Are you ashamed of your knowledge about your personal finance? Were you not lucky enough to have a parent teach you about how to manage money? Simply by learning some personal finance vocabulary will get you started on the right track.
Your personal finance vocabulary should include these 6 terms
If you’re just starting your journey into personal finance, you may not know any of this vocabulary – that’s ok. All of us had to start somewhere.
I’m lucky enough to have a father who taught me much of what I know today. If you have someone in your life to talk money, cherish that person. The time you invest in learning about money will pay dividends (a term we’ll cover later) many times over in the future.
By expanding your own personal finance vocabulary starting today, you’ll find a hunger to learn more every year. Remember that nobody is perfect. If you ask any wealthy person out there, every single one of them will tell you all about their mistakes and their missed opportunities.
Much like many things in life, simply showing up everyday, with a sprinkle of luck, can get you well ahead in life.
1. Compound Interest
If you don’t know the value of compound interest, ingrain this into your mind as soon as possible: compound interest is the #1 reason why you should start saving money today.
By saving money today, you give your money more time to grow into what it can become.
To understand compound interest, you should familiarize yourself with the Rule of 72.
The Rule of 72 is an easy way to see how long it takes for your money to double. For example, your money can double every 8 years if you earn an annualized return of 9%.
Rule of 72
- With 1% returns, your money will take 72 years to double.
- On the other hand, with 8% returns, your money will only take 8 years to double.
- Finally, with 12% returns, your money doubles in a quick 6 years.
2. Expense Ratio
When you’re researching places to invest your money (research mutual funds and index funds), you should always look at one factor before investing: expense ratio.
The expense ratio of a fund is how much of your assets a fund will take as a fee each year. As an example, if you have $10,000 in assets invested in a fund with a 0.50% expense ratio, the fund will take $50.
Expense ratios can add up over time. If you keep those $10,000 in assets invested in the fund for 10 years, the fund will take $500 when it all adds up.
As you can see in the screenshot above, the difference between a 0.10% and a 0.75% expense ratio is significant. In terms of 30 years, the 0.75% expense ratio fund will cost you $51,000 in fees.
When you think about that $51,000 along with compound interest, that can be a significant loss in your retirement account.
Think of an expense ratio like this. For every $10,000 invested, a 0.50% expense ratio will take $500 every 10 years.
3. Annualized Return
By looking at your annualized return, you can see how your money has increased each year, on average, over a given time period.
For example, if you see annualized returns of 12% over 6 years, it likely means your money doubled in that time period.
When reinvesting dividends, the Dow Jones had annualized returns of 7.9% over 2005-2015. If you remember what happened during that same time period, you’ll know the Great Recession was a key part of that. Yes, the Dow Jones had annualized returns of 7.9% with a recession stuck in the middle.
When you review your investments, always look at annualized returns. Your annualized return will give you a quick glimpse on how your investments performed.
If your annualized return is below 5%, don’t panic. Annualized returns of less than 5% do happen – sometimes you may even lose money over a period of time.
Remember, over 2005-2015, the Dow Jones would have returned 7.9%. That’s including the Great Recession – where the Dow Jones lost over 54% of its value in less than two years.
Any personal finance vocabulary would not be complete without an explanation for dividends.
Dividends are sums of money paid by a company to its shareholders. Typically, a company pays these quarterly or annually. It’s a mechanism of attracting shareholders.
Contrary to popular belief, companies will sometimes increase their dividend during a down period to convince shareholders to stick with the company.
For example, Coca-Cola has paid a quarterly dividend since 1920. In each of the last 54 years, they’ve actually increased their dividend.
As a general rule, you should always reinvest dividends. In the case of the Dow Jones from 2005-2015, reinvesting dividends would have increased your annualized return from 5.2% to 7.9%.
If you want to see for yourself, take a look at this dividend reinvestment calculator.
5. Pay Yourself First
In order to pay yourself first, you need to commit to contributing to retirement accounts before you spend any money elsewhere. This means you save for retirement before paying your mortgage, paying your credit card bill, or buying that new pair of shoes.
While this sounds extreme and isn’t always possible, paying yourself first increases your saving discipline.
Essentially, paying yourself first lowers your monthly income and you make do with what’s left over. Save first – spend money later.
For example, if you have a monthly income of $4,000, you immediately save $500 and work with the remaining $3500. If you budget your money regularly, this means you’ll only have $3500 to budget.
To form great saving habits, paying yourself first is the #1 way to train your self discipline. By lowering your monthly income, you may never miss that money in the first place.
Better yet, when you get an increase in your income, you can maintain your lifestyle on $3500 per month. With the extra income, you can increase the speed of your retirement savings.
6. Tenbagger, Twentybagger, 240bagger?
A personal finance vocabulary would be extremely lacking without the good ‘ole tenbagger.
For some people, Netflix was a tenbagger.
A tenbagger is any investment which returns 10 times what you invested (in other words, you investment would have increased 900%). A twentybagger is 20 times, and a 240bagger would be 240 times.
While it’s fun to dream of tenbaggers, you shouldn’t always try to pick them. In fact, it’s usually far smarter to invest in index funds or mutual funds than try to win the lottery.
If investing isn’t your day to day passion, consider sticking with index funds instead of picking stocks. If you want to have fun and you can afford to lose the money, picking stocks is sometimes worth the risk.
- Any personal finance vocabulary would be incomplete without mentioning compound interest, expense ratios, and paying yourself first.
- Expense ratios can result in lost opportunity. When choosing funds, always review the expense ratio.
- By paying yourself first, you essentially lower your monthly income with the added benefit of increasing your savings before you give money to any companies.
- As a general rule of thumb, always reinvest dividends when given the option.
- Typically, you shouldn’t try to win the lottery by finding tenbaggers. Invest in index funds and mutual funds instead.
What did I miss? What’s in your own personal finance vocabulary? Let me know by submitting your comment below.