14 Confusing Money Terms Explained

You hear money jargon everywhere, whether in conversation, online or blaring from the TV and radio.

Yet how many of us know what terms such as APR, expense ratio and ETF actually mean?

If confusion over money talk makes you feel dumb, we have got a way to get over it. Following is a detailed look at 14 money terms and what they really mean.

1. Compound Interest

Compound interest is interest that’s earned and added to an account balance so that the interest, too, earns interest. Compounding speeds up earnings because, as your account balance grows, each new interest payment is based on a larger amount.

2. APR

APR stands for “annual percentage rate” and is often confused with interest rate. They are related, but not the same.

Think of interest as the cost of borrowing money. Interest and APR both are shown as a percentage of the loan amount. But APR includes interest and other fees and costs, so APR is always higher.

A mortgage APR, for instance, includes closing costs, origination fees and discount points.

The federal Truth in Lending Act requires lenders to tell you the APR when offering a loan. Compare APRs, not interest rates, when you shop for a loan.

3. APY

Here is another commonly confused term. “Annual percentage yield,” or APY, is the yearly amount you earn on savings, or that you pay to borrow, including compounded interest.

APR doesn’t include compounded interest, APY does.

Compare APYs when you are shopping for savings accounts, investment products, credit cards and loans.

4. Mutual Fund

A mutual fund is a basket of different stocks or bonds. A fund offers the chance to make smaller investments in many companies, making it less risky than investing in individual stocks.

5. ETF

ETFs, or exchange-traded funds, are traded like stocks on a stock exchange. Like an index mutual fund, an ETF typically follows the performance of a particular index: the S&P 500 Index, for example, or the NASDAQ-100 Index.

“When you buy shares of an ETF, you are buying shares of a portfolio that tracks the yield and return of its native index,” says NASDAQ.com.

It is worth noting that some ETFs do not track an index, so know what you are getting into before you invest.

6. Diversification

Diversifying is a way to minimize risk by putting your eggs in many different baskets. Investors do this by mixing different investments within a portfolio.

If all of your savings were invested in real estate during the recent housing crash, for example, you likely were hit very hard. But if your investments were diversified and included stocks, bonds, cash and real estate, you might have fared better.

7. Asset Allocation

If spreading your investment risk by diversifying is the goal, asset allocation is how to get there. You divide (allocate) your portfolio among different classes of assets. Stocks, bonds, real estate and cash are common ones.

Another example is allocating certain percentages of your stock market investments to a mix of investment types, such as large-cap mutual funds, small-cap funds, international funds and technology funds.

8. Expense Ratio

An expense ratio is the cost of owning a mutual fund — the operating expenses. If you have mutual funds in your 401(k), look for the expense ratio on the fund’s disclosure statement, listed as a percentage.

In 2014, the average mutual fund charged 1.19%, according to Morningstar. But mutual fund expense ratios range widely, and you can easily find funds with expense ratios below 0.25%.

Expense ratios look small, but they can add up to lots of money over time.

9. Rebalancing

As investments grow or shrink in a portfolio, the allocations change. At the end of a good year in stocks, for example, you may have more stocks and fewer bonds than your asset allocation plan intends.

So, you can buy or sell shares — or rebalance — to get investments back in line with your plan.

10. Credit Score

A credit score is a three-digit number assigned by credit reporting agencies for predicting the likelihood you will repay a loan or credit card charge. It represents your “creditworthiness.”

A score is different from a credit report, which is a detailed record of your credit history.

There are many types of credit scores with varying ranges, but the most widely used are FICO scores, which range from 300 to 850. They are based on information about your credit history collected by the three national credit reporting agencies: Equifax, TransUnion and Experian.

Lenders use credit scores to decide whether to lend money or extend credit, and at what interest rate.

11. Net Worth

Your net worth is all of your assets minus your liabilities. In other words, it is the value of everything you own after subtracting what you owe.

12. Cash Flow

“Cash flow” is an accounting term. It defines how much cash comes into a business and is used in a certain time period.

In essence, it is used in financial conversation to mean “money available.” You might say, “I can’t go with you to the movies tonight. My cash flow is low.”

13. Opportunity Cost

You often have to give up something to get something you want. The value of what you give up is the opportunity cost.

For example, if you quit a $100,000-a-year job to go back to school, your opportunity cost is the money you would have made if you had kept working.

14. Realtor

Real estate agents belonging to the National Association of Realtors can call themselves Realtors (with a capital R). The NAR owns the Realtor trademark.

However, the word often is used generically — and incorrectly — as a synonym for “real estate agent.”

This post originally appeared on Money Talks News.

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