If you’re a having a bit of a WTF moment right now because you’re a REAL ADULT paying taxes and bills all by yourself, you’re definitely not alone. Entering the finance world can be pretty scary because it is guarded by toxic finance bros and confusing terminology that seems to be an entire language on its own. So if you clicked on this article, you’re probably thinking that you’re just a beginner trying to get your feet wet, but honestly, you’re one step ahead! The HerCapital team is here, and we’re going to show you that money can be easy and approachable, by introducing you to 10 basic financial terms that you need to know.
1. Compound Interest
Ever heard the phrase “time is money”? Well, whoever coined that phrase (no pun intended) definitely knew what they were saying because in financial markets, time literally equals more money! Compound interest is the interest an investor earns on their original investment and all the interest that has been earned from the interest added up over time—essentially it’s “interest on interest.” The effect of compounding becomes especially powerful with time, which is why it is advised to invest early, even if it is with a small amount.
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2. Federal Reserve
If there’s anything quarantine can be remembered by, it would probably be Dalgona coffee, wearing PJs to our zoom meetings, TikTok binges, and all that hubbub about the Federal Reserve. Wait…who…what? The Federal Reserve—“Fed” for short. Serving as the bank’s bank, the Federal Reserve is responsible for setting monetary policy for the United States and maintaining the overall stability of the economy through altering money supply and interest rates. Through the sh*tstorm of COVID-19, the Federal Reserve is the one behind the scenes supporting households, small businesses, and government, through actions like lowering federal funds rates (the interest rate at which banks borrow and lend money to each other) and encouraging banks to lower lending requirements so they can give more money out to borrowers.
Inflation is the rate at which the general level of prices for goods and services is rising or decreasing, even when the quality of said products is constant. Today, most central banks set inflation target rates at 2%. During the Great Depression, inflation rates were negative over a long period of time, which meant that prices were dropping like it’s hot! Sometimes this happens because people hold off on buying goods, in turn hurting the economy in the long run since there is limited economic activity. On the flip side, positive inflation can be troublesome as prices of goods increase dramatically—imagine that $2 coffee doubling to $4 in a year; that would not be great for your budget.
4. FICO Score
We personally would never go on a sketchy Tinder date without going on an FBI-esque investigation and going down the rabbit hole of weird 2014 Facebook photos. When it comes to credit, it’s pretty similar. By ranking consumers on how likely they will be to pay off their credit obligations, FICO scores help lenders make informed decisions on whether or not they will extend credit. Scores range from 300 to 850 and baked into this score are elements like how much you currently owe, your payment history, and the length of your credit history. The higher your score, the higher your creditworthiness, and people with higher scores often have an easier time securing loans and seeing benefits in their terms and interest rates. Ah, if only spotting red flags in people were that easy.
P.S. In case you are wondering, the name comes from the Fair Isaac Corporation who created the score.
5. Individual Retirement Account (IRA)
If there’s anything everyone in the world can agree on, it’s that we f*cking love free money. So think of IRAs as piggy banks that let you set aside money for retirement, where your contributions grow with interest and you don’t even have to lift a finger. Traditional Individual Retirement Accounts (Traditional IRAs) let you deposit pre-tax income to a retirement account where that money grows tax-deferred until you take it out for the golden years. Roth IRAs, on the flip side, are not tax-deductible (meaning you deposit after-tax income), but you can still make contributions as long as you are earning an income and withdrawals are tax-free. A key difference between the two is that you cannot deposit into a Roth IRA if you earn too much (>139k if single and 206k if you are married)! To open a Roth IRA, you need to find an institution (banks, brokerage companies, federally insured credit unions, and savings and loan associations) that has IRS approval to offer this type of account.
6. Capital Gains
Like the term itself describes, capital gains are the gains (income) that stems from the sale of an asset, such as financial investments or real estate. If you hold the underlying asset for less than a year, the capital gains are taxed at the same rate as your income. This profit is typically taxed at 20% or less for long-term assets i.e. assets held for longer than one year.
Now, while putting your money in a savings account is better than just parking it under your mattress, you could honestly get so much more by putting your money into securities, tradable financial assets used to raise capital for governments and corporations both privately and publicly. Traded in financial markets, securities include stocks, bonds, and options, all varying in definition and ownership. What you really need to know, though, is that investing in securities typically comes with a higher yield, which means more bang for your buck, literally. Read more about them on our website.
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8. Financial Statement
If you’re an investor, you have probably heard of people screaming to buy the “hottest stock” of the moment. But you might wonder, what’s the hype? That’s where financial statements come in. Financial statements clear the noise and get to the down-and-dirty realities of a company’s financial performance. They are written records of all business transactions and activities, reporting elements like profit and losses, liquidity, and assets. The four main financial statements are the balance sheet, income statement, statement of shareholder’s equity, and cash flow statement. So when you invest, be sure to do your research, comb through those statements, and make an informed decision.
9. Asset Allocation
There are appropriate times to be risky and times to play it safe. Just like in life, you might want to try out that piece in your closet that you never, ever wear, but if you’re cutting bangs after a fresh heartbreak we’d tell you to slow down a little bit. When it comes to your financial plans, asset allocation is all about understanding and tolerating your risk and wisely choosing where to put your money. Different asset classes react differently in the economy, thus you can create your own mix that caters to your needs, time horizon, and goals. And take the time-tested tip to diversify, diversify, diversify!
10. Bull & Bear Markets
Within the financial world, the terms bull and bear markets refer to the general sentiment about the markets. A bull market is a sustained period where prices for securities are on the rise, often driven by optimism, investor confidence, and high expectations. On the flip side, a bear market is a period of contraction, characterized by falling prices. It generally occurs amid investor pessimism and shaken confidence and is often accompanied with an economic downturn, such as recession. I guess you could say that investors find this time to be unBEARable… sorry.
And that’s it—the 10 financial terms everyone should know. Wasn’t too bad, right? If you have any more questions or are looking for more resources, you can drop a comment here, or check out our HerCapital website and Instagram @her.capital. We’ve got lots of stuff for our community of badass women invested in their financial futures like you.
Images: Sharon McCutcheon / Unsplash; @her.capital / Instagram