10 Financial Terms Everyone Should Know
One of the most powerful tools you can have when dealing with your finances is knowledge. If you’re not aware of all the options available to you, or if you don’t fully understand what those options mean, the potential to be taken advantage of or to make a mistake is greatly increased. In order to help ensure that you’re completely prepared to tackle any financial situation that you may find yourself in, we’ve prepared a list of ten commonly used terms that many people may not know, or may not fully understand.
1. Checking Account
A checking account is the most accessible and fluid of all bank accounts. Checking accounts are typically used for day-to-day purchases with debit cards, setting up automatic bill paying, etc.
2. Savings Account
A savings account is a bank account that is typically used to save money for short-term purchases (such as vehicles, vacations, furniture, etc.) as opposed to more long-term methods such as investments or retirement plans. Money in a savings account is easily accessible.
3. Compound Interest
Compound interest is interest that you earn based on your principal and interest you’ve already earned. For example: If you invest $100 and get 10% interest annually, after a year you would have $110. With compound interest, you would earn 10% of the entire sum ($110) during the next year, so you would get $11 and have $121 total.
4. Emergency Fund
An emergency fund is a lump sum of easily available cash, usually equivalent to between three and six months’ pay, that is intended to help you get through a financial crisis such as being laid off or a medical emergency.
5. Cash Cushion
A cash cushion is a small amount of money kept in a checking account to prevent you from overdrawing the account and incurring fees.
6. Retirement Account
A retirement account is the general term for any account where an individual is storing money in anticipation of retirement. This includes 401k’s, IRA accounts, etc. Retirement accounts are usually tax-deferred, meaning that you don’t pay taxes on the money put into them until you begin withdrawing it.
A 401k is a retirement plan in which your employer will make a set contribution, usually based on the amount you contribute (they will often “match” what you contribute, up to a certain amount.) A 401k is tax-deferred, meaning any money you put into it is not taxed until you begin withdrawing from it.
8. Traditional IRA
An IRA, or Individual Retirement Account, is a retirement account that is opened and maintained by you, the individual. There is a cap on the amount you can contribute to your IRA, and as with a 401k the money you put into it is tax-deferred until you begin withdrawing.
9. Roth IRA
A Roth IRA functions much like a regular IRA, with one key difference. Instead of your money being tax-deferred, you instead pay interest on the initial investment up front. After that is paid, you pay no interest on the money in the account ever again, meaning that it’s a greater cost up front, but you avoid being taxed on larger sums of money in the future when you begin withdrawing.
10. Certificate of Deposit
A Certificate of Deposit, or CD, is a fixed-interest investment with a set period that you must wait before accessing your money, anywhere from a few months to over a year. If you withdraw the money early, you face penalty fines, but if you wait the entire term of the agreement, you get your investment back along with a set amount on interest.