Definitions in personal finance and investment: Common Terms in Finance and Banking

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Since this is Financial Literacy Month, I bring you a series of personal finance and banking terms that everyone should know. They’re terms and phrases we hear on TV, the radio, or read about on the news, and at some point in life, they could be instrumental for making informed decisions about what we want to do with our money. Also, keep in mind that on the Credit Union’s Facebook page, throughout this month you will find more definitions of terms that are equally important.

401(k)
This is a retirement plan that companies offer their employees, which allows the employees to make pretax deductions from their salaries, which are then invested according to the wishes of each employee

Diversification

In Investments, diversification refers to the act of investing in a variety of options, which allows the consumer to obtain the best rate of return while respecting the amount of risk he/she wishes to take; thus, the money is invested in financial products, bonds and stocks with greater or lesser risk, and the combination tends to determine the greater or small chance of return on investment.

Bear and bull markets
These terms refer to the state of the stock market. When the market is down, incurring a

loss of over 20% of its value over a period of 2 months, it’s considered to be a bear market (the bear that burrows down during adverse times). Alternatively, when the stock market is rising more rapidly than usual, which shows investor confidence regarding the future of the economy, they call it a bull market (the one that charges ahead, full speed).

Adjustable rate mortgages
Here’s a blog article that I wrote explaining what they are. 

The prime rate
This is the interest rate that the Federal Reserve charges banks for overnight loans when banks can’t meet their lawful liquidity reserves. Because this rate is decided by the central bank, it’s considered a standard and many financial institutions use it to base their own loan rates on it.

Escrow

A secured savings account maintained by a third party with the purpose of securing the relationship between two people, institutions, or a person and a financial institution. In real estate lending, an escrow account is opened when a person obtains a mortgage. Every month, part of the mortgage payment that he/she pays goes into that escrow account, and that balance on escrow is used to pay pre-agreed expenses, such as property taxes and certain types of insurance. 

Term life and whole life insuranceTerm life insurance is one purchased for coverage during a limited, specific time period. Whole life insurance is purchased for a person’s life duration and is maintained until his/her death. To understand the difference of purpose between one and the other, please read this article on the subject of insurance. 

AnnuityA retirement investment product that has the goal of providing the investor with a fixed income for life at the time of her/his retirement. 

Bankruptcy
The legal process by which a person or company states his/her/its inability to meet all incurred debts and obligations. Depending on the type of filing the person/company selects, the consumer/company is either relieved of all debt or just part of it. Bankruptcy is a last-resort prospect because it has very long-term financial consequences. 

IRA (individual retirement account)

An account that allows a person to make tax-deductible deposits that are kept accruing dividends until that person retires; at that time, she/he will have to pay taxes on any withdrawals made. These are very safe investments, but they should only be considered by U.S. citizens and permanent residents to the United States who plan to retire in the US, because otherwise the deposits will not be tax-deductible.