5 financial terms you're probably using all wrong
There's a lot to learn about money.
"It's not taught in high school," Bob Gavlak, CFP and wealth adviser with Strategic Wealth Partners in Columbus, Ohio, told Business Insider. "You get taught about parabolas and Venn diagrams in high school, but you don't get taught about taxes and budgeting and credit cards and mortgages, which would be much more helpful to your long-term personal success."
And then, he pointed out, we tend not to learn financial literacy in college or at work. When are we supposed to pick it up?
So it's no stretch to imagine that many of us are running our finances with some degree of misunderstanding.
Below, Gavlak helped us identify five common financial terms that many people regularly use incorrectly.
Investopedia says: "Volatility refers to the amount of uncertainty or risk about the size of changes in a security's value."
The CFP explains:
"People tend to look at volatility and think that it's purely a bad thing. They think that you never want to have any volatility in your portfolio, and, for the most part, you don't want to have a ton. You don't want to just have your portfolio double one day and then get cut in half the next, but over a long enough period of time, the day-to-day movement almost has zero impact on client portfolios.
"The only place volatility is bad is if you're taking unnecessary risk, or if you need your money in a one month period of time. Then, you don't want to have a major downturn."
Use it better: If you're completely avoiding volatility, you're completely avoiding risk. As comforting as that may seem, in investing as in life, there's no reward without taking some degree of risk. As part of a carefully created and thoughtful long-term financial plan, a degree of volatility can be a good thing to help your money grow.
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Investopedia says: "Diversification is a risk management technique that mixes a wide variety of investments within a portfolio."
The CFP explains:
"Diversification is not just about having a bunch of different mutual funds or ETFs or even stocks. A lot of people will say, 'Yeah, my portfolio is diversified,' and then I look at their portfolio and they have 10 different mutual funds, but all 10 of those mutual funds are large cap value mutual funds or something like that. Just because you have a bunch of mutual funds or ETFs does not mean you are necessarily diversified the way that you should be depending on your investment goals.
"The importance of diversification is that when the markets work — and they work in cycles — certain asset classes or certain pieces of the world economy are going to be up when others are going to be down. The goal is to minimize your overall exposure to one asset class so if that asset class does not perform as well, there are others holding up the portfolio or keeping you more in line with your long-term investment goals."
Use it better: Ask yourself, "What do I need my investments to do for me in order to be successful?" Gavlak recommends. From there, he says, you can better develop an investment strategy that's properly diversified among the appropriate set of asset classes rather than through different funds that may overlap.
Investopedia says: "'Financial advisor' is a generic term with no precise industry definition, and many different types of financial professionals fall into this general category. Stockbrokers, insurance agents, tax preparers, investment managers and financial planners are all members of this group. Estate planners and bankers may also fall under this umbrella."
The CFP explains:
"It's unbelievable the scope or range of people that can consider themselves financial advisers or financial planners. The majority of time, if somebody calls themselves a financial adviser, usually all that means is that they're investment advisers — all they do is investment management.
"A financial adviser doesn't necessarily mean that they're going to have training and are going to be able to help you with taxes, insurance, investments, and estate planning. A lot of times people will look at financial advisers and certified financial planners and they think that they're all the same, but that would be like looking at a restaurant and saying McDonald's is the same as some really fancy steakhouse."
Use it better: Identify what you need from your financial adviser before you become a client. Is it insurance? Is it a financial plan? Is it solely investment advice? Ask about your prospective adviser's expertise and experience upfront, to make sure their specialty aligns with your needs.
'Fee-based' and 'commission-based'
Investopedia says: "[A commission-based investment account is] An investment account in which the advisor's compensation is based on a set percentage of the client's assets instead of on commissions. Contrast this to commission-based investment, in which the advisor makes money based on the amount of trades made or the amount of assets sold to the client."
The CFP explains:
"There are two sides: advisers who work on commission and advisers who charge fees for the services they offer. I've had clients come into my office and say, 'I'm working with this guy and he works for free.' Nobody works for free. They're not charging a direct fee to the client because they're working on commissions that come through the sale of commissionable products like mutual funds and annuities.
"On the other side, the fee-based advisory firms have to disclose their fees. It's much more black and white. They want to make all financial advisers fiduciaries, which basically means that I have to put my clients' wants and needs ahead of my own. I always have to act in their best interest. As a fee-based financial adviser, I have that fiduciary responsibility to my clients.
"The commission-based advisers, at least in the current environment, do not have a fiduciary responsibility to their clients. They have a suitability responsibility, meaning that as long as an investment is suitable — as long as it fits their investment goals and timeline — that they can put the client in that investment, even if there is more of a benefit financially for the adviser than for the client."
Use it better: Ask your adviser how they get paid, Gavlak recommends. Ask whether or not they have fiduciary responsibility. In most cases, you'll want to work with someone who has it, to make sure your own interests are being prioritized.
Investopedia says: "An annuity is a contractual financial product sold by financial institutions that is designed to accept and grow funds from an individual and then, upon annuitization, pay out a stream of payments to the individual at a later point in time ... Defined benefit pensions and Social Security are two examples of lifetime guaranteed annuities that pay retirees a steady cash flow until they pass."
The CFP explains:
"People tend to look at an annuity and think it's a bad thing. But if you go to somebody and ask them if they would like to have a pension, most people would have a positive reaction to that.
"The reasons that people have such negative feelings about them are, one, as an insurance product, they are a commissionable product. Very often people put too much of their money into an annuity and they lose the liquidity of just being invested normally in the market.
"The second thing people don't understand is the true lack of liquidity that comes with an annuity. If you're given these guarantees, if you have this guaranteed income stream that the insurance company is promising you, they require you to leave the money with them for an extended period of time. If you take your money out early, they're going to charge you a surrender charge.
"If it was properly explained and put in place within the context of a plan and not too much a portion of your assets, then very often annuities can be very beneficial pieces to a successful long-term financial plan."
Use it better: Don't balk at annuities straight away. Discuss with your adviser whether they can be a beneficial part of your long-term financial plan, and, if so, remember that they'll make a portion of your investable assets illiquid and inaccessible for a period of time.
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