DO YOU know the difference between an index fund and an Isa, or understand why you should care about interest rates?
Financial jargon can catch out even the savviest savers and leave you missing out on the best returns on your nest eggs or investments.
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Although many Brits are keen to grow their personal wealth, nearly half are put off by complex and hard to understand terminology, according to digital bank Zopa.
So prepare to get schooled as we explain the most misunderstood terms that could be holding you back from building your wealth.
Index funds
Index funds are designed to track and mimic the performance of stock markets around the world, such as the UK FTSE 100 or US S&P 500.
Instead of relying on a fund manager to choose the stocks, index funds automatically hold a sample of all the companies in the chosen index.
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By doing this your money is spread across lots of different companies and sectors, which can help to reduce the risks that a single company, or sector’s failure could wipe out all your investments.
What it means for your money: Index funds can be a great way to start investing, so it’s important to understand how they work.
Asset allocation
Asset allocation is how investors divide their portfolios across different assets, such as stocks, bonds, cash and cash equivalents.
How you allocate your assets will in-part dictate the returns you are able to get.
When allocating assets, investors usually aim to balance the risks and rewards of certain assets with their goals, how much risk they want to take on and length of time they plan to invest.
There’s no formula for how to allocate your assets and every person will do it differently depending on their circumstances.
What it means for your money: Knowing how to allocate your assets can help you to maximise your returns and build your wealth, or keep your money stable ahead of a big purchase such as a house deposit.
Diversification
Diversification is a strategy that combines a range of investments in a portfolio to try and reduce the overall risk of investing.
It is most often done by investing in different assets such as stocks, bonds, property or cryptocurrency.
Another approach is to invest in different countries, industries, size of companies or for different periods of time.
What it means for your money: Spreading your investments can help to reduce the risk that you lose money during periods of market turbulence.
Equities
Equities are another name for shares that are issued by a company and represent owning part of the company.
The more equities you have, the larger the proportion of a company you own.
When you buy equities you become a shareholder, which means you also gain the rights to a proportion of a company’s assets and profits, often paid out as dividends.
You may also get a say on some company decisions that are put to shareholders.
What it means for your money: Equities are a common way to invest and can give you an annual return, known as a dividend.
Volatility
Volatility represents how much a stock or other asset’s prices move up and down over a specific period of time.
In most cases if an asset is more volatile then it is often considered riskier as it is seen as being less predictable.
What it means for your money: Understanding how volatile an investment is can reduce the chance you lose money.
Interest rate
When you borrow money the interest rate is the amount you get charged to do so.
It is usually a percentage of the total amount you borrow.
The higher the percentage, the more you have to pay back.
Meanwhile, if you’re a saver then the interest rate tells you how much money you will get as a return on your nest egg.
The higher the savings rate the more money you’ll get.
What it means for your money: Interest rates can have a big impact on the cost to borrow and save money so it’s important to keep an eye on them.
Compound interest
Compound interest is when you earn interest on the money you have saved and also the interest you earn along the way.
So your savings grow faster as you’re earning money on more than the cash you put in.
Compound interest acts like a snowball effect, helping you to grow your savings at a much faster rate.
The earlier you start saving the more time you have to earn compound interest.
What it means for your money: Knowing how compound interest works can help you to increase your returns without lifting a finger.
Capital gains
A capital gain is a profit you make when you sell an asset for a higher price than what you originally paid for it.
When you make a capital gain you have to pay capital gains tax.
For example, if you bought a painting for £5,000 and sold it later for £25,000 then you would have made a gain of £20,000.
You would then need to pay tax on the £20,000.
How much capital gains tax you pay depends on your rate of income tax and what type of asset you are selling.
What it means for your money: Understanding capital gains can help you to avoid a costly tax bill.
Bonds
A bond is a type of fixed investment where individuals lend money to the government or a company for a specified interest rate for a set period of time.
They are often issued by companies to raise cash for projects.
When the term of the bond ends the holder receives the amount they originally paid for it plus any interest owed.
Interest is also paid to the bondholder throughout its term.
Bonds are considered a safe investment as they can give a reliable income.
What it means for your money: Bonds are often a reliable investment as governments are unlikely to default, which could make them a good investment.
Risk tolerance
Your risk tolerance is how willing and able you are to tolerate fluctuations in price and potential losses in the value of your investments.
Often the greater the risk you are prepared to take the higher the returns you could get in the long run.
But if your investments don’t perform then the more money you could stand to lose.
As you age your investment goals and income can also affect your tolerance to risk.
What it means for your money: Understanding how much of a risk an investment is can help you to choose the right investments to meet your money goals.
Isa allowance
An Isa allowance is the amount of money you can pay into an Isa account each financial year without paying tax.
You can save up to £20,000 in a Cash Isa or Stocks and Shares Isa or split the allowance across multiple accounts.
You can only pay £4,000 a year into a Lifetime Isa, which is designed to help you save to buy a house or retirement if you are aged 18-39.
However, the government will add a 25% bonus to your savings in a lifetime Isa, up to a maximum of £1,000 per year, although you can only withdraw the money under certain conditions.
What it means for your money: Isas are a key way to save for the future, allowing you to stash cash or invest without facing a tax bill.
Cash Isa
A Cash Isa is a tax-free savings account that allows you to earn interest on your savings without paying income tax.
Your money is held in cash, instead of investing in the stock market.
This is often seen as a safer option as the value of your money can rise but not fall.
But the returns from a Cash Isa are often smaller than if you invested in the stock market.
From April next year under-65 year olds will only be able to save £12,000 of their total Isa allowance as cash, the rest must be invested in stocks and shares to get the tax benefit.
What it means for your money: Cash Isas can be a good option if you want to save money for the short term, such as for a new car or holiday.
Easy Access Isa
There are two types of Cash Isa – an easy access account and a fixed-rate account.
An easy access account lets you withdraw your money at any time, while a fixed-rate account locks it away for a set period, such as a year or two.
Usually there is a penalty to access your cash before this point.
What it means for your money: Easy Access Isas give you instant access to your money while avoiding paying tax.
Stocks and Shares Isa
A Stocks and Shares Isa lets you invest up to £20,000 every tax year in the stock market without paying income or Capital Gains Tax on the returns you make.
It can be a good way to build up your long term wealth, so it is best to open one of these accounts if you are able to put money aside for five years or more.
What it means for your money: Stocks and Shares Isas invest your money in the stock market, helping it to grow in the long term.
Personal Savings Allowance
The Personal Savings Allowance is the amount of interest you can earn on your savings without paying tax.
It only applies to savings accounts so it will not affect your Isa.
The exact amount depends on your income tax band.
Basic rate taxpayers can earn £1,000 in interest before they need to pay tax.
Meanwhile, higher-rate taxpayers can earn just £500 and additional-rate taxpayers have no allowance.
What it means for your money: Understanding your personal savings allowance can help you to avoid a costly tax bill.
