Foundation

A personal budget set aside as a financial safety net for the possible future event that you lose your source of income or a large unexpected expense comes up. Most experts will say you need at least 3-6 months worth of living expenses saved up for a healthy emergency fund.

A capital loss is when a capital asset (investment or real estate) is sold at a lower price than the purchasing price. There is a financial strategy called tax-loss harvesting that intentionally uses capital losses to offset capital gains so that not as many taxes are paid. Check out Stock Basics for a more in depth look how capital gains/losses are used.

A profit that results from the sale of a capital asset (stock, bond, or real estate). The gain is the difference between the higher selling price and the lower purchasing price. Depending on the length of time that you have owned the asset will determine whether you are taxed on the profit as regular income or a lower capital gains rate. Check out Stock Basics for a more in depth look!

Side note: The sale of a piece of real estate can be considered capital gains if the money received isn’t spent towards other items. Contact your tax advisor if your are thinking about selling.

Net worth is a financial indicator that is calculated by taking your assets and subtracting your liabilities. This number gives you the state of your financial health and will let you know if you need to adjust your financial plans for the future. Check out Understanding Assets vs Liabilities & Net Worth for a more in depth look!

A liability is something a person or company owes, typically a sum of money. These can be broken down into current liabilities (which are paid back in less than one year) and long term liabilities (which are debts payable over a longer period). Check out Understanding Assets vs Liabilities & Net Worth for a more in depth understanding!

In the financial accounting world, assets represent the value of ownership that can converted into cash. Some examples are:

• Cash, Cash Equivalents (Stocks, Bonds, etc.)
• Inventory
• Property
• Equipment
• Trademarks
• Patents

Check out Understanding Assets vs Liabilities & Net Worth for a more in depth explanation!

A measure that the Bureau of Labor Statistics (BLS) defines as the average change over time in the prices paid by consumers for a market basket of goods and services. This number is used to define the inflation percentage over time.

The CPI uses a base value of 100 for a given number of goods and services and uses the years 1982-1984 as its base years. The BLS then calculates what the same number of goods and services would cost each year. For example the Feb 2019 index (for all goods) was 252.776 and the Feb 2020 index was 258.678. By dividing the two numbers we see that the inflation in this 12 month period is a 2.3% increase.

Tax Deduction

A reduction of taxable income. This number is subtracted from your adjusted gross income (AGI) and taxes are owed on the lower number. For 2020 the standard deduction is $24,800. The amount of taxes owed varies on your incoming. Check out Understanding the New (2018) Marginal Tax Bracket for more information and to find out how to estimate how much you owe in federal taxes.

Tax Credit

A reduction in total taxes owed.

Example

Let’s take a look at what the difference between a $1,400 tax deduction and a $1,400 tax credit would look like for a married couple filing jointly.

Before Deduction/Credit:
Adjust Gross Income: $80,000
Income Tax Owed: $6,284

$1,400 Tax Deduction
Income Tax Owed: $6,116
Difference: $168

$1,400 Tax Credit (Child Tax)
Income Tax Owed: $4,884
Difference: $1,400

You will receive $1,232 more for a tax credit than a tax deduction of the same amount.

A distribution of a portion of profits given to shareholders. This typically occurs quarterly and averages 2.22% according to dividend.com. You have the option of re-investing that dividend or taking a cash payout. This is considered a form of passive income.

Annual Fee that is charged on all funds or exchange traded funds (mutual/index). The amount is typically a percentage of all assets in the fund. The fee covers the cost of things such as administration, compliance, distribution, management, marketing, shareholder services, and record-keeping. The average fee for a managed account can be .5%-1%. Index funds are usually lower with an average of .2% and can be as low as .04%.

Example:

Return: 6%
Annual Investment: $500/Month
Expense Ratio (Managed Fund): .54%
Expense Ratio (Index Fund): .04%

After 30 years of investing:
Managed Fund Amount: $434,000
Index Fund Amount: $474,000
Difference: $40,000

Summary: Assuming the same return on investment an index fund will provide you with an additional $40,000!

Follow-up: Index funds have historically outperformed a majority of managed funds!