The financial world can be confusing if you lack financial literacy. Understanding common terminology can make a significant difference for individuals looking to save money, make suitable investments, and prepare for their financial futures. Here are a few essential financial terms that everyone should understand.
Stocks and Bonds
An asset is anything an investor chooses to purchase. There are many different classes of assets including stocks and bonds. Stocks and bonds, also called securities, are sold to raise money for a business, and they are among the most common and well-known assets. There are two primary kinds of stocks: common and preferred. With common stock, shareholders own a share of the company and can participate in discussions about the business and the direction the company takes. Those who hold preferred stock do not have the same rights but have priority for payment of dividends. Stocks are generally bought and sold through financial markets and their price will fluctuate based on company performance, economic conditions, supply, demand and other factors.
Bonds differ in that the investor, rather than purchasing an ownership share in the company, lends money to a business. With a bond, the company makes a promise to pay back the money in a set amount of time plus pay a fixed rate of interest.
Over time, the average price of goods and services tends to increase, meaning that the same amount of money will purchase less in the future than it does today. This decline in purchasing power is referred to as inflation. Inflation is normally referred to as a percentage; the higher the percentage, the faster the decrease in the purchasing power.
Mutual Funds and Exchange Traded Funds (ETFs)
Ideal for investors looking to maximize the diversification of their portfolio as well as novice investors, mutual funds and ETFs provide an opportunity to invest in multiple companies and asset classes at once. Mutual funds and ETFs operate by collecting a pool of money from different investors and using the total funds to invest in many different assets rather than just one. Investing in these types of securities can help mitigate overall risk due to diversification. Minimum purchase requirements are generally low or non-existent and most funds offer the convenience of monthly investments via a debit from a bank account.
Put simply, the principal refers to the initial value of a loan or investment. How much money a borrower obtains from a lender as well as the amount an investor puts into their investment is the principal.
In banking, interest refers to how much a bank pays individuals for keeping their money on deposit. When you deposit your funds in a bank, certain accounts (money market and savings) will accumulate interest over time, making the account worth more in exchange for your deposit. Conversely, when taking out a loan the bank will charge you interest on the principal balance. Generally, the longer you owe the money, the more interest you will pay. Credit cards also charge interest on unpaid balances. Those rates can be high so be sure to shop around for a card with a lower rate. If possible, pay your balance every month to avoid those charges.
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