Financial Definitions

Tab through to find a quick definition to the most common financial terms, with links to relevant articles.

An employer sponsored retirement plan that allows an employee to contribute a percentage of his or her earnings to an investment account for retirement. Investment selections are generally limited to funds, which can have an expense ratio and other fees. Many employers match part of the employee’s contribution to their plan. Most 401k plans are tax-deferred, meaning the money contributed is not taxed until it’s withdrawn. Although there are exceptions, most 401k plans will penalize participants if they withdraw their money before age 59 ½.

Related terms:

ROTH 401K

TRADITIONAL IRA

ROTH IRA

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For our purposes, asset simply means something that makes you money. Savings accounts, profitable stocks, bonds, funds, rental properties, and businesses are all assets.

Related terms:

LIABILITY

LIQUIDITY

CAPITAL GAINS

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Buying a bond is the equivalent of issuing a loan to either the government or a corporation. The interest paid on the bond can be fixed or variable, and is purchased for a specified period of time.

Related terms:

CD

INVESTMENT VEHICLE

STOCK

The profit from the sale of an investment. If you purchased a share of stock for $100, and sold it for $130, you had $30 in capital gains. If your share is worth $130 but you aren’t selling it yet, that’s called an unrealized capital gain. You have to pay taxes on capital gains (not on unrealized capital gains, only if you sell), but long-term capital gains are usually taxed at a lower rate than your earned income.

Related terms:

ROI

DIVIDEND

DISTRIBUTION

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Short for Certificate of Deposit, a CD is a type of investment vehicle where the bank promises to pay you a predetermined interest rate, and you promise to keep your money there for a specified length of time. Early withdrawal can give the bank the right to charge you a penalty.

Related terms:

INVESTMENT VEHICLE

BOND

OPPORTUNITY COST

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Magic.

Related terms:

DIVIDEND REINVESTMENT

ROI

PASSIVE INCOME

Nope, not the janitor here at Bottom Up (that would be me). A custodian is the institution that holds your assets for safekeeping. Some investment advisors will act as a custodian for their clients, but many advisors keep funds at a 3rd party bank or brokerage.

Related terms:

ROTH IRA

TRADITIONAL IRA

TRADING FEES

Taking profits in cash from your investments, often in retirement.

Related terms:


401K

ROTH IRA


DIVIDEND

CAPITAL GAIN

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When you purchase a share of stock, what you are actually doing is buying a piece of that company. You have become one of many owners of the company. A dividend is the way some publicly traded companies pay their owners (shareholders). Dividends are generally a predetermined quarterly payment, although some corporations pay them annually, semi-annually, or monthly. Dividends are often taxed at a lower rate than regular wages. Dividends are not paid by all companies, but many high-quality companies that pay them are committed to raising their dividends yearly, even during economic downturns. Dividends differ from (read: are even better than, in my personal opinion) capital gains because they’re paid to you directly without touching the principal. In order to take your capital gains in cash, you have to sell the asset, which could also trigger tax liability.

Related terms:

PASSIVE INCOME

DIVIDEND REINVESTMENT

CAPITAL GAINS

When a company pays you a dividend, you can opt to receive it in cash or choose to have it reinvested, which means the custodian will automatically buy you more shares and or/fractions of shares of that same company with the dividends received, often with no trading fees. Dividend reinvestment can be an excellent way for small and beginning investors to keep their investment costs down and compound their wealth more quickly by immediately putting the dividends to work for them.

Related terms:

COMPOUND INTEREST

ROI

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This just means to do your research before you make any investment, business-related, or legal decisions.

Related terms:

RISK

INVESTMENT VEHICLE

ETF is short for exchange traded fund. Similar to a mutual fund, it pools money from many investors to invest in a basket of assets. Unlike a mutual fund, it’s traded like a stock on the stock exchange. Because of this, ETFs are generally considered more liquid than mutual funds because they can be bought and sold easily.

Related terms:

CUSTODIAN

INVESTMENT VEHICLE

These are the costs to operate any fund, including ETFs, mutual funds, index funds, and hedge funds. This expense is passed along to the investor and can be found on the prospectus. The expense ratio can vary quite a bit, from a fraction of a percent to 2.5%. The majority of the expense ratio is used to pay the fund manager. Even relatively low expense ratios can eat away at your overall return. If your fund has returned 5% for the year but the expense ratio is 1%, 20% of your returns have been eaten away in fees.

Related terms:

401K

TRADING FEE

RISK

A fiduciary has both an ethical and legal responsibility to act in the best interest of the person he/she represents. When you employ a fiduciary, he or she has a duty of loyalty and care. That person must, to the best of her or his ability, make financial decisions that benefit you over themselves. This means they cannot profit from investment decisions they make for you. Investment advisors are fiduciaries and are held to a much higher standard than some other financial professionals. For example, brokers are not fiduciaries, and are able to put you into the investments that earn them the highest commission. Brokers are only legally required to sell you investments that are just suitable. In other words, while both professionals can help you invest, a broker works for him/herself and his or her firm, and your investment advisor works for you.

Related terms:

TRADING FEE

NET WORTH

DUE DILLIGENCE

The rate at which prices rise and, as a result, the value of your money falls.

Related terms:

RISK

ROI

PRINCIPAL

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These are all the various options you have to invest your money. A share of stock is an investment vehicle, as is a rental property, savings account, mutual fund, certificate of deposit, or a business.

Related terms:

DUE DILLIGENCE

ETF

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Liabilities are the opposite of assets: they cost you money. Contrary to popular belief, your home and vehicles are usually liabilities, especially if they are financed. Other liabilities include a vacant rental home, a business that costs more to run than it brings in, or any investment that is dropping in value with no sign of recovery.

Related terms:

PRINCIPAL

EXPENSE RATIO

RISK

Liquidity is a measure of how quickly an asset can be turned into it’s fair cash value. Assets come in varying degrees of liquidity. Cash is the most liquid way to keep your money. Collectibles like rare coins are considered much more illiquid, as is real estate.

Related terms:

NET WORTH

DIVIDEND

An investment vehicle that pools funds from many investors and invests in a variety of products, which can include stocks, money market products, and bonds.

Related terms:

EXPENSE RATIO

S&P 500

ETF

Your net worth is calculated by subtracting your total assets from your total liabilities. If you have $50,000 in assets but $25,000 in debt, your net worth is $25,000.

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Related terms:

CAPITAL GAINS

COMPOUND INTEREST

DIVIDEND REINVESTMENT

Passive income is income that you do not have to trade your time or labor to receive. Passive income can come from dividends, rental property, or businesses, among other things. Many times passive income is taxed at a lower rate than earned income.

Related terms:

DIVIDENDS

DISTRIBUTION

The value of your original investment, not including any capital gains, dividends or interest. If you put 1000 in a savings account and it earns $5 in interest, your principal is still $1000, and your return is $5.

Principal can also refer to the amount of money borrowed without interest. Your mortgage payment is usually made up of a combination of principal (actual repayment of the loan), interest (fees charged by the bank for lending you the money), and insurance.

Related terms:

COMPOUND INTEREST

DIVIDEND

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The probability of losing some or all of your principal. Different investment vehicles carry different levels of risk. In general, the higher risk an investor is willing to take, the higher the potential return. It’s important to note that there is no such thing as risk-free. Even taking no action carries risk.

Related terms:

INFLATION

FIDUCIARY

LIABILITY

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ROI stands for return on investment. It is calculated by comparing the investment’s cost to the profit. To calculate ROI, divide the profit from the investment by the original cost of the investment. ROI is reflected by a percentage. If you buy a share of stock for $100, and later sell it for $120, your return on investment is 20%.

Related terms:

DIVIDEND

CAPITAL GAIN

RISK

Similar to a 401k, except these employer-sponsored plans are funded with after-tax contributions. They are beneficial from a tax perspective because while taxes are paid on contributions, the earnings are not taxed upon distribution.

Related terms:

TRADITIONAL IRA

EXPENSE RATIO

Standard and Poor’s 500 Index, commonly referred to as the S&P 500, is a stock market index of 500 large-cap, American based companies. At Bottom Up Wealth we frequently use it as a gauge to measure overall economic and market performance.

Related terms:

STOCK

INVESTMENT VEHICLE

ETF

Also referred to as a “share”, buying a stock signifies that you hold partial ownership in the assets and earnings of a company. Historically, stocks have outperformed most other types of investment vehicles.

Related terms:

BOND

CAPITAL GAIN

DIVIDEND

The cost paid to a custodian to buy or sell an investment product for you. Discount brokerages trading fees can vary, from charging by volume or charging per trade. For example, my personal brokerage charges me a flat $10 per trade, whether I’m buying 1 or 100 shares, so it’s advantageous for me to buy as many as is appropriate for my portfolio all at once. Your investment advisor is required by law to place your trades in a manner that is cost effective for you (ie, not buying you $50 worth of stock at a time at $10 per transaction or trading in and out all day). Many brokers are paid on commission, which means the more trading they do in your account, the more money they make…at your expense. Excessive trading to generate fees is known as churning.

Related terms:

INVESTMENT VEHICLE

FIDUCIARY

IRA is short for Individual Retirement Account. This is different from a 401k in that it is not sponsored by your employer, giving you more control over your investment choices. Your Traditional IRA is funded with pre-tax money. IRAs can be held at banks or brokerage firms. Banks, however, may have a much more limited selection of investment choices. Traditional IRAs, like 401ks, are tax-deferred.

Related terms:

ROTH IRA

DISTRIBUTION

Bottom Up Wealth seeks to help individuals understand their financial options and provide some helpful tools to make sense of their finances. The information on this website is not intended as a substitute for personalized, professional investment advice. Bottom Up Wealth LLC is not a registered investment advisor. Your individual investment performance can vary. Historical performance is never a guarantee of future results.  Bottom Up Wealth LLC sometimes participates in affiliate programs for products or services we already use and love.  Please read full disclaimer.

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