14 Financial Words You Need to Understand

You hear money jargon everywhere — whether in conversation, online or blaring from the TV and radio.

Yet, how many of us know what terms such as APR, expense ratio and ETF actually mean?

If confusion over money talk makes you feel dumb, we have got a way to get over it. Following is a detailed look at 14 money terms and what they mean. Your financial health depends on understanding this lingo.

1. Compound interest

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Compound interest is interest that’s earned and added to an account balance so that the interest, too, then earns interest. Compounding speeds up your earnings because, as your account balance grows, each new interest payment is based on a larger amount.

Calculate compound interest with from the U.S. Securities and Exchange Commission.

2. APR

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APR stands for “annual percentage rate” and is often confused with “interest rate.” They are related, but not the same.

Think of interest as the cost of borrowing money. Interest and APR both are shown as a percentage of the loan amount. But APR includes interest and other fees and costs, so APR is always higher.

A mortgage APR, for instance, includes closing costs, origination fees and discount points.

The federal Truth in Lending Act requires lenders to tell you the APR when offering a loan. Compare APRs, not interest rates, when you shop for a loan.

3. APY

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Here is another commonly misunderstood term: “Annual percentage yield,” or APY, is the yearly amount you earn on savings — or that you pay to borrow. It includes compounded interest.

APR doesn’t include compounded interest, but APY does.

Compare APYs when you are shopping for savings accounts, investment products, credit cards and loans.

4. Mutual fund

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A mutual fund is a basket of different stocks or bonds. A fund offers the chance to make smaller investments in many companies, making it less risky than investing in individual stocks.

5. ETF

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ETFs, or “exchange-traded funds,” are traded like stocks on a stock exchange. Like an index mutual fund, an ETF often follows the performance of a particular index: the Standard & Poor’s 500 Index, for example.

It is worth noting that some ETFs do not track an index, so know what you are getting into before you invest.

6. Diversification

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Diversifying is a way to minimize risk by putting your cash eggs in many different baskets. Investors do this by mixing different investments within a portfolio.

If all of your money was invested in real estate during the last housing crash, for example, you probably fared very poorly. You likely would have fared better if your investments were diversified and included stocks, bonds and cash.

7. Asset allocation

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If spreading your investment risk by diversifying is the goal, asset allocation is how to get there. You divide (allocate) your portfolio among different classes of assets. Stocks, bonds, real estate and cash are common ones.

Another example is allocating certain percentages of your stock market investments to a mix of investment types, such as large-cap, small-cap, international and technology mutual funds.

8. Expense ratio

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An expense ratio is the cost of owning a mutual fund — the operating expenses. If you have mutual funds in your 401(k), look for the expense ratio on the fund’s disclosure statement, listed as a percentage.

Expense ratios look small, but they can add up to lots of money over time.

9. Rebalancing

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As investments grow or shrink in a portfolio, the allocations change. At the end of a good year in stocks, for example, you may have more stocks and fewer bonds than your asset allocation plan intends.

So, you can buy or sell shares — or rebalance — to get investments back in line with your plan.

10. Credit score

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A credit score is a three-digit number assigned by credit-reporting agencies for predicting the likelihood you will repay a loan or credit card charge. It represents your “creditworthiness.”

A score is different from a credit report, which is a detailed record of your credit history.

There are many types of credit scores with varying ranges, but the most widely used are FICO scores, which range from 300 to 850. They are based on information about your credit history collected by the three national credit reporting agencies: Equifax, TransUnion and Experian.

Lenders use credit scores to decide whether to lend money or extend credit, and at what interest rate.

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