Do you know what FICO, asset allocation and capital gains mean? Better yet, do you know what they have to do with your own finances? If you didn’t study economics or finance in college, then there’s a good chance that these terms are unfamiliar to you. Yet, gaining a good grasp of key financial terms is the foundation for smarter financial decisions and a lifetime of building wealth for women.
It’s in women’s own best interest to take financial literacy seriously. Seventy-five percent of women will be single by the age of 75. We live longer than men and will need a bigger nest egg to sustain more years spent in retirement. Yet, women continue to score lower than men in financial literacy tests. In fact, more than 80% of women between the ages of 60 and 75 failed a 2017 Retirement Income Literacy Quiz.
In another study, Women, Power and Money, more than 50% of women surveyed said that they are the CFO of their households and have the primary responsibility for managing their family’s savings and investing. While they reported that they felt more financially savvy, 63% said that they wished they knew more about financial planning and investing.
When you consider the primary mission of Her Wealth®—to empower women with the financial confidence and resources to take control of their money and wealth—then you know that financial literacy is the cornerstone of what we do. We work with women every day to help them re-engage with their finances so that they have more financial security and confidence.
As they say, knowledge is power, and in the case of financial literacy, knowledge is literally money! We can’t change that abysmal financial literacy failure rate overnight, but we can begin to beef up women’s vocabulary and general knowledge with a quick lesson on financial terms we all should know.
A good place to start is with these 20 wealth-building terms. Financial jargon is difficult to understand, so we’ve translated them into more user-friendly language.
Net Worth = Personal Wealth Score Card
Simply the difference between your total assets and total liabilities (or debts).
Positive Cash Flow = Wealth building engine
Net income (after taxes) exceeds ALL your expenses so you can SAVE.
Qualified Retirement Plan = Long-Term Security
These are tax-deferred retirement plans such as a 401K, 403b, IRA, etc.
Amounts are contributed pre-tax by both employer and employee and earnings accumulate tax-deferred until you take withdrawals from your retirement plan (preferably after age 59 ½ to avoid penalties) at which time, your withdrawals will be taxed as ordinary income.
Inflation = Buying power of money
Rising prices of goods and services which increases your cost of living over time. As prices increase, your money buys less in the future. An item that increases 3% each year will double in cost in 24 years so your long-term investments need to grow more than inflation for you to have the same standard of living in the future.
FICO Score = Credit Worthiness
Credit score used by banks and other lenders to measure a borrower’s credit worthiness. Credit scores are based on several factors and range from 300 (worse) to 850 (best). The higher your credit score, the better the loan terms a borrower will receive.
Debt to Income (DTI) Ratio = Borrowing Power
This is your monthly total debt divided by monthly gross income. Most lenders follow the “28/36%” rule when approving loans. Monthly mortgage principal & interest, real estate taxes and insurance (or rent) should not exceed 28% of your gross monthly income; all monthly debts including mortgage (or rent), credit cards (minimum payments), car and personal loans should not exceed 36% of your gross monthly income.
Amortization = Scheduled debt repayment
Process of paying off your debt in fixed installments over a set time period.
Compound Interest = Money making money
Interest earned on the amount you deposit plus interest you accumulate over time. Bottom line, investing takes patience and money grows on money by compounding each year.
Asset Allocation = Collection of investments owned
Process of determining what proportion of your Portfolio will be invested in various asset classes based on your personal goals, time horizon and risk tolerance. Different asset classes include stocks, bonds, cash, real assets, commodities and alternative investments.
Rebalancing = Buying low and selling high
Process of buying or selling securities over time in order to maintain your desired asset allocation. Although hard to do mentally, trimming back on your winners (sell high) allows you to buy investments that are not performing as well at a lower cost (buy low), protect your gains and position your portfolio to benefit from a change in the market’s favorites since it’s hard to know which asset class is going to be the next winner. Cycles are inevitable and rebalancing your portfolio is a prudent risk management tool by making sure your portfolio is not overly dependent on the success or failure of one investment or asset class.
Life Insurance = Financial protection for your loved ones
Provides death benefit lump sum amount to replace deceased person’s future earnings
Umbrella Insurance = Liability Protection
Additional liability coverage beyond your home and auto insurance’s primary coverage to protect against lawsuits for property damage or personal injury from others such as employees who regularly work in your home.
Disability Insurance = Future income protection
Insurance designed to replace a portion of your gross income should an illness or disability keep you from working so that you have an income stream to pay your expenses even though you can’t work.
Capital Gains or Losses = Increase or decrease in value of an asset’s original purchase price
For tax purposes, you report a “realized” gain or loss upon the sale of the asset, like a stock. The length of time that you owned the asset prior to selling it defines whether the gain (or loss) will be taxed as short term (1 year or less) or long term (more than 1 year). This can have a significant effect on the taxes you pay because long-term capital gain rates are generally lower than short-term capital gains which are taxed as ordinary income.
Marginal vs. Effective Tax Rate = Your tax bracket vs. your actual tax rate
Your marginal tax rate is the percentage of tax you will pay on your next dollar of income while your effective tax rate is the amount of tax you owe divided by your taxable income. Since the U.S. has a progressive income tax, the more money you make, the higher your tax bracket and marginal tax rate will be.
Difference between Exemption, Deduction & Credit = Tax trimmers
A tax credit is a direct reduction to the amount of taxes you owe. Tax deductions for qualified expenses reduces your taxable income and tax exemptions are allowances for yourself and dependents that also reduce your taxable income. Keep in mind, there are income threshold limits which may reduce or completely phase-out allowable exemptions, deductions and credits on a taxpayer’s return.
Dependents = Tax deduction
A person who is financially dependent on your income, typically a child or adult relative that you support more than 50%. Depending on your income level, you can claim a tax exemption for dependents when filing your tax return, which reduces your taxable income.
Annual Gifting = Gifts with estate planning benefits
The IRS allows annual tax-free gifts of $14,000 (for year 2017) from one person to another which is totally separate from the lifetime gift exemption amount. You can give up to $14,000 a year (2017) to as many people as you like, without incurring a gift tax.
Irrevocable vs. Living (Revocable) Trust = Unchangeable vs. changeable trust
Irrevocable Trust terms cannot be changed and assets are not included in Grantor’s estate. Living (Revocable) Trust terms can be changed and assets are included in Grantor’s estate. The Grantor retains control over assets in a living (revocable trust) but not in an irrevocable trust. Understanding the pros/cons of both types of Trusts is important for estate planning.
Estate Tax Exemption = Death and taxes
Estates that are valued less than the Federal estate tax exemption (2017 value of $5.49 Million per person) will not be subject to federal estate and gift taxes. If your estate is worth more than the exemption limit (after taking prior lifetime gifts into account), your estate will be subject to federal estate taxes at a rate of up to 40% as well as any applicable state estate taxe. Estate taxes reduce the amount of your estate available to pass on to your heirs.
Fortunately, there’s no final exam. If this mini-lesson ignited your curiosity and interest to get serious about your money and building your wealth, then I encourage you to visit Her Wealth® frequently. I am confident that with our help, you will become the master of your money!
Shawn: Now you hear all kinds of deals about leasing cars, how can you negotiate a better deal if you want to lease?
Nina: Okay, well many people don't realize that they can actually negotiate the sticker price on a leased car in the same way that you would do that if you're buying a car. And since when you lease -- when you're, you know, your lease payments basically cover the depreciation, the difference between the sales price and the residual value. So it's definitely in your best interest to try to reduce that sales price as much as possible because then you'll pay you know, smaller dollars over the life of the lease. Make sure you pay attention to the down payment at the lease signing. And so here's an example, you might see an ad that says you know, lease payment is only 1.99 a month and that sounds like a great deal for thirty six months. The catch is, is that it might require a $3,600 down payment. So, if you amortize the down payment, then actually that 1.99 special, becomes 2.99. So, you really have to kind of look at total costs.
And then lastly, dealerships use the term, money or lease factor, when they're calculating your financing costs and a lease factor is not the same as an interest rate. So, you have to make sure the dealer converts that lease factor into a comparable interest rate so you know what your financing charges are.
Shawn: At the end of the day, does one method wind up being more expensive more often than the other, or can we tell that?
Nina: You know what, it really depends on how long, if you're going to hold the car for a long time, you're better off buying. But if you know, and if you're not, if you just really enjoy driving and you want to have a new car, then go ahead and lease. I mean, there's pros and cons to both, to be honest with you, it's not one size fits all.
Shawn: Alright Nina, great. Happy Thanksgiving to you. Alright, Nina Mitchell is with The Colony Group, for more go to wtop.com and search Her Wealth.
Consider this your training manual to get and stay financially fit for life!