financial literacy terms is complete without stocks. When you mention the word “investing,” most people think about stocks. However, few actually understand exactly what stocks are. They understood it as a vague concept that allows them to make (or lose) money depending on how they play their cards.
Simply put, a stock is a small share of a company. After “going public,” people can buy and sell those small shares of company on stock markets. Visit this past blog we wrote for a more elaborate explanation.
Bonds are essentially loans. If a company issues a bond, the money they receive is a loan that must be paid back over time.
There must be an incentive in order for an investor to lend their money to a corporation or government entity who issues a bond, or else investors would have no reason to spend their money on bonds. This incentive comes in the form of interest payments. Interest rates on bonds are often referred to as “yields.”
Bonds are considered fixed-income securities because the lender knows exactly how much of a return to anticipate if they hold the bond until maturity.
4. Risk Tolerance
The term “risk tolerance” is sometimes incorrectly used interchangeably with the term “risk capacity.” Risk tolerance refers to an individual’s emotional ability to withstand fluctuations in their investment portfolio.
Risk capacity, on the other hand, is their financial ability to withstand fluctuations. In other words, it refers to whether or not they will be able to handle a significant market downturn without a personal financial crisis occurring.
5. Capital Gains
Capital gains refer to the profit made from the sale of an investment. It is calculated by subtracting the original purchase price of an investment from the sale price. Of course, if the sale price is less than the original purchase price, the investor will have lost money. This is known as a “capital loss.”
Volatility is the statistical measurement of how much an investment’s value fluctuates over a given period of time. In general, the higher the volatility, the riskier the investment—and, the higher potential for reward.
There are numerous ways to cope with market volatility, which we’ve written about in a previous blog.
7. Tax Deferral
A tax deferral refers to earnings that accumulate tax-free until an investor reaps the profits. For example 401(k) contributions aren’t taxed, but withdrawals from a 401(k) are.
This list is by no means a comprehensive guide to financial literacy terms, but we believe everyone should know them.