Learning the Lingo

Oct 30, 2006 by

An anonymous person notified me today that it would be helpful for me to explain more of the acronyms and terms used on this site. In order to rectify this, I wrote some definitions.

Here are helpful definitions for understanding my previous posts:

Annual Percentage Yield (APY): APY is the one year rate of return of an investment. The concept of APY assumes that compounding has occurred during the course of the investment, hidden from the view of the person using the APY. So, if I put $100 in a CD for one year with 6% APY, at the end of the year, I would have $100 * 1.06 = $106.

Annual Interest Rate: The annual interest rate is the rate of interest that the bank actually pays on the investment, ignoring the benefits of compounding. If the bank compounds interest more than once a year (annually), the APY will be higher than the annual interest rate.

Certificate of Deposit (CD): A CD is a loan that a consumer makes to a bank. The consumer gives the bank money for a predetermined period of time, at a fixed interest rate. During that period of time, the consumer cannot retrieve the money in the CD without paying a financial penalty.

Compounding: If your investments produce a positive return, after a period of time, you will have more money to invest than when you began investing. During the next period of investing, you will be able to get a return both upon your initial investment, and upon the proceeds from your previous investment. The concept of reinvesting interest is known as compounding.

Exchange-Traded Fund (ETF): An ETF is a fund that is traded on a stock exchange, like any company. (Mutual funds are not openly traded on stock exchanges.) All ETFs disclose all of their holdings at all times, unlike closed end funds and mutual funds which do not regularly do so. ETFs often contain several assets, such as shares of stock, which are jointly owned by the fund. They may contain assets mirroring a pre-existing index, or may consist of assets in a particular sector, or of a particular nature. While it is common for ETFs to cover nations, such as FXI, which covers China, it is also possible for them to cover resources, like GLD, which covers the price of gold.

 If you need further assistance, please feel free to ask questions through the comments feature. Additionally, you can look up the definitions of investment terms yourself at http://www.investorwords.com

3 Comments

  1. Charles Barr

    This is a particularly useful posting and helps explain what many of the terms you use in subsequent blog postings mean. However, I would suggest compiling this into some sort of side column for “quick reference.” I realize that you suggest that those who need further assistance with the definitions should look them up themselves, but you could increase your amount of traffic by providing definitions which are used in the context of this blog. In this manner, you could maintain a good amount of people who are personal finance savvy while increasing the number of layman. Otherwise, cheers!

  2. Scott

    Explaining the acromyms and terms is very helpful. Too many times people use them in everyday conversation without knowing their true meaning or origin. Not everyone will necessarily need to know about each of them, but a broad background in the most relevant terms is best.

    Others that you might want to explain in a future post – FDIC, SEP, Treasury bond, Treasury bill, and there might others.

  3. Ceci

    Insurance lingo is also a bit difficult to understand. For your readers, here are a few examples:

    Term insurance: This is the cheapest, simplest kind of life insurance. Buy a policy for a set term (typically 10 or 20 years) and if you die during that time, your beneficiary will receive the benefit.

    Whole life: This is the simplest type of permanent life insurance. Your premiums remain the same throughout the life of the policy, and a portion of each premium is invested by the company, allowing you to accumulate this money (the cash value) on a tax-deferred basis.

    Universal life: This has the same basic features as whole life, but is a bit more flexible. If you choose, you can pay in amounts above your regular premium, and adjust the death benefit relative to the cash value amount.

    Variable life: With a variable policy, you get a choice of different funds where the company will invest your money for you. Generally, if the investments do well you’ll have a higher death benefit and greater cash value. It they don’t do well, you’ll have a lower death benefit and cash value, though some policies guarantee a minimum death benefit.

    Variable universal life: This combines the flexibility of adjusting the amount of the death benefit and premium (as in universal life) with the ability to take a little more risk in investment choices in the hope of getting a bigger return (as in variable life).

    Bottom Line: While complex at first glance, life insurance need not be overly confounding. If you understand your choices and are clear about why you’re buying life insurance in the first place, the right option for you will be obvious.

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