Financial jargon buster: common money terms explained

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Active and passive

Fund managers usually set a benchmark against which they can assess how a fund is performing or make decisions on what it will invest in. There are different types of benchmarks depending on a fund’s individual objectives, for example it could be a financial market index such as the UK’s FTSE® 100 Index. 

If a fund is actively managed, the fund manager decides which investments to select, in an active attempt to beat the performance of the benchmark. 

In contrast, passive funds (also sometimes called tracker or index-tracking funds) aim to follow the movements of the benchmark (down as well as up) to give comparable returns.

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AER

AER stands for ‘annual equivalent rate’ and refers to the actual interest rate on your savings, for example in a bank savings account. The higher the AER, the more interest you can get.

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APR

One you’re likely to see if you’re taking out a loan – including a student loan – or making a large purchase such as a sofa or car on a repayment plan. APR stands for ‘annual percentage rate’.

In simple terms, this shows how much you are charged every year for a loan, or money you’ve borrowed on a credit card, for example, including any fees. It normally gives you the overall cost of a debt.

What this actually means in money terms is that when you borrow £1,000 over one year at 10% APR, it costs you £100 in interest on top of your loan (10% of £1,000); taking the total you need to repay to £1,100 over that year. Source: MoneyHelper

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Asset classes

Asset classes are categories of investments. The four main ones are equities (also known as stocks and shares), bonds, property and money market investments (including cash). 

It’s generally considered a good idea to have a mix of assets, which is called diversification – more on this later.

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Base rate

You’ve probably heard about the base rate on the news: there’s always a big story when the Bank of England’s Monetary Policy Committee – which decides on the rate – makes a change to it.

The base rate is used by many financial institutions to set the interest rates they charge and pay customers. When you hear that the base rate has changed, you’d expect savings and mortgage rates to change too, although this doesn’t always happen.

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Bonds

Bonds are usually described as loans to institutions, such as governments and companies, that need to raise money. So when you buy a bond, you’re giving your money to the government or company that’s issued it for an agreed period of time. 

Bonds aren’t risk free, and unless you invest in a guaranteed bond, there’s a chance that you won’t get back what you paid in.

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Bull and bear markets

This may sound a bit ‘Wall Street’, but bull and bear markets can affect any money you’re investing for the future, so it’s worth understanding what they are. A bull market is where financial markets are going up in value, while a bear market is when they’re falling. The substantial market falls we saw in March 2020 are an example of a bear market. And you may have seen the value of your pension plan or other investments fall as a result.

What’s important to remember is that investing is a long-term commitment (usually more than five years), so be careful not to base decisions on what markets are doing at any one moment. It could backfire, and history shows us that financial markets generally recover over time. Investments like your pension savings are usually invested over a much longer time period, so holding out could actually give your money more of a chance to recover in value.

If you have a good mix of investments – in other words you’re diversified – you shouldn’t need to make changes every time you hear about rising or falling markets.

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Compounding

Compounding is something Albert Einstein is said to have dubbed the eighth wonder of the world. It basically means the longer you keep your money invested, the more likely it is to grow. This is because each year you have the opportunity to achieve growth, not only on the money you’ve invested, but also on the growth you might have already experienced. 

Let’s say you invest £100, and in the first year you achieve £10 investment growth on that £100. Any further investment growth you get is now added to your original £100, plus the £10 of previous growth. Meaning, if we assume the same growth rate, in the second year your investment might grow by £11, and so on.

If you leave your investments with the aim to grow, this could happen year on year – a ‘snowball’ effect. It might not sound like much, but over time it may build up to be a fair chunk of the final value of your investments.

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Credit union

A credit union is a type of financial institution, similar to a bank, but it’s owned and controlled by the members who deposit money into it. A credit union’s goal is to serve its members rather than make a profit, which means they’re sometimes able to offer lower interest rates and reduced fees.

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Diversification

This simply means having a mix of investments – in other words, a diverse range. 

Diversification can help to manage risk and means that the overall value of your investments should be less likely to change dramatically than if you were just invested in one type of investment. It’s a bit like not putting all your eggs in one basket. 

If you’re invested through a workplace pension plan, particularly if you’re in your plan’s default investment option, it’s likely that your investments will already be diversified.

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Equities

Equities, or stocks and shares, are what many people think about when it comes to investing. When you buy shares, you effectively become a part owner of that company – a shareholder. 

Historically, equities have generated higher returns over the longer term than most other types of investments, so they can play an important part in many investment portfolios. But please be aware that past performance isn’t a guide to future performance, so there’s no guarantee they’ll do so in the future.

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Funds

A fund is a way of pooling the money you invest with other people’s money. This allows you to invest in a wider range of options than if you invested directly yourself – and a professional fund manager will do the hard work of ongoing management for you. 

There’s plenty of choice when it comes to funds, including options that help you diversify across different types of investments. You also have a choice of actively managed or passive funds, which we explained earlier.

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Inflation

The rate of inflation is the level at which prices for goods and services increase over time. It’s an important consideration if you’re looking to save or invest because it can affect the purchasing power of your money.

For example, if you save your money into a bank or cash ISA where the interest rate is lower than the rate of inflation, you could effectively lose money. This is because, as the price of goods and services rise over time, eventually your money won’t be worth as much in real terms because you won’t be able to buy as much with it.

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Interest

Not to be confused with interest rate or base rate.

You earn interest on your savings or pay interest on your borrowings at the rate set, based on the APR or AER

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Interest rate

An interest rate is the amount you are charged to borrow money, or the amount paid to you on the amount you save.

If you’re borrowing money, for a mortgage or credit card for example, you’ll need to pay back the original amount of the loan plus interest. So in this case the interest rate will be a percentage of the total amount of the loan you’re taking out.

If you’re saving money, the interest rate will be the amount you earn on top of the amount you save. So if you save £2000 in a year into a savings account with an interest rate of 2%, you’ll have £2040 at the end of the year, because you’ll have earned £40 of interest.

Changes in interest rates, even small ones, can have a big impact on your money. So it’s worth keeping track of them.

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Investing... and saving

Investing is putting your money into something like a pension plan or other financial product, stocks and shares, property or a business, to try and make a profit in the future – although that’s not guaranteed and you could get back less than was paid in. 

Saving is where you put some money aside, usually into a savings account, and you’ll normally get back what you’ve saved, plus interest on top of that. 

You might not think you’re investing, but if you have a pension plan, for example through your employer, or some types of Individual Savings Account (ISA), you probably are. So it’s important to understand the difference.

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Investment risk

When it comes to investing, risk isn’t always a negative, so this is a useful term to understand. In fact, taking a bit of risk when you invest your money could be crucial to help give it a better chance to grow more than inflation. 

For example, if you take more risk with your investments, there’s the potential for higher long-term returns, although on the flip side, there’s also the potential for greater losses. Investing is normally better suited for long-term goals (five years or more) because that gives you more time to balance out these highs and lows.

There are different levels of risk that can be dependent on your own investment goals, financial circumstances and aspirations for your money. The amount of risk you’re prepared and able to take with your investments might be very different to someone else, and may change as you go through life. We have a questionnaire that can help you find out how you feel about investment risk.

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ISA (Individual Savings Account)

The two most common types of ISAs are Cash ISAs, which are a bit like a bank savings account and give you tax-free interest, and ISAs you invest through, called Stocks and Shares ISAs. These let you put your money in different types of investments, often through funds. 

There are different levels of risk involved with each ISA type. Your money is generally more secure in a Cash ISA since your money isn’t exposed to any investment risk, but you’re more likely to see your money grow over time with a Stocks and Shares ISA. Although that’s not guaranteed as the value of investments can go down as well as up and you may get back less than was paid in.

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Pension plan

Put simply, a pension plan lets you, a third party, and your employer if you have a workplace pension plan, put aside money for your retirement. With modern, flexible pensions, your money is invested, giving it a better chance to grow in value than if it was saved into a bank account. However, because a pension plan is invested, its value can go down as well as up and you could get back less than was paid in. On the flip side, savings accounts aren’t exposed to investment risk, so your money is generally more secure in a bank account or cash ISA.

How and where your pension plan is invested will affect how much it may move up and down in value, so it’s important to understand the investment choices you have. If you have a Standard Life pension plan, you can review and manage your investments through online services.

You can also get tax benefits on money you contribute to your pension plan, meaning it can be a tax efficient way to save for retirement.

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Portfolio

Your portfolio is made up of the collection of investments or assets you have, such as stocks and shares, bonds and cash.

You could manage the portfolio yourself, or you might have a financial adviser or investment professional to do this for you.

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Responsible investing

There are many different ways you can invest responsibly – whether you want to generally avoid companies involved in harmful practices and focus more on responsible companies, or to tap into specific ethical, environmental or social goals. 

As well as the ethical reasons, it can also make financial sense to consider how responsible an investment is. For instance, how a company treats its employees, local communities, waste disposal and energy use could all indicate future performance – and potential growth for investors. And companies coming up with solutions to sustainable issues may offer opportunities in new markets. This is why investment managers analyse these areas and, using their influence as an investor, often encourage companies to do better. 

If you’re in one of our easy options or your company’s default then it's likely that the experts managing them are already considering responsible investments for you. You can find out about Standard Life’s approach to responsible investment by checking our online guide.

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Stock markets

These are where companies list their shares, and people can buy and sell them. 

You may also hear people refer to a stock market index, such as the UK’s FTSE® 100 Index or the S&P 500 in the US. These give a measure of how the shares listed on stock markets are doing overall.