Financial terms glossary

An employer-sponsored retirement plan that lets you contribute part of your pay before income tax is applied, with taxes deferred until withdrawal.

Contributions come straight out of payroll, which is why 401(k) saving tends to stick better than manual transfers. Many employers add a matching contribution up to a percentage of salary. Money withdrawn before age 59½ is generally taxed as income and hit with a 10% additional tax unless an exception applies.

The process of paying off a loan through fixed periodic payments that cover accruing interest first and reduce principal with whatever remains.

Early in an amortised loan most of each payment is interest, because interest is charged on a large outstanding balance. As principal falls the interest portion shrinks and the principal portion grows, which is why extra payments made early save far more than the same payments made late.

The yearly cost of borrowing expressed as a percentage, including interest and most required fees, so that loans can be compared on one number.

APR is more complete than a quoted interest rate because it folds in origination fees and points. It still does not capture everything — it assumes you hold the loan to term, so a low APR achieved by paying large upfront points is a poor deal if you refinance or sell early.

The yearly return on a deposit account including the effect of compounding, which makes it the correct number for comparing savings accounts.

APY differs from a stated interest rate whenever interest compounds more often than annually. An account paying 5% compounded monthly has an APY of about 5.12%, so comparing one account's rate against another's APY understates the second.

How a portfolio is divided across asset classes such as stocks, bonds and cash — historically the largest controllable driver of how a portfolio behaves.

Allocation determines most of a portfolio's volatility. Choosing between two similar index funds matters far less than choosing whether to hold 90% stocks or 40% stocks, because that single decision sets how much the portfolio can fall in a bad year.

One hundredth of a percentage point. Fifty basis points means 0.50%.

The unit exists to remove ambiguity: 'rates rose 1%' could mean from 4% to 5% or from 4% to 4.04%, while '100 basis points' can only mean the former. Fund fees and interest-rate changes are conventionally quoted this way.

A fall of 20% or more from a recent peak in a market index.

The 20% threshold is a convention, not a mechanism — nothing changes in the market when it is crossed. Its practical use is historical: it lets past declines be compared, and the record shows they have varied enormously in both depth and duration.

The person or entity named to receive an account or policy when the owner dies.

A named beneficiary on a retirement account or life insurance policy generally overrides what a will says about that asset, which is why stale beneficiary designations are a common and costly estate-planning failure after a divorce or death in the family.

A loan to a government or company that pays scheduled interest and returns the principal at maturity.

A bondholder is a lender, not an owner, so returns are contractual rather than a share of profits. Bond prices move inversely to interest rates: when prevailing rates rise, existing bonds paying lower rates become less valuable.

The profit realised when an asset is sold for more than its cost basis.

Gains are only taxed when realised — an investment that has risen in value but has not been sold generates no tax. Assets held longer than a year qualify for lower long-term rates, which is the single largest tax lever available to most investors.

Interest calculated on the original principal plus all previously accumulated interest, so growth accelerates over time.

Compounding is why time horizon dominates contribution size over long periods, and why high-interest debt is so corrosive — the same mechanism works against a borrower. The effect is close to linear over a few years and sharply curved over decades.

The original value of an asset for tax purposes, used to calculate gain or loss when it is sold.

Basis is usually the purchase price plus commissions, adjusted for events such as reinvested dividends or stock splits. Overstating a gain by forgetting that reinvested dividends raised your basis is a common way to overpay tax.

A record held by a credit bureau of your borrowing history, including accounts, balances, payment history and public records.

A report contains data, not a score — scores are calculated from the report by separate models. Federal law entitles you to free copies from each nationwide bureau and to dispute inaccurate entries, which the bureau must then investigate.

The share of your available revolving credit that you are currently using, typically the largest scoring factor after payment history.

Utilisation is measured from the balance reported on the statement date, not from what you eventually pay. Someone who pays in full every month can still show high utilisation if the balance is large when the statement closes.

The amount you pay out of pocket on an insurance claim before the insurer begins paying.

Raising a deductible lowers the premium because you are absorbing more of the small, frequent losses. That trade only makes sense if you actually hold enough cash to cover the higher deductible without borrowing.

Spreading investments across many holdings so that no single failure can dominate the outcome.

Diversification reduces the risk specific to one company or sector. It does not remove market-wide risk — a broadly diversified stock fund still falls in a general downturn, which is what bonds and cash are for.

A distribution of company profits to shareholders, usually paid quarterly in cash.

A dividend is not free money: the share price drops by roughly the dividend on the ex-dividend date. In a taxable account dividends are taxed in the year received whether or not you reinvest them, so high-dividend strategies carry a tax cost.

Cash held in an accessible account specifically to cover income loss or unplanned expenses.

The purpose is to keep a temporary shock from becoming permanent debt. Size should be driven by real exposure — income stability, dependants, insurance deductibles — rather than a round number of months.

An account held by a third party that collects and pays property taxes and insurance on a homeowner's behalf.

Escrow is why a mortgage payment changes even on a fixed-rate loan: the principal and interest are fixed, but the tax and insurance portions are re-estimated annually and can rise sharply.

The annual percentage of assets a fund charges to cover operating costs, deducted automatically from returns.

Because the fee is charged on the whole balance every year, its effect compounds against you. The difference between 0.03% and 0.75% is trivial in one year and very large over an investing lifetime.

The central bank of the United States, which sets monetary policy and influences short-term interest rates.

The Fed sets a target for the federal funds rate, which ripples into savings yields, credit-card APRs and mortgage pricing. It does not set mortgage rates directly — those track longer-term bond yields and lender margins.

A widely used credit score, generally on a 300–850 scale, calculated from information in your credit report.

There is no single score. Different model versions and different bureaus produce different numbers on the same day, so a score seen in one app will rarely match the one a lender pulls.

A person legally required to act in your best interest rather than their own.

The standard matters because not everyone offering financial guidance is held to it. Asking whether someone is a fiduciary at all times, and how they are compensated, surfaces most conflicts of interest quickly.

A fund that holds the constituents of a market index rather than trying to select winners.

Because it requires no research staff, an index fund can charge very little, and that cost advantage is the main structural reason it has outperformed most actively managed funds over long periods after fees.

The rate at which the general price level rises, reducing what a given amount of money can buy.

Inflation is why a nominal return can be misleading. Cash earning 2% while prices rise 3% is losing purchasing power, even though the account balance is growing.

How quickly an asset can be converted to cash without a meaningful loss of value.

A savings account is highly liquid; a house is not. Money needed on a known date belongs in something liquid, because being forced to sell an illiquid asset on someone else's timetable is where real losses occur.

The rate applied to your next dollar of income — not the rate applied to all of your income.

Progressive brackets mean each slice of income is taxed at its own rate, so entering a higher bracket does not re-tax everything below it. This is the most persistent misconception in personal tax.

Total assets minus total liabilities.

Net worth is the single most useful summary statistic in personal finance because it captures both sides of the balance sheet. Income tells you what flows in; net worth tells you what has actually accumulated.

The amount originally borrowed or still owed, excluding interest.

Interest is charged on the outstanding principal, so any payment directed at principal permanently reduces all future interest. This is the mechanism behind every extra-payment strategy.

The minimum amount that must be withdrawn annually from certain retirement accounts once you reach the age set by law.

RMDs exist because tax on those accounts was deferred, not forgiven. Missing one carries a penalty on the shortfall, and because the amount is recalculated each year from the prior year-end balance, it is not a fixed figure.

A retirement account funded with after-tax money, where qualified withdrawals are tax-free.

The Roth trade is paying tax now instead of later. It favours anyone who expects a higher tax rate in retirement than today, which is why it is often attractive early in a career.

A fixed amount subtracted from income that reduces taxable income without itemising individual deductions.

You take either the standard deduction or your itemised total, whichever is larger. Because the standard deduction is now comparatively large, most filers no longer benefit from itemising.

Selling an investment at a loss to offset taxable gains elsewhere in a portfolio.

Losses first offset gains of the same type, then the other type, with a limited amount usable against ordinary income and the remainder carried forward. Buying a substantially identical security within 30 days triggers the wash-sale rule and disallows the loss.

Life insurance that covers a fixed period and pays out only if death occurs within it.

Term is inexpensive because most policies never pay a claim. It fits the actual shape of the risk for most households, where the need for coverage falls as a mortgage is paid down and children become independent.

How long until money is needed, which governs how much volatility it can tolerate.

Horizon is the bridge between a goal and an allocation. Volatility is only a real risk if you must sell during a decline, so a long horizon converts short-term fluctuation into something survivable.

The process by which employer contributions become permanently yours.

Your own contributions are always yours. Employer money may vest gradually over several years, which means leaving a job early can forfeit part of a match that already appears in the balance.