Personal finance is an important area of knowledge to understand, but it can also be confusing for those who are not professionally trained financial advisors. Although rules and regulations change at a lightening pace in the financial world, a basic understanding of personal finance terminology can empower you to make more informed and educated personal finance decisions.
Why is it important to understand personal finance terminology? First, understanding the terminology can help when working with professional services, like lawyers, CPAs, and financial advisors. While they are experts and should be able to give you a high-level overview, understanding the terminology is important to grasp the larger picture of your money, taxes, and estate.
Second, personal finance terminology is important to understand so that you can take control of your money! Understanding the terminology, whether you have a dedicated financial planner or not, makes it easier to manage your money in a way that makes sense and works for you, and with no surprises due to lack of understanding.
Finally, understanding the terminology can allow you to make decisions more quickly and easily. This is something that is important in the fast-moving world of personal finance. Buying a new car, deciding about retirement benefits, or even choosing which checking account to open can be time-sensitive decisions, and understanding the basic terminology can make it easier!
Most Common Terms
There are many personal finance terms, but, broadly, they can be put into three categories: retirement and investment terms, earning and budgeting terms, and document and institution terms. The Institute for Financial Literacy has a long, comprehensive list of terms used in personal finance with short descriptions, and this list can be a good place to start for many. Duke University notes that understanding budgets and cash-flow, even on the most basic level, is crucial.
Here are several of the most basic terms for retirement and investment, earning and budgeting, and documents and institutions:
Retirement and Investment Terms
Some of the most important terms you can learn are about investing and retirement. After all, the end goal is to grow your money and eventually be able to live a work-optional lifestyle!
A 401(k) is a retirement plan provided by your employer. These have many different options within them and can be confusing, so Human Resources should have a retirement plan expert to assist you as well! These are important because your employer is likely to match your contributions up to a certain percentage, which is basically like getting free money!
A 403(b) plan is like a 401(k) but is generally offered by educational institutes and non-profits. Again, these may have a match component!
An Individual Retirement Account (IRA) is exactly what it sounds like. It is an account that can only belong to one person, with funds earmarked for retirement. There are several different types, and each has its own rules about taxes and withdrawals, but each allows an individual to save for retirement in a dedicated account.
The Rule of 72 is particularly interesting and useful. According to Northwestern Mutual, the Rule of 72 allows you to estimate how long it will take you to double your investment. For example, if you estimate that you will earn 7% annually on an investment (keeping in mind that most investments have no guaranteed earnings), you would, according to the Rule of 72, divide 72 by 7, resulting in a little over 10. It will take, if you earned 7%, 10 years to double your money!
Earning and Budgeting Terms
While the “golden rule” of personal finance is simple – spend less than you earn – even the simplest earning strategies and budgeting plans have terminology associated with them.
A budget, is simply something that shows how much money is coming in and how much is going out. This can take many forms such as an app, a spreadsheet, a word document, or even a written notebook. It is crucial to understand what a budget is and that it’s not a bad word!
Checking accounts and savings accounts are both important to understand. Although many don’t write checks anymore, a checking account is an account that allows for unlimited deposits and withdrawals, but does not earn any interest. Many are free, but some require a certain number of direct deposits or debit card withdrawals. Savings accounts earn a nominal amount of interest and often allow unlimited deposits, but may limit withdrawals. Both are important to have!
Credit scores get talked about a lot and seem mysterious, but they all follow some basic rules. Consumer Reports notes that many people don’t know the ins and outs of credit scores, but that this number (which ranges from 350 to 850) can determine how much interest you’ll pay for many things, whether you can get credit, and even if you can get a job or new apartment! Basically, your credit score is composed of 5 factors: how much of your available credit you’re using, how good your payment history is, how long you’ve had credit, how much credit you’ve applied for recently, and the variety of debt you have.
Document and Institution Terms
One of the most frustrating things is going to one place or having one form, and being told you need to go to another place, or fill out another form! Here are some common terms about personal finance documents and institutions.
Banks are institutions that hold money, sometimes lend money, and are regulated by the state and federal governments. All reputable banks should be FDIC insured. The Federal Deposit Insurance Corporation protects consumers if a bank fails. Many banks also offer notary services for their customers, as well as safe-deposit boxes.
Estate planning documents vary based on personal situations, but there are 4 basic documents everyone should have so that in the event of your death or incapacitation, your loved ones will know your wishes and be able to act on your behalf.
A living will allows an agent you choose (can be a family member, friend, or spouse) to make decisions based on your wishes about end of life care, such as life support or hospice.
A will states how you want your assets distributed after your death.
A durable power of attorney gives someone else the power to make legal decisions on your behalf if you are absent or incapacitated.
A healthcare power of attorney allows someone to make decisions about your healthcare if you are unable to do so.
No one likes to think about death or tragedy, but these documents are crucial. They are also generally easy and affordable to have done!
For more information on personal finance terminology, see these additional resources:
- The Financial Dictionary examines various definitions: Financial dictionary
- The CFA Institute has a glossary of terms: CFA glossary
- FINRA discusses how credit scores work: How your credit score impacts your financial future
- The National Business Education Association offers persona finance advice: Economics and personal finance