We’ve all been there. You’re at a party talking about the federal shutdown and Miley Cyrus' Chun-Li buns, and someone somehow nonchalantly throws around one of those financial terms that you know you should know, but never bothered to look up the first time...or the second, or third, or fourth. Now, you've dug yourself into this hole where when someone asks whether or not you'd consider taking out a 3/1 ARM loan or what type of 401(k) plan your company offers, you mumble something about "fixed-rate, million-dollar bucket, high-risk adjustment lender" and change the subject to something where you actually understand the words you're using. So awkward. This ends now — capiche?
The first step to really taking control of your own finances is understanding how to talk about them. Sure, this vocabulary lesson isn't particularly fun, but it is super important in your quest to money mastery. Take some time — 10 minutes worth! — to read through some of the most essential and most common personal finance terms you should stop pretending to understand.
Liquidity is the amount of cash you have easy access to. Cash, your savings account, checking account, money-market accounts, or short-term CDs are considered liquid assets because they can be easily converted into cold, hard cash (your home, your car, and stash of beanie babies are not). Liquidity is a sign of your financial health. In case of an emergency or a great investment opportunity, you need liquid assets in order to stay afloat and take advantage.
No, not compact discs. In this case, CDs are Certificates of Deposit and a great alternative to a regular savings account because CDs actually accrue interest. CDs are also appealing because they are rather risk averse, as the interest rate is determined ahead of time and you will get back exactly what you put in, plus interest after a period of time. If you do withdraw before the CD matures (usually before six months), then you will face a major penalty.
CDs are a great investment for people of all ages, especially when you have saved up a bit of cash that you don't want to touch for a bit.
A 3/1 ARM (Adjustable Rate Mortgage) is one the most commonly used mortgages today. It's great for people who are looking to buy a house, but plan on only being in it for a short amount of time (around five years). With a 3/1 ARM, your interest rate is fixed for the first three years of your mortgage and then the rate adjusts annually based on a slew of factors. People may choose an ARM over a fixed-rate mortgage in low-interest times (like right now!) because they're initially way cheaper, and borrowers can get bigger houses than they normally could afford. But, the downside is that rates and payments can substantially increase after three years. It is a considered a riskier option than a typical fixed-income mortgage.
A mutual fund is a pool of money from multiple small investors. The manager of the fund then takes that collection and buys stocks, bonds, or other securities with it, and contributors to the fund gets a stake in all the fund's investments. The price of a share in a mutual fund is based on the Net Asset Value, which is the total value of the securities the fund owns divided by the number of fund shares. Most mutual funds are open-end funds, which means there is no limit to the number of shares issued, which means you can be in a fund with a ton of other people.
Mutual funds are one of the most popular investment instruments in the U.S. and a great option for young people looking to invest after they have made a few thousand dollars. You'll get access to a much more diversified portfolio than you would just buying a stock or a bond, which means that your investment will make you a pretty guaranteed steady stream of money over a longer period of time.
Traditional and ROTH IRAs
A Traditional IRA (that's a Traditional Individual Retirement Account all spelled out) allows you to put aside money for retirement and not get taxed on it until it is withdrawn. A traditional IRA will be able to grow much faster because none of your dividends, interest payments, and capital gains will be taxed.
The biggest difference between Traditional and Roth is that contributions to a Roth IRA are tax deductible. A qualified withdrawal (meaning you have to be age 59 ½ and have had the account for at least five years), including earnings, from a Roth won’t get taxed because it already has been. Roth is a tax-exempt plan rather than a tax-deferred savings plan like Traditional IRAs are.
If you're trying to buy a place, you're definitely going to hear this term. Because a home is one of the biggest purchases a regular person ever makes and involves so many moving parts, it can take longer for you to secure the funds. Enter a third party (usually an attorney or escrow agent) that's going to be in charge of taking your money, sales agreement, or contract and putting it in an escrow account while you and the seller figure out the details of the purchase. Once all the conditions of the sale have been fulfilled, then the escrow transfers the funds to the seller and the buyer receives the property or title.
A 401(K) is an employee-sponsored retirement plan. Basically, it takes money straight from your paycheck (before taxes) and invests it in mutual funds, stocks, and bonds. Most companies usually offer a 401(K) plan and some even offer to match whatever the employee puts in it. If 5% of your yearly income goes into your 401(K), your employer will put an equal amount into your fund. You will not pay taxes on the money in your 401(K) until you take a withdrawal from it (not usually allowed until you're around 59). Because of this setup, it's worth contributing more to your plan so you can pay less in taxes.
Contributions you make to your 401(K) plan are completely vested, meaning you own everything you put into it. The money your employer puts into it most likely follows a plan where the vesting percentage increases every year you work for them, until you own all of it. It's good to start saving money for retirement as soon as possible so if you have the option to pick between companies, how good its 401(K) plans should be an important factor.