Here are 10 financial terms everyone should know

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Financial terminology can sometimes feel like a race to use the most syllables to describe a concept.

To make sure you’re on top of your own finances, here’s a list of the top 10 key terms you should know, as compiled by CNBC editors.

– By’s Natalia Wojcik
Posted May 17, 2017

1. Compound Interest

Compound interest is interest on the amount of money you have deposited or borrowed.

When you invest or save, compound interest is earned on the amount you’ve deposited, plus any interest you’ve accrued over time.

However, when you borrow, compound interest is charged on the original amount loaned to you, as well as interest charges that add to your outstanding balance over time.

2. FICO Score

FICO is an acronym for Fair Isaac Corp., the company that developed the methodology for calculating a credit score.

Your score is based on several factors, including payment history, length of your credit history, and total amount owed.

FICO scores range from 300 to 850, and the higher the score, the better terms you could receive on your next loan or credit card. People with scores below 620 may have a harder time getting credit at a favorable interest rate.

3. Net worth

Your net worth is simply the difference between your assets (what you own) and your liabilities (what you owe).

You can calculate yours by adding up all the money or investments you have, including the current market value of your home and car, and the balances of any checking, savings, retirement, or other investments.

Then subtract all of your debt, including your mortgage balance, credit card balances, and any other loans or obligations.

The resulting net worth number helps you take the pulse of your overall financial health.

4. Asset Allocation

Asset allocation is where you choose to put your money.

The three main asset classes are stocks, bonds and cash (or cash equivalents). Each of these reacts differently to market and economic conditions, so be sure to pick the ones that best suit your personal goals, risk tolerance, and time horizon.

For example, investing in stocks can give you strong growth over time, but they can also be quite volatile. So, one of the most common investment tips is to diversify your portfolio – or put your money in several buckets to make sure you’re risking as little as possible while achieving your particular goals.

5. Capital gains

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Capital gains are the difference between the current value of something and the price at which it was originally purchased.

The gain, however, is only on paper until the asset or investment is actually sold. The other side of the coin is a capital loss, which is the decrease in value of the asset or investment since you bought it.

You pay tax on short-term capital gains (one year or less) and long-term capital gains (more than one year) when you sell an investment.

On the other hand, a capital loss could help reduce your taxes.

6. Rebalancing

Rebalancing is a common practice in any portfolio. It is the process of bringing your stocks and bonds down to your desired percentages.

For example, let’s say your target allocation is 60% stocks, 20% bonds and 20% cash. If the stock market has done particularly well over the past year, your allocation can now be changed to 70% stocks, 10% bonds and 20% cash.

To rebalance your portfolio, you can sell some of your stocks and reinvest that money in bonds, or invest new money in bonds to bring the portfolio back to the original balance.

7. Stock Options

Stock options may be offered by companies as management incentives. These options give you the right (but not the obligation) to buy your employer’s stock at a predefined price within a specified time.

For example, if a manager helps increase the value of the company’s stock above its option price, the manager can buy the stock at the lower price and pocket the gain if it sells. But all shareholders benefit from the increase in share value.

8. Defined contribution plans

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The most common examples of defined contribution plans are 401(k) and 403(b).

Essentially, these are retirement plans that companies may offer as benefits that you, your employer, or both contribute to on a regular basis.

The money that goes into these accounts comes from pre-tax income, so you don’t pay tax on the amount you set aside each year.

Qualified withdrawals from these (usually those you make at age 59½ or older) are taxed as ordinary income. The value of the pension benefit is determined by the performance of his investment.

Unlike defined benefit plans, you, rather than your employer, bear the investment risk in the account.

9. Term life insurance

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Term life insurance provides coverage for a fixed period, usually five to 30 years.

If you die within the specified period, your beneficiaries receive compensation. If you don’t, the strategy expires worthless. The policy owner can choose to renew coverage after the end of the term and can cancel at any time without penalty.

10. Umbrella Insurance

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Umbrella insurance provides additional liability coverage beyond what your home, auto or boat insurance can provide.

You might consider umbrella insurance if you are at risk of being sued for property damage or injuries to other people, such as a nanny or other employees who regularly work in your home.

It can also protect your assets if someone sues you for slander or defamation.