Broker Check
Top 15 Confusing Financial Planning Terms Defined

Top 15 Confusing Financial Planning Terms Defined

October 11, 2023

Maybe this experience sounds familiar – you’re meeting with a financial professional who starts throwing around technical terms you’ve heard before but aren’t sure you fully understand. It’s not a good feeling, especially when the conversation is about your money. 

One of the big messages I try to communicate to clients is that financial planning is not as complex as some people like to make it. Like any industry, the world of finance has its own vocabulary that you wouldn’t necessarily know if you don’t work in the field, but once you become acquainted with the terms, you’ll see the definitions are pretty straightforward and the ideas they represent are probably familiar.

 Here’s a list of 15 financial terms I get asked about the most.

  1. Amortization

Amortization is the process of paying off a debt in equal installments over time. When a loan is amortized, part of each payment goes toward the loan principal, and part goes toward interest, and with each subsequent payment, more goes toward principal and less toward interest. A home mortgage is an example of amortization.

  1. Annual Percentage Rate

Annual Percentage Rate is the amount of interest and other fees someone pays on their loan or line of credit. This is a hot topic lately because, after a long stretch with historically low annual percentage rates, they have risen as a result of the Federal Reserve’s actions to fight inflation. Changes to annual percentage rates impacts the interest rate for things like home mortgages, car loans, credit cards, and lines of credit.

  1. Asset Allocation

Asset Allocation refers to how you choose to divide your investments among different assets, with a certain percentage devoted to stocks, bonds, and alternatives. Deciding what your mix of assets should be depends largely on your time horizon – how long you intend to hold the assets – and your overall risk tolerance. The allocation that works best for you will change at different times in your life.

  1. Capital Gains - Capital Losses

Selling an asset, such as stocks, bonds, or property, at a profit represents capital gains. Capital loss is the opposite - selling an asset at a loss. Capital gains and losses affect your taxes and should be planned for to minimize the impact.

  1. Cost Basis

The cost basis is the amount you originally paid for an asset or investment, including any fees associated with the purchase. For instance, in the case of stock shares, in addition to the purchase price of the stock, you might also include brokerage fees in the cost basis.

  1. Diversification

Diversification is an investment portfolio’s way of not “putting all your eggs in one basket.” It involves spreading your money across a variety of investments and asset classes to help reduce the overall risk within the portfolio.

  1. Dividend

Dividends are regular payments of profit made to shareholders who own a company's stock. Payments may be made in cash or stocks, although not all companies pay dividends. Among those that pay, the dividend amount can vary significantly. Dividends are a factor in determining an assets total return.

  1. Equities

Equity and stocks are commonly used interchangeably. A share of stock would equal an equity interest in a company. An equity investment is money that is invested in a company by purchasing shares of it in the stock market.

  1. ESG Investing

Environmental, social, and governance (ESG) investing refers to a type of socially conscious investing where a company’s conduct is used to screen investments based on corporate policies. Rather than focusing solely on profits, ESG investing is meant to encourage companies to act responsibly.

  1. Fiduciary

A fiduciary is a financial advisor who is legally and ethically bound to always act in the best interests of their client and prioritize their client’s needs above their own. By contrast, a financial advisor who is not a fiduciary may sell or recommend a product that benefits their firm or for which they receive a commission. The recommendation must still be appropriate for the client, but does not have to meet the "best interest" standard.

  1. Fixed income

Fixed income is a type of asset that will pay out a set, or “fixed” level of cash flow to an investor, typically in the form of fixed interest or dividends. Government and corporate bonds are the most common types of fixed-income products. The payments are called “interest” or “yield” and help determine the total return of the investment over time.

  1. Rebalancing

Rebalancing is like getting a tune up for your car. Every portfolio has an investment plan, with assets allocated based on your risk tolerance. Over time, things change - asset prices increase or decrease, and rebalancing is necessary to make sure you stay on track with your investment plan. Rebalancing is the process of buying and selling assets to get the portfolio back to the original asset allocation.

  1. Risk-Adjusted Performance

Risk-Adjusted Performance puts returns into context based on the amount of risk involved in an investment. Basically, the higher the risk, the higher return an investor should expect. A widely accepted way to measure risk is the Sharpe Ratio. The ratio is a mathematical equation that compares the return of an investment with its risk. Simply put, the Sharpe Ratio describes how much excess return you receive for the extra volatility you endure for holding a riskier asset.

  1. Standard Deviation

Standard deviation measures how far a variable, such as an investment's return, moves above or below its average, or mean, return. In other words, it measures volatility and is used to understand the overall risk of the portfolio. If an investment has a high standard deviation, you can expect more volatility, making it a riskier investment than one with a low standard deviation. The higher the standard deviation, the higher the risk.

  1. Trust

A trust is a legal agreement that allows a third party, or a trustee, to control assets on behalf of a single beneficiary or multiple beneficiaries. Trusts can be set up in many ways to accomplish many things and are commonly used in estate planning as a way to minimize taxes. Because trusts can usually bypass the probate process for administering a deceased person’s estate, they may allow beneficiaries access to assets more quickly.

It's about Your Goals

Far more important than understanding the terminology of the financial industry, is knowing what’s important to you. What goals do you have for the next five, ten or twenty years? If you can start to answer those questions, we can help you make a financial plan that moves you in the direction you want to go.

To get answers to all your financial planning questions, contact our team at Marshall Financial Group. We believe it’s never too late or too early to start planning for your financial future. Give us a call today.