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(More) language of the wealthy
If you want to become a savvy investor who knows the rules of the game, first you have to be able to read the instructions! Trying to become financially free when you don’t know the language is a bit like trying to assemble Ikea furniture. There is a chance you might get lucky, or, more likely, you might end up with suspicious ‘extra’ pieces and a chair that sitting on is like a game of Russian roulette.
This is why we’re breaking down some of the financial terms you will frequently come across as you learn to master the game of money. If you missed part one of the series, learn the basics here.
A United States government corporation that operates as a independent agency. Essentially, it works like an insurance company for banks. It ensures that the financial institutions are sound and then charges them a premium for deposit insurance coverage. As of August 2014, it provides deposit insurance up to $250,000 for each ownership category, guaranteeing the safety of a depositor’s account in member banks. (Does not receive funding from Congress.)
Aka “The Federal Reserve” or “The Fed.” The Fed has been the central banking system of the United States since 1913 and is considered to be an independent central bank because its monetary policy decisions do not have to be approved by the executive or legislative branches of government, and it does not receive funding from Congress. The Fed attempts to maintain a secure economy through maximum employment, stable prices and moderate long-term interest rates. As of 2009, the Fed is also responsible for the supervision and regulation of banks.
These are your basic Settlers of Catan goods – traditionally, grains, gold, oil, cattle and natural gas, although in recent years the definition has expanded to include bandwidth and foreign currencies. The idea is that this basic good meets minimum standards and therefore is interchangeable with other commodities of the same type, no matter its origin.
A financial instrument, such as a stock, bond or option that represents some type of financial value and is tradable. Typically divided into debt securities (such as bonds and CDs) and equities (stocks) and derivatives (futures, options, etc.). Debt securities return interest and the repayment of the principal, while equities holders can profit from capital gains. Therefore, based upon the varying nature of securities, they may belong in either the Risk/Growth bucket or your Security bucket.
A contract in which a seller (called an option writer) agrees to sell an asset to a buyer (called an option holder) at a pre-determined price at a specific date. (It’s like pre-ordering a book on Amazon.) The primary difference between an option and a future is that an option gives the holder the right, but not the obligation to buy or sell the asset.
Aka “a futures contract.” A contract in which the buyer (or seller) agrees to an obligation of buying an asset for a price determined today, with payment and delivery occurring at a future point. These contracts are determined at a futures exchange, which acts a marketplace (like Amazon in the example above). Sellers are called the short-position holder and the buyer is called a long-position holder. Futures originally were drawn up for agricultural commodities and natural resources but now include financial instruments such as currencies and interest rates.
An economy that has some of the features of a developed market, such as a physical financial infrastructure, stock exchanges and unified currency, but without level of market efficiency and strict standards and regulations of developed nations. Current examples include: Russia, India, Brazil and Turkey. Because of their ability to produce high returns coupled with their volatility, emerging markets belong in your Risk/Growth bucket.
Usually smaller and less accessible than emerging markets, frontier markets are countries with investible stock markets that are less advanced than the capital markets of developed nations. Frontier markets often have low correlation to developed markets and can therefore provide diversified risk within a portfolio; however, the greater risk due to the volatile nature of these markets means this investment would be a Risk/Growth venture.
An “individual retirement account.” An investment tool provided by many different financial institutions that allows individuals in the United States tax advantages for designating funds specifically for retirement. Different types of IRAs include: Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs. Roth IRAs are not tax-deductible; however, you pay no tax when you withdraw the funds in retirement. Traditional IRAs are tax-deductible, but eventual withdrawal is taxed as income.
Also called a “money market mutual fund.” Regulated in the United States under the Investment Company Act of 1940, a money market fund is made up of short-term (less than one year) high quality securities such as US Treasury bills. Unlike stocks, which vary in price per share, money market fund share always equal $1. The objective of the fund is to provide the investor with a higher rate of interest (called a yield). Generally low risk and highly liquid, however they are not covered by federal deposit insurance and like all mutual funds you are relying on a manager to turn a profit.
A profit made when you sell an asset for more than you paid. For example, if you buy a house for $100,000 and sell it for $150,000, you have made $50,000 in capital gains. Physical property is not the only asset that can accrue capital gains, though. Financial assets, such as stocks and bonds, and intangible assets also draw this investment income. Short-term capital gains (profit made on the sale of an asset held for one year or less) are must be claimed on income taxes, but long-term capital gains (assets held over one year) are taxed at a lower rate.
Aka “income” and “profit.” Different than capital gains, earnings are the profits made by a company in a specific period (usually three calendar months, otherwise known as a quarter). Earnings are the main basis of a company’s share (stock) price and generally display a company’s profitability.
Generally referring to a positive imbalance between the potential reward and potential loss of an investment; however, it can also be negative. This is a fancy way to say that the reward is drastically disproportionate to the risk.
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