Personal Finance Terms You Should Know
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A
Accelerated depreciation. For most business property, except real estate, the law allows you to depreciate the cost at a rate faster than would be allowed under straight-line depreciation.
Example, automobiles and computers are assumed to have a five-year life for tax purposes. With straight-line depreciation you would be permitted to write off 20% of the cost each year. The accelerated method generally lets you deduct
- 20% of the business cost the first year
- 32% the second
- 19.2% the third
- 11.52% in years four and five
- 5.8% in the sixth year
It takes six years to fully depreciate the property, thanks to the "midyear convention," which, for simplicity, basically assumes that business assets are put into service in the middle of the year.
Account executive. The title given by some brokerage firms to their stockbrokers. Other variations on the title include registered representative, financial counselor and financial consultant.
Accounts receivable. Money which is owed to a company by a customer for products and services purchased on credit. Considered a current asset on the balance sheet.
Accretive. Creating asset growth, as in "accretive to earnings."
Accrued interest. Interest that is due but hasn't yet been paid.
Acquisition indebtedness. This is the technical term that Congress uses for what most of us call home mortgage debt on which the interest is deductible. To qualify, the debt must be used to buy, build or substantially improve your principal residence or a second home and must be secured by the property. The interest on up to $1 million of acquisition indebtedness is deductible.
Active participation. The level of involvement that real estate owners must meet to qualify to deduct up to $25,000 of losses from rental real estate. Failure to pass this test could make such losses nondeductible under passive-loss rules.
Adjustable rate mortgage (ARM). Mortgage agreement between a financial institution and a real estate buyer stipulating predetermined adjustments of the interest rate at specified intervals. ARMs generally start lower than their fixed-rate cousins but their interest rates can rise or fall during the term of the loan.
Adjusted basis. Your basis in property is the stepping-off point for determining taxable gain or loss when you sell it.
The basis generally starts out as what you pay for the property, although special rules apply to assets you inherit or receive as a gift. Your basis can be adjusted while you own property. When you buy rental property, for example, the basis begins at what you pay for the place, including certain buying expenses and it is adjusted upward by the cost of permanent improvements. The basis is reduced by the amount of any depreciation you are allowed to deduct while you own the property. You use your adjusted basis to figure the gain or loss on the sale.
When stock or mutual fund shares are involved, your adjusted basis is the cost of the shares plus any brokerage commissions or load fees minus any return of capital payouts.
Adjusted gross income (AGI). This is your income from all taxable sources minus certain adjustments and is the key to determining your eligibility for certain tax benefits and the phase-out of your eligibility for others.
It's the amount from which deductions (the standard deduction or itemized deductions) and the value of personal and dependent exemptions are deducted to arrive at the amount that will be taxed. The adjustments -- sometimes called above-the-line deductions because you can claim them whether or not you itemize deductions -- include:- Deductible contributions to IRAs (individual retirement accounts), SIMPLE and Keogh plans
- Job-related moving expenses
- Any penalty paid on early withdrawal of savings
- The deduction for 50% of the self-employment tax paid by self-employed taxpayers
- Alimony payments
- Up to $2,500 of interest on higher education loans
Adoption credit. This credit effectively refunds to you the first $10,160 for expenses paid to adopt a qualifying child. The credit is phased out as modified adjusted gross income exceeds $150,000.
An eligible child is generally one under age 18 or one who is physically or mentally incapable of caring for himself or herself. The credit is $10,160 if you adopt a "special needs" child regardless of whether you have qualifying expenses.
To take the credit, complete Form 8839 (PDF), Qualified Adoption Expenses and it to your Form 1040 (PDF) or Form 1040A (PDF). For more on the adoption credit, download Publication 968 (PDF, 55.6KB), Tax Benefits for Adoption .
Advocate. See Taxpayer Advocate.
After-tax provision. An estimate of a current year tax liability, used to compare profitability between companies.
Alimony. Qualifying payments to an ex-spouse that can be deducted as adjustments to income whether or not you itemize. The recipient must include the payments in his or her taxable income.
Alpha. A mathematical measure of price volatility that attempts to isolate the price movements of a stock from those of the market. A stock with a high alpha is expected to perform well regardless of what happens to the market as a whole. (See also beta.)
Alternative minimum tax (AMT). A special tax designed primarily to prevent the wealthy from using so many tax breaks that their regular tax bill is reduced to little or nothing. The AMT ignores certain tax benefits allowed by the regular rules and applies special rates -- 26% and 28% -- to a larger amount of income than is hit by the regular tax.
The instructions for line 43 of the 1040 will help you determine if you are subject to the alternative minimum tax.
You must complete Form 6251 (PDF), Alternative Minimum Tax/Individuals, if you are required to file the AMT.
Amended return. A revised tax return, filed on Form 1040X, to correct an error on a return filed during the previous three years. An amended return can result in owing added tax or deserving a refund, depending on the mistake you are correcting.
American depositary receipt. Certificates traded on U.S. stock exchanges or over the counter, representing ownership of a specific number of shares of a foreign stock.
Annual fee. A yearly bank charge for use of a credit card.
Annualized. A year-long average. Often the return on securities, most typically mutual funds, is reported on an annual basis. Some months, the fund might experience big gains, in others, dismal lows. To make reporting easier, the months are averaged together into the annualized return. Likewise, to compare securities over longer periods of time, annualization can stretch to three, five or ten years.
Annual report. This document contains information about the performance of a company or mutual fund. (See also 10-K.)
For a company, it contains a record of the company's financial condition, including earnings and operating expenses, an overview of the company's accomplishments for the past year and comments from management.
For a fund, it shows the fund's performance, how it invests shareholders' money to achieve those results, what the fund is currently doing and its future plans. It should also include performance charts which calculate returns for hypothetical investments and managers' analysis.
Annual revenue. How much money the company reported taking in, before expenses, during the previous 12 months. The number is expressed in millions of dollars and is updated quarterly.
Annuity. A series of regular payments, usually from an insurance company, guaranteed to continue for a specific time, usually the annuitant's lifetime, in exchange for a single payment or a series of payments to the company.
With a deferred annuity, payments begin sometime in the future. With an immediate annuity, payments begin right away. A fixed annuity pays a fixed income stream for the life of the contract. With a variable annuity, the payments may change according to the relative investment success of the insurance company.
Antidilutive. A convertible security which could increase a corporation's earnings per share if exercised or converted into common stock.
Appraisal. An estimate of market value placed on property.
There are two kinds of appraisal: mass appraisal, in which a community is valued for tax purposes; and fee appraisal, in which one property is appraised, often in comparison with other properties. Each is accomplished under a different set of rules and guidelines.
Arbitrage. An attempt to profit from momentary price differences that can develop when a security or commodity is traded on two different exchanges. To take advantage of such differences, an arbitrageur would buy in the market where the price is lower and simultaneously sell in the market where the price is higher.
Asset. Something you own. An asset can be property, such as your home or a company's warehouse, a diamond ring or a piece of manufacturing machinery; securities; debts owed to you; or cash. Assets minus liabilities equals one's net worth.
Asset allocation. The process of dividing investment funds among the different categories of assets, such as cash equivalents, stocks and bonds.
At-the-market. When you buy or sell a security "at-the-market," the broker will execute your trade at the next available price.
Audit. For taxpayers an audit is a review of your tax return by the IRS, during which you are asked to prove that you have correctly reported your income and deductions.
A corporation, however, will employ auditors to review its bookkeeping and to verify the balance sheet. Auditors can be from outside the company or inside. Outside auditors are typically hired to offer an independent opinion on the company's value, and typically sign off on the annual report.
Average maturity. The average number of years the fund’s income securities will take to mature, weighted by the value of each security. In general, the higher the number, the more susceptible the fund is to interest-rate swings. Longer maturities benefit you when interest rates go down (causing the prices of bonds to rise) and hurt you when rates rise.
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B
Back-end load. A fee charged by mutual funds to investors who sell their shares before owning them for a specified time. (See also front-end load.)
Back office. The support operations of a bank or brokerage firm that don't deal directly with customers. "Back office problems" usually refers to slow paperwork or other bottlenecks in the execution of customers' orders.
Bargain sale to charity. Selling property to a charity for less than the property's actually worth. Depending on the circumstances, this could result in a tax deduction or extra taxable income.
Basic earnings per share. Earnings divided by the number of shares available for sale to the public. See also fully diluted earnings per share.
Basis. See Adjusted basis.
Bearer bond. Also called a coupon bond, it is not registered in anyone's name. Rather, whoever holds the bond (the "bearer") is entitled to collect interest payments merely by cutting off and mailing in the attached coupons at the proper time. Bearer bonds are no longer issued.
Bearish. A bear thinks the market is going to go down. This makes bearish the opposite of bullish.
Below-market-rate loans. If you make an interest-free or bargain-rate loan to a friend or relative, you may be required to include in your taxable income some of the interest the IRS figures you should have charged.
Benchmark. An index or other performance indicator against which a security's performance is measured.
Beta. A measure of price volatility that relates the stock or mutual fund to the market as a whole. A stock or fund with a beta higher than 1 is expected to move up or down more than the market. A beta below 1 indicates a stock or fund that usually jumps up and down less than the market. (See also alpha.)
Bid/Asked. Bid is the price a buyer is willing to pay; asked is the price the seller will take. The difference, known as the spread, is the broker's share of the transaction.
Blind. For tax purposes, you're considered legally blind if:
- You are totally blind.
- You can't see better than 20/200 in your better eye with glasses or contact lenses, or
- Your field of vision is 20 degrees or less.
Blue chips. There is no set definition of a blue chip stock, but most would agree it has at least three characteristics: It is issued by a well-known, respected company, has a good record of earnings and dividend payments, and is widely held by investors.
Board of directors. Elected by shareholders and empowered by the corporation's charter. Typically these duties include, picking top-level executives, deciding broad policies, approving management compensation, determining dividend payments and initiating stock splits or buybacks. The board usually contains top managers, known as inside directors, and members of the community or business world, or outside directors.
Boiler room. A blanket term used to describe the place of origin of high-pressure telephone sales techniques, usually involving cold calls to unsuspecting customers who would be better off without whatever is being offered to them.
Bond. An interest-bearing security that obligates the issuer to pay a specified amount of interest for a specified time, usually several years, and then repay the bondholder the face amount of the bond. Bonds issued by corporations are backed by corporate assets; in case of default, the bondholders have a legal claim on those assets. Bonds issued by government agencies may or may not be collateralized. Interest from corporate bonds is taxable; interest from municipal bonds, which are issued by state and local governments, is free of federal income taxes and, usually, income taxes of the issuing jurisdiction. Interest from Treasury bonds, issued by the federal government, is free of state and local income taxes but subject to federal taxes.
Bond premium. The amount above par value that you pay to buy a bond paying higher than market rates. With taxable bonds, a portion of the premium can be deducted each year that you own the securities.
Bond rating. A judgment about the ability of the bond issuer to fulfill its obligation to pay interest and repay the principal when due. The best-known bond-rating companies are Standard & Poor's and Moody's. Their rating systems, although slightly different, both use a letter-grade system, with triple-A the highest rating and C or D the lowest.
Book value. For investing purposes, this is the net-asset value of a company, determined by subtracting its liabilities from its assets. Dividing the result by the number of shares of common stock issued by the company yields the book value per share, which can be used as a relative gauge of the stock's value.
Brokered CD. A large-denomination certificate of deposit sold by a bank to a brokerage, which slices it up into smaller pieces and sells the pieces to its customers.
Bullish. A bull is someone who thinks the market is going to go up, which makes bullish the opposite of bearish.
Burden of proof. When filing your tax return, you have the responsibility to prove that it is accurate, rather than the IRS having to provide convincing evidence that it is inaccurate. Although Congress, with great fanfare, recently shifted the burden of proof to the IRS in certain tax disputes, don't throw away your records. The change will have no effect on the vast majority of taxpayers. The burden shifts only if a case gets to court -- which happens vary rarely -- and then only if the taxpayer has complied with all record-keeping requirements and has cooperated with IRS requests for information. In almost all cases, then, the burden of proof remains on your shoulders.
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C
Call. See Option.
Callable bond. Bonds that can be redeemed by the issuer before they mature. A company might decide to call its bonds if, for instance, interest rates fell so far that it could issue new bonds at a lower rate and thus save money. Callable bonds often work to an investors' disadvantage because they would be losing a comparatively high yield.
Capital expenditure. The cost of a permanent improvement to property. Such expenses increase the property's adjusted basis.
Capital gain. The profit from the sale of such property as stocks, mutual-fund shares and real estate.
Gains from the sale of assets owned for 12 months or less are "short-term gains" and are taxed in your top tax bracket, just like salary. For most assets owned more than 12 months before selling, profits are considered "long-term gains" and are taxed at a top rate of 15%, unless you are in the 15% bracket, in which case a flat 5% rate applies. In 2008, the 5% rate falls to 0%.
The 15%/5% rate for long-term gains does not, however, apply to all gains from investment real estate.
Also, long term-gains from the sale of collectibles are taxed at 28%.
Capital gain distribution. A mutual fund's distribution to shareholders of the profits derived from the sale of stocks and bonds.
Capital loss. The loss from the sale of assets such as stocks, bonds, mutual funds and real estate. Such losses are used to offset capital gains and then up to $3,000 of excess losses can be deducted against other income, such as your salary. Long- and short-term losses (distinguished by whether the property was held for more than one year or a shorter period of time) are first used to offset gains of a similar nature. Any excess offsets the other kind of gain first, then other types of income.
Capital-loss carryover. Capital losses can be used to offset capital gains, and up to $3,000 of any excess loss can be deducted against other income, such as your salary. Losses not currently deductible because of the $3,000 limit can be carried over to future years.
Capital structure. A corporation's financial framework; the mix of long-term debt, preferred stock and stockholder equity used to fund the company.
Cash flow. On a personal basis, this is how much money is coming into (in the form of wages, dividends, etc.) your home, and how much is going out (via debts and expenses). For a company the concept is the same -- inflow from revenue, outflow through overhead, debt and taxes (cash receipts minus cash payments).
Casualty loss. Damage that results from a sudden or unusual event. After being reduced by $100, such losses are deductible to the extent that they exceed 10% of your adjusted gross income.
For more information on casualty losses, see IRS Publication 574, Casualties, Disasters and Thefts (PDF, 123.7KB). If your loss was from a presidentially declared disaster, you can file an amended return, and take the deduction against the previous year's income. Otherwise, casualty losses are claimed on Form 4684 (PDF).
Charitable contribution. A gift of cash or property to a qualified charity for which a tax deduction is allowed. A receipt is required as proof for any single contribution of $250 or more.
Certificate of deposit (CD). Usually called a CD, a certificate of deposit is a short- to medium-term instrument (one month to five years) that is issued by a bank or savings and loan association. CDs pay more interest than most other bank accounts, however once deposited your money must remain in the CD for the entire term. There is usually a penalty for early withdrawal.
Charting. Another name for technical analysis.
Child credit. This credit is worth $1,000 for each child you claim as a dependent who is younger than 17. The right to this credit is phased out as adjusted gross income rises over $110,000 on a joint return, $75,000 on an individual return or head of household return and $55,000 if you're married filing separately. For each $1,000 (or part thereof) that your AGI exceeds the threshold, you lose $50 of credit.
Child- and dependent-care credit. Not to be confused with the child credit, this one offsets part of the cost of paying for care for a child under the age of 13 or disabled dependent while you work. The yearly limit on the amount of work-related expenses you can use is $3,000 for the care of one individual and $6,000 for two or more.
Child support. Payments made under a divorce or separation agreement for the support of a child. The payments are neither deductible by the person who pays them nor considered taxable income to the person who receives the money.
Churning. Excessive buying and selling in a customer's account undertaken to generate commissions for the broker.
Closed-end investment company. Also called a closed-end fund, it is a pooled investment fund that issues a set number of shares and then no more. When the initial offering of shares is sold out, the closed-end fund trades on the secondary market at a price determined by investor supply and demand. For contrast, see the definition of mutual fund.
Cold calling. The practice of brokers making unsolicited calls to people they don't know in an attempt to drum up business.
Combat pay. Pay received by members of the U.S. Armed Forces and support personnel in combat zones. Military pay received by enlisted personnel serving in combat or designated peace-keeping efforts is tax-free. Officer pay is tax-free up to the maximum pay for enlisted personnel (plus imminent danger/ hostile fire pay).
Commercial paper. Short-term IOUs issued by corporations without collateral. They are bought in large quantities by money-market funds.
Common shares outstanding. The amount of common stock in shareholders' hands. In the event of liquidation, common stock holders have rights to a company's assets only after bondholders, other debt holders and preferred stock holders have been satisfied.
Common stock. A share of ownership in a corporation, which entitles its owner to all the risks and rewards that go with it. In case of bankruptcy, common stockholders' claims on company assets are inferior to those of bondholders. For contrast, see preferred stock.
Comprehensive coverage. Portion of an auto insurance policy that covers most damage to the policyholder’s car that is not caused by a collision. Includes protection from fire, explosions, earthquakes, floods, riots, etc.
Consensus earnings estimates. The majority estimate of company's quarterly or annual earnings by securities analysts.
Typically, high-market-value companies will be followed by a flock of analysts, whose job is to get to know the business, markets and managers of the company and report on its potential for profits or loss. The research company Thomson Financial/First Call collects these quarterly earnings estimates. The earnings figure selected by the majority of analysts becomes First Call's consensus earnings number. Consensus earnings reflect operating earnings, what the company would have earned before extraordinary expenses or credits.
Consolidated financial statement. A financial statement that covers profit and loss information for a holding company and its subsidiaries.
Constructive receipt. A concept of tax law that taxes income at the time you could have received it, even if you don't actually have it. A paycheck you could pick up in December is considered constructively received and taxed in that year, even if don't get and cash the check until the following January. Also, interest paid on a savings account is considered constructively received and taxable in the year it is credited to your account, whether or not you withdraw the money.
Consumer interest. See Personal interest.
Contingent deferred sales charge. Levied by some mutual funds if a customer sells fund shares within a specified number of years. Instead of charging a traditional front-end load of, say, 5%, a brokerage firm may offer the same fund with a contingent deferred sales load. Customers who sell the fund within the first year pay a 5% load. If they sell in the second year, the charge would be 4%, and so on until the sales-charge period ends.
Contrarian. An investor who thinks and acts in opposition to the conventional wisdom. When the majority of investors are bearish, a contrarian is bullish, and vice versa.
Convertible bond. A bond that is exchangeable for a predetermined number of shares of common stock in the same company. The appeal of a convertible is that it gives you a chance to cash in if the stock price of the company soars. Some preferred stock is also convertible to common stock.
Coverdell education savings account. Formerly known as an education IRA. You may contribute up to $2,000 per year if your adjusted gross income is less than $190,000 on a joint return ($95,000 on an individual return). Earnings are tax-free if withdrawls are used for qualified expenses -- elementary and high school as well as college expenses may qualify. Withdrawals for non-education purposes will be taxed at your normal rate and subject to a 10% penalty. Anyone can open an account for your child, but total contributions can't exceed the annual $2,000 limit. The funds also must be used (or transferred to someone else) before the beneficiary turns 30.
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D
Debenture. A corporate IOU that is not backed by the company's assets and is therefore somewhat riskier than a bond.
Debt as a percentage of equity. Long-term debt divided by shareholder equity, or net worth, expressed as a percentage. This statistic is a measure of leverage -- that is, the use of borrowed money to increase the return on shareholder equity. It can also indicate a company's financial stability.
Debt-to-capital ratio. The ratio of a company's liabilities to its total capital. This figure reflects long-term debt-to-capital, which is the ratio of long-term liabilities (those that won't be paid off in one year) to total capital. The higher the level of debt, the more important it is for a company to have positive earnings and steady cash flow.
Deductions. Expenses you are permitted to subtract from your taxable income.
All taxpayers may claim a standard deduction amount -- $9,500 for 2003 joint returns, $4,750 for individual returns. If your qualifying expenses exceed your standard deduction, you may claim the higher amount by itemizing your deductions on Schedule A (PDF) of IRS Form 1040 (PDF). Although no records are needed to back up your right to the standard deduction, you must maintain records of qualifying expenditures if you itemize.
Dependent. Someone you support and for whom you can claim a dependency exemption on your tax return. For each dependent you claim, the exemption knocks $3,000 off your taxable income in 2002. The value increases each year with inflation. Each dependent under age 17 also qualifies his or her parent for a tax credit. Higher-income taxpayers can lose these breaks.
Depreciation. A deduction to reflect the gradual loss of value of business property as it wears out. The law assigns a tax life to various types of property, and your basis in such property is deducted over that period of time.
Direct transfer. A method to move funds from one individual retirement account or Keogh plan to another. You can also use this method to move money from a company retirement plan to an IRA. With a direct transfer, you order one sponsor to transfer the money directly to your new IRA; you do not take possession of the funds. There is no limit on the number of times you can move your money via direct transfer. However, if you take possession of the funds and personally deposit them in the new IRA, the switch is considered a rollover. You can use the rollover method only once each year for each IRA account you own. The direct transfer method must be used to move funds from a company retirement plan to an IRA, or else 20% of the money withdrawn from the company plan will be withheld for the IRS, even if no taxes are due.
Disabled. A person is permanently and totally disabled if both of the following apply:
- He or she cannot engage in any substantial gainful activity because of a physical or mental condition; and
- A physician determines that the condition has lasted or can be expected to last continuously for at least a year or can lead to death.
Discount broker. A cut-rate firm that executes orders but provides little if anything in the way of research or other investment aids.
Discount rate. The interest charged when banks borrow overnight loans directly from the Federal Reserve. This rate is under the control of the Federal Reserve and does not fluctuate with the market. The discount rate provides a base for interest rates.
Discretionary account. A brokerage account in which the customer has given the broker the authority to buy and sell securities at his or her discretion -- that is, without checking with the customer first.
Dividend. A share of company earnings paid out to stockholders. Dividends are declared by the board of directors and paid quarterly. Most are paid as cash, but they are sometimes paid in the form of additional shares of stock.
Dividend reinvestment plan (DRIP). This is a program under which the company automatically reinvests a shareholder's cash dividends in additional shares of common stock, often with no brokerage charge to the shareholder.
Dividend yield. A percentage of annual return for stock investors calculated by dividing dividends per share by current market price per share. Broadly speaking, stocks with above-average yields will usually be less volatile than those with below-average yields or no yields at all.
Dollar-cost averaging. A program of investing a set amount on a regular schedule regardless of the price of the shares at the time. In the long run, dollar-cost averaging results in your buying more shares at low prices than you do at high prices.
Dow Jones Industrial Average. A price-weighted average of 30 actively traded blue chip stocks which are primarily industrial and service-oriented firms prepared by Dow Jones & Company. The index is calculated by adding the trading prices of the component stocks and dividing by a special divisor that has been adjusted through the years to account for stock splits, distributions, replacements and mergers. Quoted in points, not dollars.
Dow Theory. A belief that a major trend in the stock market isn't signaled by one index alone but must be confirmed by two -- specifically, a new high or low must be recorded by both the Dow Jones industrial average and the Dow Jones transportation average before it can safely be declared that the market is headed in one direction or the other.
Due diligence. The work performed by a broker or other representative in order to investigate and understand an investment thoroughly before recommending it to a customer.
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E
Earned income. Compensation, such as salary, commissions and tips, you receive for your personal services. This is distinguished from "unearned" income such as interest, dividends and capital gains.
Earnings (net income). What it's all about -- profit. What's left over after all expenses have been subtracted from total revenues.
Earnings per share. A company's profits after taxes, bond interest and preferred stock payments have been subtracted, divided by the number of shares of common stock outstanding.
EBITDA. (pronounced "ebb-ih-dah") Earnings before interest, taxes, depreciation and amortization. EBITDA is mostly used by fund managers, analysts and other Wall Street insiders as a way of measuring income to assign some type of valuation to a stock.
Education interest. Up to $2,500 of interest on college loans can be deducted as an adjustment to income, so you get a benefit even if you don't itemize deductions. To qualify for the write off, the debt had to be incurred to pay higher education expenses for you, your spouse or your dependent.
Enrolled agent. A tax preparer who, by virtue of passing a tough IRS test or IRS experience, can represent clients at IRS audits and appeals.
Equity. Represents ownership. For investors that ownership would commonly be the amount of stock they hold in a particular corporation. Stocks are commonly referred to as "equities." For homeowners, however, equity is the portion of their houses that they actually own (principal + appreciation). Therefore, if you have paid $30,000 in principal into your home, and it has appreciated $10,000 since you've owned it, your equity in the property is $40,000.
Estate tax. The federal tax that applies -- beginning at a 37% rate -- when a decedent's taxable estate exceeds $1,000,000. It will rise gradually until it reaches $3.5 million in 2009.
Estimated tax. If you have income not subject to withholding (such as self-employment or investment income) you may have to make quarterly payments of the amount needed to cover your tax bill. In general, you can be penalized if estimated payments -- combined with withholding from wages -- don’t come within $1,000 or 90% of the tax owed for the year. An exception waives the penalty if your payments during the year equal the amount of tax you owed for the previous year. There is an exception to this 100%-of-last-year’s-tax-bill exception, however. (This is, after all, the tax law!) If your AGI in 2002 was more than $150,000, you must pay at least 112% of last year’s tax bill or 90% of your 2003 bill to avoid the penalty.
ETF. Short for "exchange traded fund," it is a fund that tracks an index but trades like a stock. ETFs consist of a bundle of stocks from a given index but are not actively managed. Because ETFs trade on the major exchanges, their prices fluctuate throughout the day. A brokerage account is required to trade ETFs, which boast tax-efficiency and ultra-low expense ratios.
Ex-dividend. The period between the declaration of a dividend by a company or a mutual fund and the actual payment of the dividend. On the ex-dividend date, the price of the stock or fund will fall by the amount of the dividend, so new investors don't get the benefit of it. Companies and funds that have "gone ex-dividend" are marked by an X in the newspaper listings.
Exemptions. You can claim a personal exemption for yourself. On joint returns a personal exemption is claimed for each spouse. You also get an exemption for each dependent you claim on your return. Each exemption reduces taxable income by $3,000 in 2002.
Expense ratio. A measure of the costs of running a mutual fund. Expressed as a percentage of the fund's assets, the expense ratio is the best tool for comparing the management costs you'll incur by investing in different funds. The ratio includes management and 12b-1 fees, but not sales loads.
Expensing. Also known as the Section 179 deduction, expensing lets you treat up to $25,000 of expenditures that normally would be depreciated over a number of years as current business expenses to be deducted immediately.
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F
Fannie Mae. The acronym for the Federal National Mortgage Association, which buys mortgages on the secondary market, repackages them and sells off pieces to investors. The effect is to infuse the mortgage markets with fresh money.
Federal funds rate. The interest charged by banks with excess reserves to other banks needing overnight loans in order to meet their reserve requirements. The federal funds rate is actually set by the market and fluctuates daily, but is strongly influenced by the Federal Reserve’s policy of selling U.S. Treasury securities to banks.
Federal Housing Administration (FHA). Federally sponsored agency that insures lenders against defaults on residential loans. Borrowers must be able to put at least 3% down and meet the agency's credit qualifications.
Federal Reserve bank. One of 12 regional banks that make up the Federal Reserve system. The banks are located in Atlanta, Boston, Chicago, Cleveland, Dallas, Kansas City, Minneapolis, New York, Philadelphia, Richmond, St. Louis, and San Francisco. The banks ensure commercial and savings banks in their regions follow Federal Reserve rules, such as meeting reserve requirements and adhering to reporting standards. The Federal Reserve bank is also your bank's bank. Your local bank can deposit funds in its Federal Reserve account and ask for emergency loans.
Federal Reserve Board. The governing body of the Federal Reserve System. Its seven members are appointed by the president of the United States, confirmed by the Senate and serve 14-year terms. Board members also serve on the Federal Reserve Open Market Committee. The current chairman of the Federal Reserve Board is Alan Greenspan.
Federal Reserve Open Market Committee. The committee that decides interest rate moves and credit policies for the Federal Reserve System. Its 12 members consist of the seven Federal Reserve Board members and five presidents from the 12 regional Federal Reserve Banks. Four of the bank presidents are selected on a rotating basis, the fifth is always the president of the Federal Reserve Bank of New York.
Federal Reserve System. Created on December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act into law. The Federal Reserve Act provided for the establishment of up to 12 Federal Reserve Banks to coordinate monetary policy with a seven-member Federal Reserve Board in Washington.
Filing status. Your status determines the size of your standard deduction and the tax-rates that apply to your income. For tax purposes, you are considered single, married filing jointly, married filing separately, head of household or qualifying widow or widower.
Finance charges. The charge for using a credit card, comprised of interest costs and other fees.
529 plan. State college-savings plans named after the section of the tax code that deals with them. Your money grows tax-free until it's used for qualified college expenses.
The rules and investment choices vary from state to state. Some let residents deduct contributions on their state-tax returns. Most offer aggressive portfolios when the child is young, then gradually become more conservative as college gets closer.
Five-year test. If you withdraw Roth IRA earnings before your account has been open at least five years, you usually pay taxes and a 10% penalty, even if you are older than 59½. The five-year period begins when you open your first Roth; withdrawals can't begin until at least four calendar years after the year when your first contribution was made. If you made your 2001 contribution on April 15, 2002, it's still counted as if you made the contribution on January 1, 2001, and you'd pass the five-year test in 2006.
If you convert a traditional IRA to a Roth, the five-year period begins at the time of the conversion.
The five-year test and the 10% penalty is waived (but your earnings are still taxed)if:
- You withdraw the money to pay qualifying college costs.
- Take out up to $10,000 for a first-time home purchase.
- Pay qualifying unreimbursed medical expenses that are greater than 7.5% of your adjusted gross income.
- Buy health insurance while unemployed (you must be on unemployment for 12 weeks).
- Take a series of substantially equal payments (based on life expectancy) for at least five years and until age 59 1/2.
Also note that your IRA contributions can be withdrawn at any time without taxes or penalties.
Fixed-income investment. A catch-all description for investments in bonds, certificates of deposit and other debt-based instruments that pay a fixed amount of interest.
Fixed-rate mortgage. A home loan in which the interest rate will remain the same through the life of the loan.
Flexible spending account. See reimbursement account.
401(k) plan. An employer-sponsored retirement plan that permits employees to contribute part of their pay into the plan before income taxes are applied. Money directed to the plan may be partially matched by the employer, and investment earnings within the plan accumulate tax-free until they are withdrawn. Penalties usually apply to withdrawals before age 55, although most plans allow employees to borrow from their accounts. The 401(k) is named for the section of the federal tax code that authorizes it.
403(b) plan. Similar to 401(k) plans, but set up for public employees and employees of nonprofit organizations.
Free cash flow. Cash left over after depreciation, cost of labor, goods and services, taxes and capital expenses are deducted from revenues; or cash not needed for operations or reinvestment.
Freddie Mac. The acronym for the Federal Home Loan Mortgage Corporation; it operates similarly to Fannie Mae.
Front-end load. The sales commission charged at the time of purchase of a mutual fund, insurance policy or other product. (See also back-end load.)
Full-service broker. A brokerage firm that maintains a research department and other services designed to supply its individual and institutional customers with investment advice.
Fully diluted earnings per share. Earnings divided by all possible shares in a company, including not only common shares but also preferred shares, employee options and some convertible debt.
Fund category. Describes how a mutual fund's manager intends to invest the fund's assets. The fund category should reflect your investment objectives, time horizon and risk tolerance. Here are some categories (and their abbreviations used in Kiplinger's Fund Finder):
- Aggressive growth (AggGro) funds seek maximum capital gains, often in somewhat volatile small-company stocks.
- Balanced funds invest for income by holding bonds as well as stocks.
- Diversified international stock funds invest primarily in stocks of companies based outside the U.S.
- Global stock funds can invest in the U.S. as well as overseas.
- Global bond funds can hold either U.S. or foreign bonds.
- Growth-and-income (Gro-Inc) funds concentrate on safety and dividend income.
- High-yield corporate (Yld Corp) bond funds seek higher yields by owning mostly lower-rated corporate bonds.
- High-yield municipal funds (Yld muni) funds seek higher yields by owning mostly lower-rated or unrated 'junk' muni bonds.
- Investment-grade corporate (Corp) bond funds emphasize credit safety by owning mostly BBB-rated or better corporate bonds.
- Long-term-growth (Growth) funds also seek capital gains but tend to invest in stocks of larger, more stable companies.
- Mortgage funds own mortgage-backed securities, such as Ginnie Maes or collateralized mortgage obligations.
- Municipal bond (Muni) funds emphasize credit safety by investing in mostly BBB-rated or better municipal bonds.
- Sector funds limit investments to one industry or economic sector.
- Specialized international stock funds invest in a single country or region of the world.
- U.S. government (Govt) funds hold Treasury securities or securities of federal agencies.
- Utility funds own primarily stocks of utilities and usually emphasize yield.
Fund universe. Broadly describes what types of securities the the fund invests in -- U.S. stocks, international stocks, taxable bonds or tax-free bonds.
Fundamental analysis. Study of the balance sheet, earnings history, management, product lines and other elements of a company in an attempt to discern reasonable expectations for the price of its stock. For contrast, see technical analysis.
Futures contract. An agreement to buy or sell a certain amount of a commodity (such as wheat, soybeans or gold) or a financial instrument (such as Treasury bills or deutsche marks) at a stipulated price in a specified future month, which may be as much as nine months away. As the actual price moves closer to or further away from the contract price, the price of the contract fluctuates up and down, thus creating profits and losses for its holders, who may never actually take or make delivery of the underlying commodity.
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G
Gift tax. Prevents people from avoiding the estate tax by giving their property away. You may give up to $11,000 yearly to as many people you want without worrying about this tax. Larger gifts are taxable, but a tax credit offsets the tax on the first $1 million of lifetime taxable gifts. (Any part of the credit used to protect taxable gifts will not be available to reduce estate taxes.) When the gift tax is owed, it is owed by the giver, not the recipient.
Ginnie Mae. The acronym for the Government National Mortgage Association, which buys up mortgages in the secondary market and sells them to investors via securities known as pass-through certificates.
Good-till-canceled order. An order to buy or sell a security at a specified price, which stays in effect until it is executed by the broker because that price was reached, or until it is canceled by the customer.
Gross income. All of your income from taxable sources, before subtracting any adjustments, deductions or exemptions.
Gross profit (gross margin, margin). The difference between net sales and the cost of producing the goods sold.
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H
Head of household. A filing status with lower tax rates for unmarried or some married persons considered unmarried (for purposes of this filing status) who pay more than half the cost of maintaining a home, generally, for themselves and a qualifying person, for more than half the tax year.
Health savings account (HSA). A tax-advantaged savings account used in conjunction with a high-deductible health insurance policy. Anyone younger than 65 with a health deductible of at least $1,000 for individuals or $2,000 for families may open an HSA, either individually or through an employer. Contributions can be tax deductible or made before income taxes are applied (via employer plans), and are capped at the insurance deductible amount or $2,650 for singles and $5,250 for families, whichever is less. Savers who are 50 or older can put in an extra $600. Withdraws are tax- and penalty-free if they're used for qualified medical expenses; nonmedical withdrawals are subject to income taxes and a 10% penalty. Unspent funds accrue, making HSAs a good tax-deferred savings option. Withdrawals can be made after age 65 for any reason without penalty.
Hobby-loss rule. One requirement for deducting business losses is that you show you are trying to make a profit. The law presumes you're in business for profit if you report a taxable profit for three years out of any five-year period. Otherwise, your activity is assumed to be a hobby, unless you can prove otherwise. The distinction is important because if the expenses of a hobby exceed the income, the difference is considered a personal expense, not a tax-deductible loss.
Holding period. The period of time you own an asset for purposes of determining whether profit or loss on its sale is a short- or long-term capital gain or loss. Sales of assets owned one year or less produce short-term results. The sale of assets owned more than 12 months produces long-term results. The holding period begins on the day after you purchase an asset and ends on the day you sell it. If you buy on January 4, for example, your holding period begins January 5. If you sell the following January 4, you have owned the asset for exactly one year and are stuck with short-term treatment. To be eligible for the gentler long-term tax treatment, you'd need to hold on until January 5, so that you have owned the asset for more than one. (See capital gain or capital loss.)
Home-equity loans. Debt secured by your principal residence or second home -- such as a second mortgage or home-equity line of credit -- that is not used to buy, build or substantially improve the property. Although interest on most loans is no longer deductible, interest on up to $100,000 of home-equity debt remains deductible.
Hope learning credits. Credits introduced in 1998 to help pay for college education. The Hope credit is worth up to $1,500 per year per student and is available for the first two years of vocational school or college. You can claim a Hope credit for each qualifying student (including yourself, your spouse or your dependent child) for whom you pay tuition and other qualifying fees (but not the cost of Book or room and board), so three children in college at the same time could earn you $4,500 of credit. The right to this credit disappears as adjusted gross income is more than $51,000 on an individual return and $102,000 on a joint return.
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I
Imputed interest. Interest you are considered to have earned -- and therefore owe tax on -- if you make a below-market-rate loan. The term is also used to refer to the interest income you must report on taxable zero-coupon bonds. Although the bonds pay no interest until maturity, you must report and pay tax on the interest as it accrues.
Index. A statistical composite that tracks the ups and downs in one or more financial markets.
Indexing. Certain tax benefits -- including standard deductions and exemption amounts and the beginning and end of each tax bracket -- are automatically adjusted for increases in the consumer price index to prevent inflation from eroding them.
Individual retirement account (IRA). A tax-sheltered account ideal for retirement investing because it permits investment earnings to accumulate untaxed until they are withdrawn. The contribution limit is $3,000 per year, and penalties usually apply for withdrawals before age 59½. Taxpayers whose income is below certain levels can deduct all or part of their IRA contributions, making the IRA a double tax shelter for them. For more information see IRS Publication 590 (PDF,77.8KB), Individual Retirement Arrangements.
Initial public offering (IPO). Also called an IPO, a corporation's first public offering of an issue of stock.
Innocent spouse rules. Tax rules were liberalized in 1998 to protect married taxpayers who file joint returns from being held responsible for taxes due to erroneous actions by their spouses -- such as failing to report income or claiming unsubstantiated deductions. Basically, if you can show that you didn't know and didn't have reason to know about an error that resulted in the underpayment of tax on the joint return, you can be relieved of responsibility for that underpayment. You have two years from the time the IRS begins trying to collect the underpayment to petition for innocent spouse relief.
Installment sale. An agreement to have the purchaser pay you over a number of years, and you report the profit on the sale as you receive the money rather than in the year of the sale. If you made an installment sale before May 7, 1997 -- the effective date for the capital gains tax cut approved by Congress -- the payments received on or after that date that represent long-term gain qualify for the lower rate.
Institutional investors. Mutual funds, banks, insurance companies, pension plans and others that buy and sell stocks and bonds in large volumes. Institutional investors account for 70% or more of market volume on an average day.
Interest income. Income from bank deposits and bond holdings. For banks and other financial institutions this is also the amount of income derived from interest charged on loans.
Investment Company Act of 1940. Requires mutual fund companies to register with the Securities and Exchange Commission, which regulates the industry. The Act sets the standards by which mutual fund and other investment companies operate in such areas as promotion, reporting requirements, pricing of securities for sale to the public, and allocation of investments within a fund portfolio.
Investment interest. Interest paid on loans used for investment purposes, such as to buy stock on margin. You can deduct this interest up to the amount of investment income you report.
Investment style. Describes the personality of the fund as determined by the securities in which it invests.
Irrevocable trust. See Trust.
Itemized deductions. See Deductions.
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J
Junk bond. A high-risk, high-yield bond rated BB or lower by Standard & Poor's or Ba or lower by Moody's. Junk bonds are issued by relatively unknown or financially weak companies, or they have only limited backing from reasonably solvent companies.
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K
Keogh plan. A tax-sheltered retirement plan into which self-employed individuals can deposit up to 20% of earnings (up to a maximum of $40,000) and deduct the contributions from current income. Investments within the Keogh grow untaxed until they are withdrawn. Withdrawals from the plan are restricted before age 59½. For more information see IRS Publication 535 (PDF, 407.1KB), Business Expenses.
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L
Last closing price. Price of the last transaction on the last trading day. Prices are rounded to the nearest dollar.
Late charges. Charges from the credit lender when the borrower fails to make timely payment.
Leveraging. Investing with borrowed money in the hope of multiplying gains. If you buy $100,000 worth of stock and its price rises to $110,000, you've earned 10% on your investment. But if you leveraged the deal by putting up only $50,000 of your own money and borrowing the rest, the same $10,000 increase would represent a 20% return on your money, not counting interest on the loan. The flip side of leverage is that it also multiplies losses. If the price of the stock goes down by $5,000 on the all-cash deal, your loss would be 5% of your $100,000 investment. On the leveraged deal, your loss would be 10% of the money you put up and you'd still have to pay back the $50,000 you borrowed.
Leveraged buyout (LBO). The use of borrowed money to finance the purchase of a firm. Often, an LBO is financed by raising money through the issuance and sale of junk bonds.
Liability. An obligation owed. For you that could be an outstanding loan; on a company's balance sheet, it could be taxes, overhead, interest due and debt payments.
Liability coverage. Insurance coverage that pays for your legal responsibility to others for bodily injury or property damage.
Lifetime learning credit. Credits introduced in 1998 to help pay for college education. The lifetime learning credit is worth up to $2,000 per year for additional schooling. It can be claimed each year, however, for a maximum credit of $1,000. The credit is gradually reduced if your adjusted gross income is between $41,000 and $51,000 ($83,000 and $103,000 if filing jointly). You can't claim the credit if you're married filing separately.
Like-kind exchange. The tax-free exchange of similar assets, such as real estate for real estate. The tax on profit accrued in the first property is deferred until the subsequent property is sold.
Limited partnership. A business arrangement put together and managed by a general partner (which may be a company or an individual) and financed by the investments of limited partners, so called because their liability is limited to the amount of money they invest in the venture. Limited partnerships can invest in virtually anything, but real estate is the most common choice. They often have been characterized by high fees for the general partners, complicated tax reporting requirements and elusive payouts for the limited partners.
Limit order. An order to buy or sell a security if it reaches a specified price. A stop-loss order is a common variation.
Liquidity. The ability to quickly convert an investment portfolio to cash without suffering a noticeable loss in value. Stocks and bonds of widely traded companies are considered highly liquid. Real estate and limited partnerships are illiquid.
Listed property. "Listed property" is the term used for depreciable assets that Congress has put on a list for special scrutiny by the IRS. Basically, this includes things Congress worries you might use for personal as well as business purposes -- a car, computer, cellular telephone, boat, airplane and photographic and video equipment. (If a computer, photographic or video equipment is used exclusively at your regular place of business, however, it is not considered listed property.) There are special restrictions on the depreciation of listed property if business use does not exceed 50%.
Living trust. See Trust.
Load. See back-end load and front-end load.
Long-term gain or loss. See capital gain or capital loss.
Lump-sum distribution. The payment within one year of the full amount of your interest in a pension or profit-sharing plan. To qualify as a lump-sum distribution -- and for favorable five-year or ten-year averaging -- other requirements must be met.
Luxury-car rules. The restrictions that limit annual depreciation deductions for business automobiles that cost more than a certain amount. The maximum deduction you can take is $3,060 after the first year of use of the vehicle, $4,900 after the second year, $2,950 for the third year, $1,775 for the fourth and following years.
Luxury tax. This tax on expensive automobiles is being phased out. For vehicles purchased in 2002, the tax is 3% of the excess price over $40,000. The tax will disappear in 2003. This tax is collected by the car dealer; it doesn't show up on your tax return.
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M
Management fee. Fee paid to mutual fund managers to compensate them for services, brokerage commissions on portfolio transactions, and so forth. Some funds also charge 12b-1 fees, which compensate for the cost of advertising and marketing the fund directly from the funds asset.
Marginal tax rate. The share of each extra dollar of income that will go to the IRS. It's not necessarily the same as the rate in your top tax bracket because in many cases rising income squeezes the value of tax breaks, so that the extra income is effectively taxed more harshly than advertised. Knowing your marginal rate tells you how much of each additional dollar you make will go to the IRS and how much you'll save for every dollar of deductions you claim.
Margin buying. The act of financing the purchase of securities partly with money borrowed from the brokerage firm. Regulations permit buying up to 50% "on margin," meaning an investor can borrow up to half the purchase price of an investment. See leveraging.
Marital deduction. The deduction that allows any amount of property to go from one spouse to the other -- via lifetime gifts or bequests -- free of federal gift or estate taxes.
Market capitalization. The stock market value of the company -- that is, the number of shares multiplied by the share price. The numbers are expressed in millions, so $10,000 means $10 billion. You can use this number to determine the relative size of a company and as a tool to help you diversify among companies of different sizes. As a rough rule of thumb, you could label those companies with less than $1 billion in capitalization as small cap and those with more than $10 billion as large cap.
Market discount. The difference between what you pay for a bond and its higher face value. The tax treatment varies depending on whether the bond is taxable or tax-free and whether you redeem it at maturity or sell it before that time.
Master limited partnerships. Similar to regular limited partnerships, but MLPs shares are traded on the major exchanges, making for a much more liquid investment. Although limited-partnership losses are considered passive, income from an MLP is considered investment income rather than passive income. That means passive losses can't be used to shelter MLP income.
Material participation. The test used to determine whether you are involved enough in a business to avoid the passive-loss rules. To be considered a material participant, you must be involved on a "regular, continuous and substantial basis." One way to pass the test is to participate in the business for more than 500 hours during the year.
Maximum load. The highest sales fee for purchasing shares. None means the fund charges no sales or redemption fees. Sales charges are not included when calculating total returns in these tables. But the shorter the time you own a fund, the greater the impact of the sales charge on your total return. You'll also pay the load each time you buy subsequent shares (but seldom when reinvesting dividends or capital gains).
Medical Savings Account (MSA). MSAs are tax-favored savings accounts designed to save money to pay medical bills. They work somewhat like individual retirement accounts. Contributions are deductible and earnings inside the account are not taxed as they build up. Unlike a regular IRA, though, withdrawals are not taxed, either, if the money is used to pay medical expenses. MSAs are open only to self-employed taxpayers or employees of firms that employ 50 or fewer workers. Also, to qualify for an MSA, you must have a high-deductible medical insurance policy. Basically, that means a policy that requires you to pay at least the first $1,550 (if you are single) or $3,100 (if it's a family policy) of medical bills before your insurance kicks in. Money in the MSA is supposed to be used to pay those bills.
Medicare tax. The portion of the Social Security tax -- 1.45% for employees and 2.9% for self-employed taxpayers -- that pays for Medicare. Although the part of the tax that pays for retirement benefits stops at a certain income level, the Medicare portion applies to all wages and self-employment income.
Merger. When two companies become one through the pooling of interests and assets as well as the combination of corporate governance, management and shareholders.
Midmonth convention. The rule that treats certain kinds of depreciable property, including real estate, as though it were placed in service in the middle of the month it was first used.
Midquarter convention. In general, business property is depreciated under a midyear rule that allows half a year's depreciation for the first year, whether you buy property in January or December. However, if you buy more than 40% of the business property you put into service for the year during the fourth quarter, the midquarter convention takes over. With it, you depreciate each piece of property as though it were placed into service in the middle of the calendar quarter in which it was purchased. You claim just six weeks' worth of depreciation for property put in service during the final quarter, for example.
Midyear convention. See Midquarter convention.
Minimum investment. The dollar amount it takes to open an account. For subsequent investments and for IRAs, it's usually lower. Some funds also accept lower initial amounts if you sign up for regular investments via electronic transfer from your bank account.
Money-market fund. A mutual fund that invests in short-term corporate and government debt and passes the interest payments on to shareholders. A key feature of money-market funds is that their market value doesn't change, making them an ideal place to earn current market interest with a high degree of liquidity.
Mortgage interest. A term often used to refer to deductible interest paid on debt that qualifies as acquisition indebtedness or home-equity debt.
Multiple-support agreement. An agreement under which two or more taxpayers, who together provide more than half the support for someone else, but agree that one will claim that person as a dependent and the others will not.
Municipal bond. Debt obligations of a state or local government entity that support general government need or special projects. They come in two categories: public purpose bonds that are tax-exempt and can be issued without limitation and private purpose bonds that are taxable unless specifically exempted.
Mutual fund. A professionally managed portfolio of stocks and bonds or other investments divided into shares. Minimum purchase is often $500 or less, and mutual funds stand ready to buy back their shares at any time. The market price of the fund's shares, called the net-asset value, fluctuates daily with the market price of the securities in its portfolio.
Mutual fund manager. These individuals do the specialized work of selecting which securities to buy, keep and sell. The result of their decisions determine the returns the fund pays.
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