The A to Z of Money – Practical definitions In Simple Terms
Can learning about and managing money seem complicated at times?
As a dad of two boys under 5, I am very much at that stage of life where the focus is firmly on teaching our sons how to read.
This has meant really breaking down the learning process into units of understanding and explaining it to them as though someone was learning a whole new language.
When I think of money and all things related to it, I realise that there are typical terms that people use alot of time, which sometimes can appear complex and easily overwhelm.
These terms and their practical meanings should really be broken down for easier understanding by anyone not strongly financially inclined.
As such, below are simple definitions with wisdom weaved in, that I hope anyone anywhere can understand.
Such understanding will help you in time gain greater confidence with all things money and make you a better manager of your own financial life.
This is a growing resource (currently over 90 terms), so feel free to make suggestions for words you’d like included. I’d also appreciate you sharing this post with friends and family.
Below is the A to Z of Money (so far):
A
Assets
An asset is anything that makes you money rather than costs you money.
Assets essentially help you generate financial wealth (income and capital gains) by working for you. When you hear people talk about passive income, those come from assets at work.
E.g. Rental property that generates net profits; investments in shares that earn dividends; or intellectual property (books, music etc.) that you have rights that generate some royalties.
You could also own an asset that isn’t making you any money nor costing you but is increasing in value over time e.g. Art, gold etc.
Your mortgaged home (however much it has gone up in value whilst you live in it) isn’t an asset, yet. It does, however, become an asset if for example, you start letting a spare room out and making some money on it.
Assets can either be tangible or intangible. Thanks to the internet, platforms such as Teachable have become successful and they give you and me the opportunity to create courses using what we already know.
Such courses online would fall into the category of intangible assets.
Related: How To Start Building Passive Income For Financial Independence
AER
AER stands for Annual Equivalent Rate and is there to help you be able to easily compare savings accounts.
It assumes that you’ll keep your money in a savings account for one year.
APR
APR stands for Annual Percentage Rate and is the rate associated with debt such as credit card debt.
It’s a way in which lenders measure the cost of the money they are lending you and is done to be standardised so that you can compare one debt with another.
Note is that the APR does not represent what the card will actually cost you. This all comes down to how much you use the card each month and how much you repay.
Having a good credit means that you’re more likely to get the representative APR i.e. the better your credit score, the cheaper the debt you can get.
Click here to get your Free Experian Credit Score.
Active income
This is income you earn by being present and wholly putting all your time into a particular activity.
It is the opposite end of Passive Income (covered below).
Amortisation
Amortisation is a way of spreading the cost of something intangible over time. E.g. imagine you have a budget of £2,400 for holidays this year.
This is equivalent to an amortised cost of £200 a month (£2400/12). I.e. You intend to spend the equivalent of £200/month on a holiday.
If for any reason you book your holiday and exceed £2400 for the year, it means that your cost per month according to your budget would be blown and you would likely be living above your means.
Angel investor
Professional investors who invest in early-stage businesses, taking the risk for an expected high return.
If you're trying to bootstrap your start-up, these are the last people you might want to go to as you will most definitely have to give away a material portion of ownership in your business.
Asset Allocation
Think of the universe of all your financial assets as a round cake. Asset allocation refers to the various slices of cake that make up the cake itself. I.e. what and where you have invested your money.
Alot of people hold the majority of their money in cash whereas the wealthy typically hold less than 10% of their assets in cash.
If you’re young or at the asset accumulation stage of your life, having an asset allocation of 80%+ in equities (shares) is expected.
This maximises your average returns over time.
B
Balance sheet
This is what tells you how healthy or not your business is at any point in time. It is a snapshot of what you currently own (assets), owe (liabilities) and what you have left to pay out from (owners’ equity).
In your personal financial life, you too will have a balance sheet. You might hear people use words like net worth or estate etc., all of which point effectively to your balance sheet.
Most people typically focus on their Profit & Loss (basically your income less expenses) day to day but really should take stock monthly and check how healthy or not their balance sheet is.
Related: How To Calculate And Grow Your Net Worth
Budget
Probably one of the things most talked about by people but often misunderstood and not put into practice.
A budget is a summary of your earning and spending intentions over a period of time. The most important role of a budget is that it acts as a control that stops you spending your life into trouble.
It is critically important if you plan to succeed in managing your money.
Related: How To Create A Budget That Works For You
Bond
This is an asset class that is necessary for building a balanced portfolio.
If you’re older and/or at the Wealth Preservation (as opposed to the Wealth Accumulation) stage of your life, then you’d need to change your investment approach with more money invested in bonds.
This is due to the lower risk associated with bonds, which is also tied to a lower expected return.
Broker
A middleman who makes a ton of money from connecting buyers and sellers of stuff. Rich people usually have brokers they use to get good deals on purchases.
Brokers also play an important role where there is a limited supply of a particular security. The source sellers and reach out to potential buyers.
They are usually paid by way of a small top up on the price you pay for shares.
E.g. if you bought 500 shares of Apple stock at $105, the true price might have been $103. The broker makes $1,000 commission i.e. $2 ($105 – 103) multiplied by 500 shares.
Buy and Hold
A way of investing your money if you have a long-term view. This is different from “Trading”, where you buy shares today and sell them tomorrow or in s short time frame.
C
Cash
This needs no explanation, apart from to say that it is the most liquid of all assets. When you hear that someone is worth say, £5m, it would be rare for them to have even 10% of that in cash.
This is because rich people typically want their money working for them. Cash is extremely important for liquidity and the ability to meet your bills etc as they fall due.
Cash Flow
This is the flow of cash in and out of your financial life. Your level of financial intelligence is demonstrated by your ability to manage cash flow.
In fact, the mismanagement of cash flow is the number one reason most people are broke!
One way to become Financially Independent is to generate sufficient recurring cash flow from your assets that they cover your ongoing monthly expenses.
Related: How To Stop Being Broke Forever
Compounding
Without a doubt, this is the most important aspect of investing. It is the vehicle that will make you rich if you give it enough time to work for you.
In simple terms, it refers to money creating money. Imagine if you invest £100 and makes a £5 interest. And you then reinvest that £5 and the £100, and they both generate further gains, which are then invested again.
The beauty of this is that it all happens automatically. All you need to do is get your money into an environment where it can compound.
E.g. if you invest in shares or funds that generate dividends, you can request that all your gains are reinvested automatically for you.
Then you sit back and don’t obsess over it. Give it time to work even with all the noise and panic you’ll definitely be exposed to over time.
Related: How To Teach Your Children The Magic Of Compounding Interest
Credit
This is good old debt. Your credit card is the easiest example of this. “Buy now, pay later”. Oh yeah, and you’ll most certainly pay later.
Credit is powerful if you understand how to manage cash flow. However, I’d recommend not messing around with credit where possible. Stick to cash.
Credit Score
A credit score measures your ability to manage your financial affairs in numbers. The higher your credit score, the higher your trustworthiness.
If you pay your debt down on time and never miss payments, then you’ll have a high credit score. A high score also means you’re more likely to borrow money cheaper.
If you’ve got a bad credit score, it’s not the end of the world. You can change that over time and demonstrate a better ability to manage money.
Click here to get your Free Experian Credit Score.
Creditor
These are the people you owe money. E.g. if you owe money for your internet or gas bills, then the people you owe are your creditors.
This is the opposite to “debtors”, who are the people who owe you money. A debtor is an asset on your balance sheet (see above) and is a good thing to have relatively.
A creditor, on the other hand, is a liability on your balance sheet (see above) and is a bad thing to have relatively.
Chattels
This refers to movable personal property such as jewelry, furniture or a car. What is unique about these is that they depreciate (fall in value) very quickly.
A car is a wonderful example of such assets that fall in value. The less chattels you buy, the richer you’ll become.
Capital Gains
These are the gains you generate from selling assets. Notable examples are the gains from selling shares, property or a business.
Capital gains is a way in which rich people get richer and it has its own special tax called the Capital Gains Tax (CGT). CGT is usually a lower tax rate than ordinary folk might pay on income tax from salary.
CGT is calculated as the tax on profits or the difference between the sales price and the original cost or purchase price.
Credit card
This needs no definition as most people are already trapped by it. It’s essentially borrowed money that you pay later for a crazy amount of interest.
Worth mentioning is the need to use credit cards for travel rewards i.e. you generate points, which reduce the cost of future travel.
However, please do not go anywhere near a credit card if you don’t know how to manage your cashflow.
Commodity
This is essentially another type of asset class where there is little difference between one coming from one producer and another from another producer.
A relevant example is electricity or gas. As a consumer, you see no difference between gas from EDF Energy and Gas from Economy Energy.
All you should care about is the gas at the cheapest possible price. This is the main reason why you should definitely renegotiate your electricity, gas, internet etc prices each year without fail for a cheaper deal.
Suppliers make things abit complicated when they create an offer. E.g. They might combine your internet supply with the possibility of a new phone.
This is designed to stop you being able to directly compare what is meant to be a simple commodity.
D
Debt
Another word for money that you owe. It is also a type of financing option that is available to you if you run a business and need to invest in people and equipment to make it grow.
Debt also plays an important role as leverage (see below) for investors who want to buy assets but without using alot of their own money. E.g. property investing is usually funded primarily by debt.
Keep it personal, debt should not become the norm in our personal lives. It can enslave and is the primary reason that many people run the rat race.
The quicker you can get rid of your debt (e.g. mortgage debt), the faster you’ll become Financial Independent.
In the same way that compounding (see above) can work in your favour if you have an asset, compounding interest can also work against you if you have debt.
Related: 10 Tried And tested Tips To Help You Become Debt Free
Debit
If your account is in debit, it means that you’re in the negative. If it’s in credit, it means your bank balance is in the positive.
Debit as a term is also important in Double-Entry Accounting. Assets are usually on the Debit or Left-hand side of the balance sheet (see above), whereas Liabilities are on the Credit or Right-hand side.
Debtor
As touched on above, a debtor is anyone who owes you money. A debtor is also a form of an asset.
Because it is considered to be closer to cash, it is a fairly liquid type of asset. When debtor default or end up not paying their debts, they are called bad debts. If there is a chance that debtors will pay but they are still unpaid, they are called doubtful debts.
Depreciation
This is similar to amortisation (see above) but instead it’s the loss in value of tangible assets.
A good example of this is a car, which loses value the minute you drive it out of the showroom.
The important thing to note is that depreciation is a cost i.e. because it represents a loss in value.
Assets such as land, property, art, coins etc are pretty special because they do not depreciate.
Debt consolidation
This is the process of combining various bits of debt you have into one. Practically it means that you take out one new loan to pay off all other unsecured loans that you have.
The motivation for doing this is so that you can get better terms such as a lower interest rate or lower monthly payments or both.
If you have debt collectors chasing you, a debt consolidation plan could be useful for stopping the calls.
One disadvantage of a debt consolidation is that you might have a longer payment term, which might mean that you’ll be paying more in the long term.
The final point to note is that you can do a debt consolidation yourself! You don’t need a company to charge you hefty fees for the admin.
A new personal loan with a bank or a low interest credit card is a good way to start.
Diversification
This simply refers to not putting all your eggs in one basket.
It’s an important investing principle that leads to the reduction of investing risk the more you spread your money.
Diversification can be achieved by investing in a variety of companies, assets classes, locations or even at different times.
Diversification reduces a type of risk called Specific Risk (risk directly related to companies) and cannot reduce Market Risk (risk associated with the entire marketplace).
Related: Investing Risks You Should Be Aware Of
Dividends
Dividends are the reward you get for putting your money to work. They are the bits of gold that make you richer and fuel your compounding (see above) machine.
They are payments you get based on the number of shares of a company that you have. Say you have 100 shares of Apple stock, Apple could declare a dividend i.e. pay day.
Only shareholders receive this payment and all holders of a particular shareclass are paid the same dividend per share amount. E.g. Apple could decide to pay a dividend of 50p per share to all it’s C-Class share holders.
If your 100 shares are C-class shares, you’ll get a payment of £50 i.e. 50p X 100 shares.
If you reinvest this £50, then it will eventually also earn you further dividends, hence compounding.
Note that dividends are only ever paid out of a company’s Retained Earning i.e. profits from previous years.
Dollar Cost Averaging
Dollar or Pound Cost Averaging is a way of reducing risk by not investing all your money in one go. Instead, you invest over time.
A practical example of this is the investing you might do monthly when you get paid.
If you buy Apple Stock at £100 a share this month and then buy it again at £90 a share next month, then your average price so far is £95 per share i.e. (£100+£90)/2.
Dollar cost averaging essential helps you invest efficiently and gives you a lower average cost per share over time.
E
Equity
An important equation to remember is that Assets + Liabilities = Equity.
This is the same equation that helps you work out your net worth. Equity essentially refers to what is left when you sum all your assets and deduct all your liabilities.
Equity for companies also follows the same principle, and it is out of the equity (specifically Retained Earnings) that you get paid a dividend when you invest in a company by owning their shares.
Estate
This is a collective sum of all your possessions e.g. property, shares, investments, cash, land etc. Together, they form your estate.
Estates are important for determining what happens we pass away from an Inheritance Tax (IHT) perspective.
Certain things are not included in your estate:
- Life Insurance proceeds are excluded from your estate and are usually paid directly to your beneficiary.
- Jointly owned property owned as “joint tenants” are also excluded and will pass automatically to the surviving tenant.
- A Pension such as a Self Invested Pension Plan (SIPP) has a great advantage in that is excluded from your Estate and lets you pass your pension to beneficiaries on death.
- Trusts are a separate legal entity and remain under the control of the trustee or person you appoint. Assets owned in discretionary trusts, unit trusts, family trusts, don’t form a part of your estate. This is why the rich love trusts!
Note, however, that shares in a company that you own are considered your assets and will form a part of your estate and distributed according to your will (see below).
Enterprise Value
Enterprise Value (EV) is a measure of a company’s total value as opposed to measuring the Equity value or Market capitalisation (“Market Cap”).
This is important because when you look at companies on Google Finance for example, what you tend to see is the Market Cap i.e. Total number of shares X Share price.
However, note that the Market Cap of a company only represents the Equity Value. A company usually also has a Debt Value.
Therefore, the Market Cap gives an incomplete picture of the value of a company. Hence, Enterprise Value = Equity Value + Debt Value (less cash).
Cash is deducted above because when a company buys another one, they get to keep the cash of the company they bought.
Ordinarily, you won’t know the Debt Value looking from outside. Therefore, the Equity Value or Market Cap is the closest you can come to the valuation of a public company.
Exchange Traded Fund (ETF)
An ETF is a type of fund that tracks various other assets such as commodities, bonds, an index or even an index fund (see below).
The ETF itself can be traded in the same way that you can buy and sell shares. Because you can buy and sell it very easily, it has high liquidity.
When you invest in an ETF, the ETF (usually a company or an Investment Trust) owns the underlying assets (e.g. shares, bonds etc) and then divides ownership of those assets into shares.
So, in essence, you indirectly own the assets when you invest through an ETF.
Advantages of investing in an ETF are that you get the diversification and the actual cost of buying an ETF is much lower than that of an actively managed fund. In addition, there is the ability to sell quickly and convert your investment into cash.
Read: Index Fund Investing And The Simple Path To Wealth
Enterprise Investment Scheme (EIS)
This is a tax-friendly scheme that results in an income tax rebate of 30% if you invest £10,000 in a copy that is eligible for EIS.
The scheme was set up to encourage investment in small, private companies in the UK. You have to keep your investment for 3 years, and your investment attracts no capital gains tax when you sell.
There is also no inheritance tax to pay on shares bought through EIS.
F
Funds
Funds are baskets of companies or of other funds (i.e. fund of funds). A fund is essentially a legal entity that raises money through you and me, and then goes off to make investments.
The way in which that fund is managed is can make a huge difference to the extent of your future wealth.
If the fund is actively managed, it will attract fairly high fees in the region of 1.5% to 3%. This means that your returns would have to be at least 1.5% to 3% before you see any meaningful gains.
Investing through funds can also be passive, as is the case if you invest via an ETF or tracker fund, which tracks an index (a list of stocks) or an index fund (see below).
The key advantage of passive investing is that they are super cheap. Index fund investing is a very good example. They can cost as low as 0.2% – 0.5% per annum.
Related: Understanding Investment Fees And Why It Matters
Financial Independence (FI)
Freedom from the need to work for money, with the option to do with your time whatever you want to do with it.
FI is highly desirable and offers a different path to the determined. It requires a defined plan and a combination of lifestyle changes, good money management, investing and much more to make it a reality.
It is, however, achievable and without a doubt, worth the aim. I can certainly attest to what is possible through following this path.
Read:
Plot Your Escape. Choose Financial Independence
Fixed costs
These are costs that do not vary with the level of activity. For example, when you pay for electricity, you always pay a daily “standing charge”, and then you pay another charge based on your usage.
The “standing charge” is a fixed cost. The other charge is a “variable cost as it varies with your usage.
Another good example is what happens when you invest your money. You usually have an admin fee (fixed that you pay annually.
Then you have a management fee (variable) based on the level of your assets under management.
Future value
The Future Value is the value of your investment after it compounds (see above) at a particular rate over a specified period of time.
As an example, £1,000 invested over 5 years and earning 10% interest, leads to £1,500 Future Value assuming no compounding.
The same example leads to a Future Value of £1,610.51 assuming compounding interest. This is a great example of money working for you.
£1,610.51 is calculated as £1000 X (100% + 10%)^5. You can easily type this into a calculator.
The difference between £1,610.51 and £1,500 is what you get for positioning your money in a compounding environment.
The above demonstrates that money has an important characteristic – A Time Value perspective. I.e. £1 today is worth more than £1 tomorrow because of the potential that £1 today has.
G
Gross Yield
This is the yield or return on an investment before the deduction of taxes and expenses.
The same idea can be applied to the gross interest you generate in a bank account or even to gross salary you generate through your job.
Government bonds
This is a type of debt security that a government issues. It’s a way in which a government raises money for major projects.
If you invest in a government bond, it’s most certainly one of the safest investments you can make. However, don’t expect to get rich from it as the returns usually aren’t eye-watering.
H
Hire Purchase (HP)
HP is a type of financing agreement usually associated with car purchases. What’s unique about it is that you don’t own the product until you’ve paid in full.
The HP is one reason many people have attempted keeping up with the Joneses. I personally dislike them partly because it gives people far too much opportunity to borrow excessively.
And once you’re in, it’s the double whammy! Depreciating value and near never-ending car costs.
I
Index
An index is pretty much a sample of the market or a way of segmenting the stock market.
This sample is selected by people (e.g. a committee) who come up with the rules of what individual holdings should be included.
In a way, the index itself does not exist! I.e. it’s an idea. It’s just a list of stocks and anyone can create one.
Index Fund
An index fund is a basket of individual holdings (e.g. stocks or bonds) i.e. a fund that aims to track a particular index (above).
That fund itself is a pooled structure (i.e. pot of money).
So if you buy the S&P 500 index fund, you’re buying a portfolio of stocks.
However, it’s held in a pooled structure with a portfolio manager who is responsible for tracking the index i.e. replicating the results of the S&P 500 index.
Individual savings accounts (ISA)
A standard savings account that allows you to potentially earn a return on your money. The unique things about it is that any gains in this account are tax-free.
You can get a Cash ISA, Stock & Shares ISA, Junior ISA (see below) and even an Innovative Finance ISA for investments in Peer to Peer Lending.
All the above ISAs are tax-free environments.
Insurance
A form of protection against a future negative outcome.
Although most people view insurance as just something they have to pay for, it also has an important role in risk reduction, wealth creation and preservation.
Intellectual property (IP)
Intellectual properties are intangible assets that are usually owned legally and protected by companies or individuals from use by others.
These include trademarks, patents, copyrights etc.
J
Joint venture (JV)
This where you and one or two other parties agree to join resources and advantages you each might have in other to achieve specific goals.
A good example is where you join forces with someone to create a course together on a platform like teachable and share the profits.
Junior Individual Savings account (JISA)
This is a savings account for children, with an annual contribution limit of about £4,260 per annum.
It’s a tax free account and useful if you want to give your children a head start with saving and investing for the future.
K
Know Your Client (KYC)
KYC is an ethical requirement put in place in the investing industry. It is there to protect both you and the brokers you might be dealing with.
Practically, it’s a simple process in which an investment company or platform gets to know your personal background, risk tolerance and financial position.
This way, they have the essential facts about you, to ensure the right recommendations (if any) are made.
L
Long
A long position is a trading position taken if you believe that the price of an asset or security will go up.
Liabilities
Liabilities are things that take away cash from you pocket. This can be contrasted with assets (see above).
Examples of day to day liabilities include mortgage debt, credit card balances or even bills you have that remain unpaid.
Liabilities essentially reduce your financial net worth. Instead, you should be focused on maximising assets and reducing liabilities.
Liquidity
This is the ease with which an asset can easily be converted into cash. Cash is the most liquid of all assets, followed by other current assets such as debtors and prepayments.
When you think about making investments in the near future, the ease with which you can easily convert your investments into cash matters.
Examples of illiquid assets include property or even investments in Venture Capital Trusts (see below).
Liquidation
When a company becomes insolvent (has not cash to meet its needs as they arise), the process of bringing the company to an end is called liquidation.
This process usually leads to the assets (if any) of a company being distributed to those who are claiming for it.
Life insurance
This is a type of protection that only pays out to a beneficiary on the death of the policyholder.
It plays an important role in basic financial planning and is usually taken out by people to ensure that their mortgages are paid off on death or that their loved ones don’t have to sell their home.
It also plays an important role in wealth creation or transfer if you understand how. You might recall earlier that I told you that life insurance falls outside your Estate (see above). So it does not get subjected to Inheritance tax.
In fact, life insurance can act as a leverage for your financial freedom.
M
Market capitalisation
When you invest in individual companies in the stock market, one of the key numbers you’ll come across is the Market Capitalisation (Market cap).
It represents the value of all the shares of the company outstanding. I.e. total number of shares multiplied by the price per share.
The market cap is also called the Equity Value of the company and forms a part of the Total or Enterprise Value (see above) of a company.
Management fee
This is the fee that an investment manager charges you to manage your money. This figure could range anything from 0.2% (for passive funds) to 2.5% (for active funds).
The fewer fees you pay the richer you’ll become over time. So your ultimate goal should be to maximise returns whilst keeping fees super low.
Read: Understanding Investment Fees And Why It Matters
N
Net income
Income after the deductions of tax, social security payments and others payments such as pension contributions or student loans.
O
Owners’ Equity
Previously covered in Equity (above).
Assets + Liabilities = Owners’ Equity. This is the Accounting Equation. The owner’s equity is another term for your financial net worth. For a business, it represents the Net Assets.
Options
An option is like a stock or a bond, and is, therefore, a security that you can buy or sell.
What is unique about an option is that it gives the holder the right to buy or sell something (at a specific price and by a specific date) but not the requirement to do so.
This is extremely important because you could pay an insignificant amount of money to get an option contract, however, that option could end up being alot more valuable than what you paid.
Options are a complex security only for the savvy investor, hence don’t get involved if you don’t have a good understanding of it.
The principle of an option could be applied to our personal lives though, especially as we know that options have value.
P
Peer To Peer (P2P) Lending
P2P lending is the matchmaking of people who want to borrow money and people who want to lend money as investors (e.g. you).
This matchmaking happens through platforms facilitated by the internet.
It provides an opportunity for us to make extra money from cash that would otherwise sit in our bank accounts.
It carries a higher risk than cash does, but a much lower risk that you might get from investing in individual companies.
What's really interesting is that P2P lending completely cuts out banks from the equation.
Those savings (e.g. the bank fee, cost of branches etc) of not having a traditional middleman to pay are then passed onto you and me.
The market leaders in this space include RateSetter, Funding Circle, and Zopa.
Read:
Ratesetter Review: A New Way To Invest Plus Bonus Offer
How To Invest Through Peer-To-Peer Lending
P/E Ratio
P/E stands for Price to Earnings ratio i.e. a ratio of the price per share of a stock with its Earnings (profits) per share.
In simple terms, the higher the P/E ratio, the more confidence it shows people have in the shares of a company.
As such, some of the most desirable companies in the world have high P/Es. E.g. Amazon, Apple etc.
The P/E as such is an important part of valuing a company.
Profit and Loss
The interaction between income and expenses results in profits or losses. The document which displays this profit or loss position is usually referred to as a Profit and Loss Account.
Present Value
This refers to the current value of money i.e. what it is worth today. This is different from Future Value (covered above), which looks at what money might look like in the future if gains are compounding.
The difference between the Present Value and the Future Value demonstrates an important principle of money, which is the Time Value Of Money (more below).
Passive income
This is income generated without you swapping time again and again to generate it. It is the stuff of dreams and is the opposite of Active Income.
Passive income is entirely possible to generate but requires alot of hard work upfront.
Read: How To Start Building Passive Income For Financial Independence
Prepayment
These are payments you make in advance. E.g. Imagine you pay your car insurance for a year in advance, because you’ve paid for a future period that you haven’t required insurance, that portion is called a prepayment.
A prepayment is a type of current asset (i.e. realised in less than 12 months) and as such, it’s considered to be fairly liquid.
Private Equity
This refers to the provision of capital to established businesses with potential for significant growth.
Such capital is usually provided by a Private Equity fund, which in itself raises money from institutions and super high net worth individuals.
Private Equity firms get rewarded through two means –
1) They charge an annual management fee of about 2%. So if they managed funds of say, £2bn, then their annual fees will be £40m.
2) They make a performance fee of about 20% when they profitably exit/sell companies they have invested in.
Basically, these guys aren't short of money!
Principal
Principal refers to the original money you put up for an Investment before it generates any interest.
So if you invest £1,000 generating 5% interest annually, the £1,000 is the principal.
Probate
This is a legal (court-supervised) process whereby a will is a review to ensure it is valid and authentic.
It is the first step taken to administer the estate (see above) of someone who has passed away, ahead of distributing their assets to their beneficiaries.
Q
Quick ratio
The measure of a company’s ability to meet its short-term obligations (bills, contracts etc) from its liquid assets (e.g. cash, debtors, prepayments).
In our personal lives, it is similar to working out how many times you can cover your recurring expenses from the cash/savings you currently have.
For both companies and individuals, it is a good measure of the strength of the financial position or liquidity.
The higher this ratio is, the more financially secure you are.
R
Risk
This is the potential pitfall you have whenever you set off to do anything or make a decision or an Investment.
The important thing to remember is that the minute we walk out of our doors every morning, we are already taking risks.
As such, risk is in the eye of the beholder.
The risk people think is associated with the stock market does exist. However, there is also an associated return for investing in the stock market as history has shown.
Diversification (see above) is one important method for reducing the risk that you might face from making investments.
A broad-based index fund not only gives you enough diversification, but it also helps you invest very cheaply due to the fact that your investment isn't actively managed.
Read:
Investing Risks You Should Be Aware Of
Index Fund Investing And The Simple Path To Wealth
Return
The prize for putting your money to work. A return usually comes in monetary form, although you could also have non-monetary forms of a return.
The power of a return is usually set alight when you let those returns generate further returns themselves through the power of compounding (see above).
Rental income
Income from renting a property out usually. Rental income could also come from leasing an asset out to someone else.
REIT
A REIT stands for Real Estate Invest Trust. It's an alternative way to invest in property compared to the traditional way of actually owning a property unit.
A REIT is a company that owns and manages the properties directly. It offers you and me the opportunity to invest small or large amounts of money in order to access some of the risks and rewards of owning property.
However, note that we never actually own the property units ourselves.
You most certainly have more liquidity by investing via a REIT than via owning the actual property. However, note that such investment do come with a risk as expected.
S
Safe Withdrawal Rate (SWR)
The SWR is a method in which retirees use to determine how much they can withdraw from their retirement fund each year without running out of money before they die.
Knowing your SWR also plays the important role of informing you on how much you need to be saving during your working years.
A SWR of 3% means that you will need to save more money during your working years compared to a SWR of 4%.
The SWR also assumes that you know what year you’re going to retire, which is a shortcoming of this method especially as we’re all living longer.
There are alot more things to consider re the SWR and how it relates to Financial Independence.
Read More:
Safe Withdrawal Rates For Early Retirees
Stocks/Shares
Share is your ownership in one company. When you own shares in more than one company, it is referred to as “stock” i.e. a portfolio of shares.
Stop/Loss
When you’ve made an investment, a stop-loss is an instruction you place with a broker to limit any further losses your investment might incur.
Stop losses can be used on either a Long (see above) or Short (see below) position. It is particularly useful for taking the emotion out of the process of trading.
Short/Shorting
A Short position is a way of investing whereby you’re essentially better than a share price will fall.
This is contrary to the Long (see above) position, where most people buy a share and wait for it to go up in value.
With shorting, you sell a share first and then buy it back later when you hope the price has fallen. Then you profit from the difference.
Note that shorting is risky and is for sophisticated investors. Only get involved if you know what you’re doing!
Spread betting
This betting as the name suggests. You’re essentially speculating on the price movement of a security.
It is highly risky and something you should not get involved with if you don’t have a good understanding.
T
Total Expense Ratio (TER)
TER is the expresses in a percentage form, the costs necessary to run a fun. This is extremely important especially in the current age of easy investing through various apps.
Costs (fees) play an important role in what your future wealth might look like. The lower the TER, the better.
Passively managed funds typically have TERs of 0.2% to 0.5%. Actively managed funds that promise outperformance can charge anything from 1.5% to 3%.
Tenancy in common
This is a situation where two or more people own a property together or have ownership interests.
However, note that this differs to Joint Tenancy due to the way that property interest can be passed on upon death.
For Tenancy In Common, each party to the property can choose who they want as a beneficiary of their property interest.
With Joint Tenancy, ownership is transferred automatically to the surviving owner and is excluded from your estate for inheritance tax purposes.
Time value of money (TVM)
TVM is the idea that £1 today is worth more than £1 tomorrow, due to the potential for £1 today to earn a return.
As such, it is always better to receive money today than it is in the future.
U
Utility
This is an economic term that refers to the total satisfaction you get from consuming a good or service.
It’s important as it influences demand for a product or service, and as a result, influence the price too.
V
Variable costs
This is a type of cost that varies with the level of activity. E.g. You has or electricity use is charged based on the amount you use daily and billed monthly.
This is different from Fixed Costs (see above).
Voting rights
These are the rights a shareholder has to vote on resolutions proposed by the Board. Some of these resolutions could include the reappointment of directors and even their remunerations.
Shareholders typically vote for various resolutions by completing proxy forms. The number of votes a shareholder has typically corresponds to the number of shares they hold. E.g. if you own 10,000 shares, then it counts for 10,000 votes.
Venture Capital (VC)
A type of investment usually for professional investors who want to make money from entrepreneurial businesses typically at the early of business life.
This type of investment is illiquid (i.e. not easily sold and converted into cash) and is usually for a period of 5 – 7 years.
It is also highly risky and as such VC investors require a high level of return to make up for the risk they’re taking.
VC investors invest in these companies through funds such as Venture Capital Trusts (covered below) or Enterprise Investment Scheme (covered above) or through other similar fund vehicles; primarily for tax benefits.
Venture Capital Trusts (VCT)
A VCT is a public listed company that owns assets (primarily companies).
Those companies make up the majority of the Net Assets of the VCTs balance sheet (see above).
The VCT as a company has a Board of directors, who have a responsibility to make decisions in the interest of shareholders.
The VCT board usually appoint an Investment Manager (another company), who usually manages and invests in the companies the VCT is investing in.
The manager usually has expertise in investing in such companies. For their expertise, the VCT pays the manager 2 primary fees –
1) Management fee – usually about 2%
2) Performance fee – usually about 20% of excess profits after shareholders have been given their money back.
W
An important element of basic financial planning that expresses the wishes you might have about who inherits your assets upon death.
It's a super important document and is one that's often overlooked, even by the rich and savvy.
This is often because many people never think about dying tomorrow or even today. Sadly, this is all a possibility.
As such, wills should be made a priority in your financial life.
X
eXposure
Economic exposure is the type of exposure that results from unexpected foreign currency fluctuations on your foreign investments or income.
An example of this is what happens when you in earn you income in US dollars, but you actually live mostly in the UK.
If the US Dollar weakens against the Pound, your income would buy you less in the UK.
Y
Yield
This is a return (in the form of an income e.g. dividends) on your investment.
For example, if you invest in an asset of £10,000 and want a yield of 4% per annum, it simply means you want that asset working for you and paying you £400 per annum as income.
This is super important because the yield is passive income and doesn’t require you to sell your time in order to earn it.
Z
Zero Percent
This is a promotional interest rate that is usually used to entice consumers.
Such rates are usually offered by credit card companies or companies selling things like sofas or home appliances.
There is nothing amazing about these offers, and ultimately, the consumer pays!
The companies that offer these usually do so for a short period of time after which the offer expires and the rates return back to the usual high rates.
Such companies hope that you and I essentially end up not being able to repay amounts borrowed once the promotional period ends.
The other thing to watch out for are transaction fees that are linked to such Zero Percent or Balance Transfer offers. They range easily from 1% to 3%.
In addition, these offers often hide an implied rate of interest. For example, imagine you go to buy a washing machine for £220 at zero percent.
However, you see the same product being offered somewhere else for £200 cash. This points to the previous offer including an implied 10% interest rate i.e. the £20 difference.
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What other Personal Finance or Money related terms would you like included on the list?
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