Basic Financial Terms

Principal

The amount borrowed, or the part of the amount borrowed
which remains unpaid (excluding interest)

Interest

The fee charged by a lender to a borrower for the use of borrowed money, usually expressed as an annual percentage of the principal; the rate is dependent upon the time value of money, the credit risk of the borrower, and the inflation rate. Here, interest per year divided by principal amount, expressed as a percentage

The return earned on an investment – that’s the money that you’re paid when someone borrows your money. Now, you might wonder – my money is in a savings account – they’re not borrowing it…

Compound Interest

Interest which is calculated not only on the initial principal but also the accumulated interest of prior periods.

Assets

Any item of economic value owned by an individual or corporation, especially that which could be converted to cash. Examples are cash, securities, accounts receivable, inventory, office equipment, a house, a car, and other property.

Liabilities

A financial obligation, debt, claim, or potential loss.

Net Worth

The difference between your assets and liabilities

Stock

Ownership of a corporation indicated by shares, which represent a piece of the corporation's assets and earnings.

Bond

Bonds are debt and are issued for a period of more than one year. The US government, local governments, water districts, companies and many other types of institutions sell bonds. When an investor buys bonds, he or she is lending money. The seller of the bond agrees to repay the principal amount of the loan at a specified time. Interest-bearing bonds pay interest periodically.

Mutual Fund

Mutual funds are pools of money that are managed by an investment company. They offer investors a variety of goals, depending on the fund and its investment charter. Some funds, for example, seek to generate income on a regular basis. Others seek to preserve an investor's money. Still others seek to invest in companies that are growing at a rapid pace. Funds can impose a sales charge, or load, on investors when they buy or sell shares. Many funds these days are no load and impose no sales charge. Mutual funds are investment companies regulated by the Investment Company Act of 1940. Related: open-end fund, closed-end fund.

CD

Also called a certificate of deposit, a CD is a certificate issued by a bank or thrift that indicates a specified sum of money has been deposited. A CD has a maturity date and a specified interest rate, and can be issued in any denomination. The duration can be up to five years.

401K

Under section 401(K) of the Internal Revenue Code, a deferred compensation plan set up by an employer so that employees can set aside money for retirement on a pre-tax basis. Employers may match a percentage of the amount that employees contribute to the plan. Contributions by both employees and employers as well as investment earnings and interest, are not taxed until the employee withdraws the money; if the employee withdraws the money before retirement age, he or she pays an early withdrawal penalty tax. Currently, employees are allowed to annually contribute up to 15 percent of their salary but no more than $11,000 ($12,000 for people 50 or older). Many employers now offer these deferred compensation plans in lieu of or in addition to pensions.

529

These state college savings plans, named after the section of the tax code that governs them, are the more attractive siblings of prepaid tuition programs.

A state's prepaid plan allows you to pay now -- at today's tuition rates -- for school tomorrow. But 529s, now offered in most states, are far more flexible.

The money may be used at any school you choose and for all qualified higher education expenses, including room and board (not so with a pre-paid plan).

Most 529 savings plans offer a menu of age-based portfolios, and some also offer a small selection of stock and bond funds. In the former case, your annual contributions get invested in a pre-selected portfolio of stocks and bonds. Early on, the portfolio is tilted toward stocks, and as the time for college nears, the weighting shifts more heavily toward bonds. States contract out to investments companies, such as TIAA-CREF and Fidelity, to manage the portfolios.

You never have to worry about annual taxes on dividends and gains, and withdrawals are tax-free too (at least until 2010, when Congress has the option of extending the break). What's more, if you invest with your own state's 529, you may get state-tax deductions on contributions or exemptions on withdrawals (you may, however, choose to forego the state tax break if another state has a better 529).
Contribution limits are generous
§ Investment minimums are low (plans may let you sock away as little as $25 a month), and there is no restriction on how much you may contribute every year unless the account is nearing the lifetime cap.

Each state determines its own lifetime contribution limit, ranging between $100,000 and $270,000.

Just because you can contribute as much as you want, however, doesn't mean you should -- annual contributions of more than $11,000 ($22,000 if contributing with a spouse) are subject to the gift tax.

One caveat to the gift-tax limit: You may contribute as much as $55,000 tax-free in one year ($110,000 with your spouse), but that contribution will be treated as if it were being made in $11,000 installments over the next five years. In other words, you can't make such a large contribution every year without tax consequences.

Yield

The percentage rate of return paid on a stock in the form of dividends, or the effective rate of interest paid on a bond or note.

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