As someone on the journey to financial freedom, you are likely to encounter words you do not understand. Checking a dictionary or using a random google search may not give you an in-depth understanding of these words.

Once you get familiar with these terms, investing would be much easier with less intimidation.

I will be explaining these investment terms to you so that you will never forget, and the next time somebody mentions them to you, you will understand what they are talking about, and you can contribute to that conversation.

 

1. Interest Rate

The interest rate can be in two ways; the cost of the money you have borrowed or the benefit of the one you have deposited. When you borrow money, there is a certain cost or charge for borrowing that money, and that charge is called an interest rate.

The value of the interest rate on the money you have borrowed depends on how much you borrow, how long you borrow it, and the frequency of the compounding, that is how frequently your lender wants to compound your charges.

On the other hand, if it is interest on deposit, the interest rate would be your benefit for depositing that money, that is how much the bank or whoever you have deposited the money with wants to pay you for holding on to your money.

 

2. Credit Rating

Credit rating is an evaluation of your credit risk, of what kind of debtor or borrower you will be. Your credit rating tells your lender whether you will be a good debtor who will pay back on time or whether you will be a bad debtor.

It measures your risk showing the likelihood of you defaulting on a loan or a credit card. It does not tell your lender how much you have or earn; it only reveals your risk level.

If you plan to apply for credit, the kind of credit you would get is often influenced by your credit rating because it sends a message to your lender telling them what kind of risk you are as a borrower.

 

3. Overdraft

An overdraft is what you get when your bank allows you to spend beyond what you have; that extra spending allowance you have on your account is beyond zero. It is you borrowing from your bank on your account.

When your account gets to zero, your bank allows you to go into negatives (like -£100) which they usually charge. Many banks will give you a free overdraft value of about £50, £100, and if you go beyond that, they charge you to use the extra.

The overdraft assumes that money would flow back into your account and replace whatever you have spent in terms so overdraft.

In the UK, banks charge heavily for overdrafts; they charge daily.

I discourage people from using overdrafts because you will eventually spend more. If you have spent an overdraft of £2000, your monthly charge can go up as much as £100 in many banks.

 

4. Bear Market

You may have heard that a market is bearish before and walk away because you do not understand it. Or perhaps you keep mixing up the bearish and bullish market.

A bearish market means that the value of investments in stocks, shares, and other instruments on the market has dropped considerably as much as 20% from what they regularly are.

A bear market is usually due to economic factors or investors losing faith in some instruments due to certain occurrences in the marketplace. It means the value of things has dropped.

A bearish market is a good time to invest in the marketplace. I am not one to advise you to game the market and wait for it to be bearish before investing, but it is advisable to invest regularly in the stock market.

However, when the market is in a bear market state, it is a great time to invest because what you are doing is that you are buying the dip.

Think of a soft cuddly teddy bear as synonymous with a bearish market; soft, weak, and harmless.

 

5. Bull Market

Think of a bull- aggressive, strong, pushy, and powerful; something you want to hold on to but not necessarily go into. It is a strong market where investments are at a high because the economy is doing well.

In a bull market, investors are confident about the instrument in the market. ETFs, bonds, stocks, and shares are all doing well with about 20% above the norm. It is a great time to sell, not a great time to buy.

It is also a great time to hold on to instruments you already have.

 

6. Compound Interest

Compound interest is the magic investing word that has the power to make you a millionaire; it simply means when the interest on your deposit yields interest.

If you invest money in a particular instrument and it is doing well, you get interest on that deposit which is the benefit of putting your funds.

When that interest yields another interest, that is compound interest.

For instance, if you put £200 into an investment and the £200 yields £20pounds which is 10%, your money becomes £220. Then your £220 also yields a 10% interest making it £242, and it keeps growing with compound interest.

When you take on bad debt like a high-interest debit card and the principle on the card has an interest, and you do not pay it back on time, it will also keep yielding interest for your lender. In this case, your lender is the one benefiting from compound interest.

 

7. Opportunity Cost

Opportunity cost is simply what you give up in exchange for something else. Every time you make a financial choice above the other, that is an opportunity cost.

If you order pizza, that is £20 that you could have put into an investment. That investment that you left and chose pizza for is an opportunity cost. If you buy a pair of shoes instead of a bag, the opportunity cost of the shoe is the bag that you gave up.

If you decide to go on a ship cruise instead of buying shares of the cruise company, you have given up an opportunity to own an investment in the cruise ship.

 

8. Mortgage

A mortgage is a loan given to enable you to purchase a residential or commercial property. With your mortgage, you can pay for the property over time.

You pay an agreed sum back to your mortgage lender every month to pay off that mortgage; it is usually spread over 10 to 30 years depending on your age.

 

9. Collateral

Collateral is an asset that you place as surety for a loan you have taken or a credit that you obtained. Collateral is what you give to get a loan.

When you do a mortgage, you take out a loan to enable you to buy a property; the property is collateral for that loan. So if you do not pay your mortgage, you lose that property.

Not all credits require collateral. A credit card also has no collateral. If you borrow £5000 from your bank to buy a car or renovate a house, it will not come with collateral. You will get the loan based on your credit rating and your relationship with the bank.

If you want to start a business and take a big loan from the bank, you would decide what asset you have to put down as collateral. If you get the loan and fail to pay it back, you may lose whatever you put down as collateral.

 

10. Investment Portfolio

An investment portfolio is a basket of the variety of investments you have. Think of a fruit basket with different fruits.

 

11. Loan to Value

When you get a loan like a mortgage, you will be required to contribute to the purchase of that property. This means that you must have a deposit before buying a property.

Your loan to value is the ratio of the loan to the value of the property, that is, how much of the value of the property you will get as a loan.

If your property is worth £300,000 and you get a loan of £270,000, it means you have gotten a 90% loan to value, which means your loan is 90% of the property value, and you are putting down 10%.

 

12. Capital Gains

Capital gains are the benefits of the gains made on an asset or an investment. If you buy a property at £200,00 and you can sell it for about £500,000 because you have held on to it for a long time; the £300,000 you made on that sale is the capital gains of that property.

The profit you have made on that asset or investment is usually taxed. You are required to give back something to the government out of the profit you have made.

Every year you get a capital gains allowance which means that if you sell your asset and make less than that amount, you will not need to pay tax. Once it exceeds the allowance, you will pay tax on your capital gains.

I hope you find this breakdown helpful as you make your investments in the future.

Till next time.

Love

Ronke O.