Financial Terms Everyone Should Know

Learning the terms below will make it easier for you to build a budget, understand your current financial situation, and keep your money in accounts that fit your financial goals.

Budgets

A budget is simply a plan for how you’ll spend your money over a specific period—often a week, month, or year. It should include all your income sources and expenses, including saving, investing, and paying off debt if those are your goals.

Savings account

A savings account keeps your money safe and pays interest. While traditional savings accounts typically pay low interest rates, high-yield savings accounts can offer much more attractive rates. Both traditional and high-yield savings accounts can be good options for your emergency savings and other short-term savings goals.

Money market account

A money market account is a savings account that comes with check-writing and debit card features more typical of checking accounts. Money market accounts can offer significantly higher interest yields than traditional savings accounts—but there may be a limit on the number of transactions you can do each month without penalty.

Checking account

A checking account is primarily used to complete transactions—typically via debit card or check. Some banks call them by different names, such as “spending accounts,” and some brokerage firms call similar products “cash management accounts.” While many checking accounts pay interest, rates are usually much lower compared with savings account rates.

Emergency fund

An emergency fund is money that you have ready to cover expensive surprises. This might be an emergency medical or vet bill, a car repair, or even a period of unemployment. As a general rule, most people should aim to have at least six months’ worth of expenses set aside.

Sinking funds

A sinking fund is a savings account that you use to save for an expense like a needed home repair, vacation, or new appliance. The goal is to save enough money in your sinking fund that you know you can cover the expense without destroying your budget or tapping your emergency fund.

Net worth

Your net worth is a clear, single-number snapshot of your overall financial health. It’s the total value of everything you own minus the total amount of all the money you owe—so a positive net worth means that you have more money than you owe. Consider all of your debts (credit cards, mortgages, car loans, student loans, personal loans, etc.) and assets (savings, investments, property, etc.).

Annual percentage yield (APY)

Annual percentage yield (APY) measures how much money you’ll earn in a year from a savings account or other related bank products. A higher rate is generally to your advantage, but sometimes you have to maintain a certain balance to get the best rate. Watch out for other fees, and note how often the account compounds.

Inflation

Inflation is the rate at which the prices for goods and services increase over time. Periods of high inflation can erode your purchasing power (how much your money can buy). By investing your long-term savings, you create the opportunity for your money to grow faster than inflation.

Understanding these credit-related terms can make it easier for you to be approved for loans, manage and pay off debt, and improve your credit score.

Principal

In lending, the principal is how much money you are borrowing through a loan or line of credit. It’s the initial amount that will need to be repaid. Importantly, this does not include any interest or fees that may also be due.

Collateral

Collateral backs a loan. When you take out a mortgage, for example, the home acts as collateral against the loan. If you’re ever unable to repay the loan, your lender has the option to confiscate the collateral and use it to recoup the loan.

Annual percentage rate (APR)

A loan’s annual percentage rate (APR) is a measure of the total cost of borrowing money over the course of a year. It includes interest charges as well as additional fees like origination fees, processing fees, and closing costs. APR will always match (or exceed) a loan’s interest rate.

Default

Default is what happens when you fail to repay your loan. While a single missed payment won’t typically result in default, multiple missed payments usually will. Defaulting on a loan can seriously damage your credit score, trigger the sale of your collateral, or even cause the lender to demand instant repayment of the loan.

Interest rate (fixed and variable)

A loan’s interest rate is what a lender charges you each year for borrowing money. Unlike APR, it does not include fees. When the interest rate is fixed, it will stay the same over the life of the loan. Variable interest rates may go up or down over time.

Debt consolidation

Debt consolidation merges multiple loans into a single loan—typically, by taking out a new loan for the larger amount and using it to pay off your other debts. Consolidation can make it easier to manage your debt if you have a lot of smaller loans. If you’re consolidating to a lower interest rate, it can also save you money as you repay your loans.

Credit score

Your credit score is a three-digit number that lenders use to evaluate your creditworthiness. It’s based on the information found in your credit report and influences things from how likely you are to be approved for a loan to how much you can borrow, the interest rates you pay, and more. Your payment history, amounts owed, length of credit history, credit mix, and new inquiries all affect your score.

Credit utilization ratio

Your credit utilization ratio measures how much of your available credit you’re currently using. If your credit card has a $10,000 credit limit, for example, and you currently have a balance of $2,000, then your credit utilization ratio for that card is 20 percent. Lenders typically like to see this number below 30 percent.

Debt-to-income ratio

Your debt-to-income (DTI) ratio is a measure of how much debt you own compared to your annual income. Lenders use your DTI plus other factors like your credit score to judge your creditworthiness and how likely it is that you’ll repay a loan.

Revolving credit

Revolving credit is any line of credit that automatically renews itself as you pay back what you owe. Credit cards, HELOCs, and personal lines of credit can all count as revolving credit. Revolving credit differs from installment loans, which are designed to be paid back over a specific period of time. So long as you stay current on your payments and don’t exceed your credit limit, you can continue to borrow from a revolving credit line.

Line of credit

A line of credit is a flexible type of revolving loan that you can borrow against over time as you need it, so long as you remain current on your payments. Credit cards and some personal loans are examples of lines of credit. You’ll need to repay the principal as well as any interest.

Home equity line of credit (HELOC)

A home equity line of credit (HELOC) is a line of credit that homeowners can use to access the equity they’ve built in their home. Because the home acts as collateral, HELOCs typically carry lower interest rates than other forms of debt—but this also means that if you can’t repay the loan, your home may be at risk.

Learn these terms to have a better understanding of how investing works and how you can manage your wealth over the long term.

Portfolio

Your portfolio is simply the total of all your financial assets. This can include investment assets like stocks, bonds, and real estate—whether held in a retirement account or brokerage account. But it should also include non-investment assets, like life insurance policies, physical property, savings and cash, and more.

Diversification

Diversification is the process of spreading your investments across multiple asset classes, sectors, and investing styles to reduce risk and volatility. Proper diversification means that just because one asset drops in value, your finances won’t completely fall apart.

Risk tolerance

Risk tolerance is how much risk you are willing to take in exchange for investment returns. It’s important to understand your risk tolerance to properly allocate your portfolio and reduce the likelihood that you’ll panic-sell during a downturn. You’ll also want to adjust your risk level depending on where you are in life and when you’ll need your money.

Dollar-cost averaging

Dollar-cost averaging builds an investment position slowly over time rather than all at once with a lump sum. It shifts your focus away from trying to “time” the market. This can reduce volatility and decrease your risk of putting a lot of money into an investment when it’s peaking.

Asset allocation

Asset allocation is how you diversify your portfolio among various asset classes like stocks, bonds, cash and cash equivalents, real estate, alternative investments, and more. This allocation should be based on your investment goals and risk tolerance. A 60/40 portfolio, for example, holds 60 percent stocks and 40 percent bonds.

Rebalancing

As you hold investments, some of them will increase in value while others decrease in value. Over time, this can cause your asset allocation to fall out of line with your preferred targets. Rebalancing returns a portfolio to its target allocation, typically by selling assets that have overperformed and buying assets that have underperformed.

Stocks

Stocks provide partial ownership in a company. They’re also called equities. Stocks are one of the most common investment assets. While they offer growth potential, they can also be volatile, especially over the short term.

Bonds

A bond is a loan that you make to a borrower, which entitles you to repayment of principal plus interest. Bonds come in several forms, including government bonds, agency bonds, municipal bonds, and corporate bonds. Each of these carries a different level of risk and tax treatment.

Mutual fund

A mutual fund is a professionally managed investment fund that pools together money from a number of shareholders and then uses that money to make investments. Most mutual funds have an investment thesis, or mission statement, which informs how the fund buys and manages investments. Mutual funds offer diversification but can carry higher fees compared to other options and may require minimum investments. They can be traded only once daily, after the market closes.

Exchange-traded fund (ETF)

An exchange-traded fund (ETF) is a lot like a mutual fund except it can be traded on an exchange throughout the day (just like individual stocks and bonds) and often has lower fees. ETFs are valued for their liquidity, ease of trading, and diversification.

Index fund

An index fund is a type of mutual fund or ETF designed to mimic the makeup of an index, like the S&P 500, Nasdaq, or Dow Jones Industrial Average. They are typically passively managed and carry low fees, giving investors exposure to the broad market.

Capital gains and losses

A capital gain is any profit that you make when selling an investment that has increased in value since you bought it. A capital loss, on the other hand, occurs when you sell an investment that has decreased in value from when you bought it.

Expense ratio

An expense ratio measures how expensive it is to invest in a fund. The higher the expense ratio, the more expensive it is to invest. If a fund carries an expense ratio of 0.45, then for every $10,000 invested in the fund you would pay fees of $45 annually.

Bull and bear market

A bull market is positive—it’s a period of time in which a financial market sees growth of roughly 20 percent. This typically coincides with strong economic growth and investor confidence. A bear market, on the other hand, is one in which prices are falling. Bear markets are usually challenging times or periods of economic contraction.

Learning the terms below will help you prepare for retirement and discuss your retirement plans—whether with a spouse, your children, or your financial advisor.

401(k)

A 401(k) is a tax-advantaged retirement account. You can put money into a 401(k) only if your employer offers one and you’re eligible. Some employers only offer them to full-time employees who have been with the company a certain number of years. Each year, the IRS limits how much money you (and your employer) are able to contribute to a 401(k). You can use your 401(k) to purchase a wide range of investments to save for retirement. If you withdraw the money too early, you’ll usually pay a penalty.

403(b)

A 403(b) is a tax-advantaged retirement plan for public school teachers and employees of certain governmental organizations or nonprofits. It works a lot like a 401(k) but typically has more restrictions regarding which assets it can hold.

Individual retirement account (IRA)

An individual retirement account (IRA) can be used to invest and save for retirement whether you have an employer or not. Like 401(k)s and 403(b)s, they are tax advantaged. They give you the freedom to save even more each year before you hit an IRS cap.

Roth accounts

Traditional retirement savings accounts—including 401(k)s, 403(b)s, and IRAs—are funded with before-tax funds. This lowers your income taxes for the year you make your contributions, and then you don’t owe taxes until you make withdrawals during retirement. Instead, Roth accounts are funded with after-tax contributions. So, qualified withdrawals are completely free of taxes during retirement.

Employer match

An employer match is a job benefit in which your employer makes a contribution to your retirement plan—such as a 401(k) or 403(b)—on your behalf. You’ll typically need to make contributions to claim the money. Because employer matches are essentially free money, they can be a great way of boosting your retirement savings.

Vesting

While you fully own any contributions that you make to your retirement account, you technically won’t own any employer contributions (including profit sharing, matches, or stock options) until you have vested into this account. This simply means that you’ve been an employee for a certain period that makes you entitled to the contributions. Vesting typically happens in steps.

Catch-up contributions

Catch-up contributions are additional money beyond the normal contribution limit that you’re allowed to make to an investment account once you’ve reached a certain age. Most retirement accounts offer catch-up contributions from age 50. Some allow an even higher amount for ages 60–63, known as super catch-up contributions.

Rollovers

A rollover is when you move money from one retirement account to another. This often happens when you change jobs. For example, you might roll money from an old 401(k) into a new 401(k) or into an IRA. You can also move money between IRAs. If you move money from a traditional retirement account into a Roth IRA, it’s called a Roth conversion, and you usually have to pay taxes on the amount you convert.

Required minimum distribution (RMD)

A required minimum distribution (RMD) is the minimum amount of money that you are legally mandated to withdraw each year from a retirement account. For most people, the current required beginning date for RMDs is age 73. On January 1, 2033, this age will rise to 75. Failure to take your RMD can mean fees of up to 25 percent.

Social Security

Social Security is a monthly benefit designed to provide those who are retired or disabled with a guaranteed source of income. Payments are dependent on several factors, including how much you contributed to Social Security during your working career and your age when you begin taking payments. Delaying payments can significantly increase your monthly amount.

Full retirement age

Full retirement age is the age at which you become entitled to 100 percent of your monthly Social Security benefit. For anyone born before 1960, the full retirement age is 66; for those born in or after 1960, it’s 67.

Annuities

An annuity allows you to set aside money in exchange for guaranteed income during retirement. They’re sold by insurance companies. Accumulation annuities are designed to help you save for retirement, either via recurring or lump-sum contributions. You’re allowed to access the money after certain time or age milestones. Income annuities, on the other hand, provide near-instant income and are typically purchased when someone is in or near retirement.

Life insurance can be a powerful tool for protecting your wealth and your family in the event of your passing. These terms will help you discuss life insurance and better understand your options.

Permanent life

A permanent life insurance policy is designed to pay out a death benefit regardless of how long you live. So long as you stay up to date on your premiums, your beneficiaries will get the payout. Your policy will also accrue cash value over time as you pay your premiums. Whole life, universal life, and variable universal life are all types of permanent life policies.

Term life

Term life insurance only lasts for a certain number of years (the term). If you live beyond this term, your policy expires, and your beneficiaries are no longer entitled to a death benefit when you die. Term life policies do not accrue cash value.

Term conversion

Term conversion is the process of converting a term life policy into whole or permanent life insurance. (Not all term policies can be converted.) If you might convert your term policy one day, look for a policy that is specifically described as “convertible.”

Death benefit

The death benefit is the money that your beneficiaries will receive from an insurance policy when you die. It can typically be paid out as a lump sum upon your death, or it can be used to generate income for several years.

Premiums

Your premiums are the payments that you make to pay for your life insurance policy. These may be paid monthly, quarterly, or annually. It’s important to pay your premiums on time, or your coverage may be canceled.

Riders

Riders are additional features or coverage options that you can purchase on top of your base insurance policy. Examples of riders include a waiver of premium benefit, additional purchase benefit, accidental death benefit, and accelerated death benefit. Riders add to your premium cost but may make sense depending on your financial situation.

Cash value

A permanent life insurance policy is designed to build cash value over time. With whole life insurance, cash value is guaranteed to grow in a tax-deferred way and is unaffected by market volatility. Other policies—like universal life insurance—offer flexibility regarding premium payments and death benefit, which can affect how cash value grows. Variable universal life offers the ability to get exposure to financial markets, but it also comes with investment risk. You can access the money during your life for any reason. It’s important to note that when you borrow against your cash value with a policy loan, you’ll need to repay the loan—or else your death benefit will be reduced.

These terms and definitions will help you better understand your tax situation.

Filing status

The IRS uses your filing status to determine how to tax your income each year. The five filing statuses are single, head of household, married filing jointly, married filing separately, and qualifying widow(er) with dependent child. Choosing the wrong status could mean you’re missing out on valuable tax breaks, so it’s important to make sure you’re choosing the right one.

Tax brackets

A tax bracket is a range of income that is taxed at a certain level. The U.S. has a progressive tax system, which means that the more you earn, the more your income will be taxed as it moves up in brackets. These ranges vary by filing status, for example, whether you’re married filing jointly vs. married filing separately.

Taxable income

Taxable income is the money you earn during the year that’s subject to income tax. It typically includes wages and salary (including any bonus), income from self-employment or freelance work, and investment income such as dividends and capital gains. Other sources—like rental income, royalties, and even unemployment benefits—may also count as taxable income.

Adjusted gross income (AGI)

Your adjusted gross income (AGI) is your taxable income for the year with certain IRS-approved deductions subtracted from it. The IRS uses your AGI to determine if you’re eligible for credits and deductions, like the child tax credit. Your modified adjusted gross income (MAGI) is your AGI with certain deductions added back in, and it’s used to determine eligibility for other deductions, such as contributing to a Roth IRA.

Standard deduction

The standard deduction is an amount that every taxpayer can claim to reduce their taxable income for the year without needing to itemize their deductions. It’s inflation adjusted, meaning it increases each year with inflation. Your filing status, age, number of dependents, and other factors can all influence the amount. The amount is set each year by the IRS.

Itemized deductions

Itemized deductions are individual qualified expenses—like mortgage interest, charitable donations, state/local taxes, and certain medical expenses—that can reduce your taxable income for the year. To claim itemized deductions, you must keep records, such as receipts or statements, to document each expense. Typically, you should itemize your deductions only if doing so will provide a larger deduction than the standard deduction. Bunching your itemized deductions can help you maximize this benefit.

Dependents

In the eyes of the IRS, a dependent is a person who relies on you for financial support and meets specific requirements that may be related to age, residency, income, and ability. Children are the most common dependents, but other relatives can sometimes qualify. Dependents lower your tax burden for the year.

Withholding

Tax withholdings are any funds that are automatically deducted from your paycheck and sent to the IRS. They act as a prepayment on your taxes. If you withhold too much, you will receive a refund when you file your taxes. (Big refunds aren’t necessarily a good thing!) If you withhold too little, you’ll owe the IRS the difference.

Tax credits

A tax credit is a dollar-for-dollar reduction on your income tax bill. This makes them powerful tools for lowering your taxes. For example, if you owe the IRS $2,000, and you receive a tax credit worth $1,000, then your tax bill will be reduced to $1,000. A popular example is the child tax credit.

Tax deductions

Tax deductions work differently from tax credits. Instead of reducing your tax bill directly, they reduce your taxable income. If you’re in the 24 percent tax bracket and receive a $1,000 tax deduction, for example, it’ll mean roughly $240 in tax savings.

Audit

A tax audit occurs when the IRS examines your tax return and broader financial records. The goal of the audit is to determine whether your tax return is accurate or includes an error. Audits can result in refunds if it’s found that you’ve overpaid on your taxes. If you’ve underpaid, it means you’ll have to pay any back taxes, along with penalties, and interest.

Extension

If you are unable to file your tax return on time, you can apply for an extension, which will give you an additional six months to file. Note that that this extension doesn’t apply to any payments you may owe the IRS. Those payments are still due by April 15.

Buying a home can involve a number of terms that don’t carry over to everyday life. Learning these definitions can help make the process easier.

Pre-approval

Pre-approval is an important part of applying for a mortgage in which a lender evaluates your credit and decides how much money they would be willing to lend you. This gives you a “budget” to keep in mind while buying a home. Being pre-approved can also help sellers take your offer more seriously than if you aren’t pre-approved.

Appraisal

An appraisal is an unbiased, third-party determination of how much money a home is worth on the current housing market. Appraisals help ensure that you do not overpay when buying a home. Lenders also require appraisals to determine how much they are willing to lend for a given home.

Earnest money

Earnest money is a deposit toward the purchase of a home to show the seller that you’re serious. It’s typically between 1 and 3 percent of the home’s sale price. If the deal closes, then this money goes toward the purchase. If you back out of the deal, then the seller can sometimes keep your earnest money.

Down payment

A down payment is the amount of money you personally pay upfront when purchasing a house. The traditional down payment is 20 percent, which gives you some equity in your home right away. (It can also help you avoid added costs, like private mortgage insurance.) But you may be able to make a smaller down payment.

Mortgage points

Mortgage points, or discount points, are a way of reducing the interest rate on your mortgage. Essentially, you are paying your lender a set amount of money to reduce your loan’s mortgage rate. Most lenders require you to pay 1 percent of the loan amount per point, which will usually reduce the rate by 0.25 percent, though this can vary.

Contingencies

Contingencies are specific conditions that need to be met for a home sale to be finalized. They’re a way for a buyer to make an offer on a home and a seller to accept the offer, even before certain processes—like a home inspection or financing—are complete. If the contingencies aren’t met, then either the buyer or seller can back out of the sale without repercussions.

Closing costs

Closing costs are fees paid to various people or organizations involved in facilitating your home purchase, such as your mortgage lender, underwriters, title companies, public notaries, and real estate agents, or attorneys. These fees are not included in the home’s purchase price but can often be rolled into your mortgage. As a general rule, you should budget about 2 to 5 percent of a home’s purchase price for closing costs.

Escrow

Escrow is a legal agreement where a third party holds assets or funds until a payment needs to be dispersed. When your mortgage is held in escrow, it means that you’ll make a monthly payment to your mortgage servicer. This payment includes your mortgage payment as well as any homeowners insurance costs and property taxes. When your insurance and tax payments are due, your servicer will make those payments on your behalf. Because you’re breaking those bills into smaller payments, they’re often much easier to account for in your budget.

Private mortgage insurance (PMI)

Private mortgage insurance (PMI) is a type of insurance coverage that specifically protects a lender from the risk of a homeowner defaulting on their mortgage payments. Mortgage lenders usually require a homebuyer to purchase PMI when they have less than 20 percent equity in their home (like when they buy a home with a lower down payment). Once the homeowner reaches 20 percent equity in their home, they can often stop paying for PMI.

Mortgage protection life insurance

Mortgage protection life insurance, or mortgage life insurance, is a form of life insurance that’s designed to pay off your mortgage when you die. Your lender is the beneficiary of the policy, and the death benefit will decrease over time as you pay down your mortgage.

Fixed-rate mortgage

A fixed-rate mortgage is one that has an interest rate that remains the same over the life of the loan—typically 15 or 30 years. Because it doesn’t change, monthly payments are consistent and can be more easily budgeted for, making them an ideal choice for many families.

Adjustable-rate mortgage (ARM)

An adjustable-rate mortgage (ARM) carries an interest rate that will change over the life of the loan. ARMs typically offer a lower introductory interest for a set time. Then the interest rate will change on a set schedule depending on the underlying lending market. This can make it difficult to plan for future payments.

Amortization

Amortization is paying off your mortgage over time through consistent, routine payments. At the beginning of the process, most of your monthly payments will go toward paying interest costs—with just a small amount paying down the principal. But as you continue making payments, a greater percentage will cover the principal.

These terms will help you better understand everything that goes into planning your estate and legacy.

Will

A will is simply a legal document that details how you want your money, property, and other assets distributed after your death. It includes a list of your assets and their beneficiaries. Your will can also include information about your final wishes or who you want to act as your power of attorney in the event you can’t make financial or medical decisions for yourself.

Beneficiary

A beneficiary is a person (or entity) you designate to receive an asset after your death. You can name beneficiaries in your will, in a trust, on your life insurance policy, and on many financial accounts, such as retirement plans and bank accounts. Keep your designations up to date, and be sure to change them on each policy, account, and legal document if you have children, get married or divorced, or hit another milestone.

Executor

The executor of your estate ensures that your will is carried out. This can include paying final bills and expenses, reporting your death to creditors, contacting government agencies like the Social Security Administration, distributing assets to heirs, and more.

Probate

Probate is the legal process that settles a person’s estate after their death. The probate court ensures that creditors are paid and any remaining assets are distributed to your heirs—either according to the terms of your will or according to your state’s laws. To avoid probate, consider naming beneficiaries, using joint ownership, and establishing a living trust.

Intestate

When a person dies intestate, it means that they have died without a will. When this happens, the probate court will need to distribute assets to heirs according to the state’s intestate laws.

Power of attorney

A power of attorney grants somebody else the authority to act on your behalf. A financial power of attorney allows someone else to make financial decisions for you. A medical power of attorney allows them to make medical decisions. (These can be the same or different people.) Appointing power of attorney is an important part of estate and end-of-life planning.

A trust can help ensure that your assets are managed how you want them managed—even after your death. A revocable trust can be changed at any time you wish. An irrevocable trust, such as an irrevocable life insurance trust, cannot be changed once established (except for very rare and specific circumstances). Certain types of trusts can protect assets from specific taxes and lawsuits and can help you leave a legacy after your death.

Grantor

A grantor is a person who establishes a trust. They will also typically be the person that funds the trust, at least initially. They are sometimes called the trustor.

Trustee

The trustee is the person or institution that manages the trust and ensures that the rules of the trust are followed. A reliable trustee also helps minimize family conflict and manages complex tax or legal requirements.

Estate tax

An estate tax is a tax paid by an estate when assets are transferred to heirs after someone’s death. This reduces the amount of money that is ultimately inherited by heirs. The federal estate tax and most state estate taxes are applied only to large estates—and there are several other exemptions. At the federal level the exclusion amount for 2026 is $15 million per individual (or $30 million for married couples with proper planning), meaning most will not be subject to estate tax.

Inheritance tax

An inheritance tax is a tax paid by an heir after they have received an inheritance. While there is no federal inheritance tax, several states do levy such a tax. Whether or not you are subject to the tax will depend on where you live and how much you inherit.