F3 Learning zone

Glossary

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To help navigate some of the terms and jargon used in the financial services industry, we have put together these definitions and meanings of commonly used financial terms.

Account based pension – An account in which you invest your superannuation savings in exchange for a regular and flexible income.

Active investment management – Investment approach that relies on analytical research, forecasts and individual judgement and experience in making decisions to buy, sell or trade investments. Active managers do not believe in the Efficient Market Hypothesis. The opposite of active investment management is passive investment management.

Australian Securities & Investments Commission (ASIC) – An Australian government body that regulates banks and other financial services companies. ASIC is responsible for consumer protection in superannuation, insurance, banking and credit. ASIC also regulates and enforces laws that promote honesty and fairness in financial products and services, in financial markets and in Australian companies.

Assessable Income - Income, including capital gains, on which you pay tax (ie your total income before deducting allowable deductions).

Asset Allocation – The process of selecting what type of assets you invest your money – such as cash, bonds, property and companies / shares.

Assets test – A test on your assets to determine social security entitlements. Under this test there are a certain amount of assets you can have before your entitlements to certain social security benefits is reduced or cuts out.

Bonds – Are issued by Governments and large corporations in Australia and overseas. The bondholder receives interest for the fixed term of the bond and the capital value is influenced by changes in interest rates.

Borrowing Limit - An amount the lender has agreed to lend you. This may be drawn down progressively in instalments, or never drawn down at all.

Capital - Cash or assets that can be applied towards a particular purpose.

Capital Gains Tax (CGT) - A tax on the growth in the value of assets or investments, payable when the gain is realised. If the assets have been held for more than one year, the capital gain may receive concessional treatment. Certain assets (such as the family home) can be exempt from Capital Gains Tax.

Cashflow - The amount of money received in a certain period. Surplus cashflow refers to the net inflow of money.

Choice of fund – Since 2005, many employees can choose which superannuation fund their employer superannuation contributions are paid into.

Commutation – The process by which some (or all) of your income stream is converted back to a lump sum.

Complying superannuation fund – A super fund that qualifies for concessional tax rates. A complying super fund must meet the requirements that are set down by law.

Condition of release – Circumstances upon which you can withdraw your superannuation benefits.

Co-contribution – A superannuation contribution from the Government that is paid after a number of conditions are fulfilled.

Concessional contribution cap – A cap that applies to certain super contributions, such as those from an employer, salary sacrificed contributions and personal contributions claimed as a tax deduction.

Consumer Credit Code – A set of rules that regulate certain types of lending and borrowing transactions in Australia. Lenders such as Banks must tell you what your rights and obligations are in transaction. Credit transactions made for business or investment purposes are generally not governed by the Consumer Credit Code.

Consumer Price Index (CPI) – A measure of inflation taken each quarter based on the price of a basket of typical household goods and services.

Contributions tax – A tax applies to personal deductible and employer contributions made to a superannuation fund.

Credit file – A file that is kept by an agency such as Veda Advantage or Dun & Bradstreet which shows your credit history such as loan applications that were not approved, defaults on loans and bankruptcy. A bad credit file will reduce the likelihood of obtaining debt finance.

Critical illness insurance – Insurance policy that provides a cash lump sum in the event of the insured being diagnosed with a particular medical condition (such as cancer, stroke or heart attack).

Debt - An outstanding liability that must be repaid.

Debt recycling - The process where an investor increases an investment loan (ie where the interest is tax deductible) by the same amount that they have reduced a non-deductible loan (eg a home loan) over a given period.

Deeming – A method of assessing your entitlement to social security benefits under the Income Test. Deeming assumes that certain financial investments earn a specified rate of interest, regardless of what they actually earn.

Dimensional Fund Advisors – A large and global funds management company with a focus on providing successful investment returns based on extensive academic research and theories (and cost minimisation).

Diversification – Spreading your money and investments across asset classes, industry sectors, companies and geographies to reduce investment risk.

Dividend - Distribution of part of a company's profits to shareholders.

Dividend yield – The dividend or investment income expressed as a percentage of the share price or investment value.

Dollar cost averaging - The practice of investing amounts of money at regular intervals regardless of whether the market is going up or down, resulting in an average cost per unit of investment.

Efficient debt - Debt that can potentially assist you to build wealth. It can be characterised by the fact that the assets acquired with it are both income producing (making the interest tax deductible) and expected to grow in value over time.

Efficient Market Hypothesis – The theory that says market prices are fair and fully reflect all available information. Some individual prices maybe too high, and some maybe too low, but the Efficient Market Hypothesis suggests there is no reliable way to tell.

Employment Termination Payment – A payment made from an employer to an employee on termination of employment.

Enduring power of attorney – A formal agreement giving someone else the power to make decisions on your behalf even when you lose capacity.

Equity - The interest or value which an owner has in an asset over and above the debt against it. For example, the equity of a homeowner is the value of the home less any outstanding loan.

Fixed interest – A type of interest where the rate does not change (it does not go up or down) during the fixed interest term of a loan.

Franking / imputation credits - Credits for company tax paid that are passed onto shareholders who have received franked dividends from Australian resident companies.

Franked dividends - Dividends on shares with franking credits attached.
The tax paid at the company level is credited to shareholders. Tax is assessed on the total amount of the dividend and the imputation credit, and they can claim a tax offset equal to the imputation credit. A company is able to declare that a percentage (up to 100%) of a dividend is franked depending on the amount of tax the company has already paid.

Fringe Benefit - A benefit provided by your employer in respect of your employment. Super contributions made by an employer to a complying super fund are excluded from Fringe Benefits Tax.

Fringe Benefits Tax – A tax payable by your employer on the grossed up value of certain fringe benefits that you receive as an employee. The current rate of tax is 46.5%.

Gearing - Borrowing money, often for investment purposes.

Guarantor - A party who agrees to be responsible for the payment of another party's debts.

Home loan - A loan taken out to acquire a home or secured by a residential property.

Income producing asset - An asset that generates income for the owner (eg a share that pays a dividend). The interest on a loan taken out to acquire an income producing asset is generally tax deductible.

Income protection insurance - A policy that pays you a portion of your lost income in the event of you being unable to work due to illness or injury.

Income streams – Investments that provide a regular income, such as account based pensions and annuities.

Income test – A test on your total income to determine your entitlement to certain social security benefits.

Index Fund – A passively managed investment fund that tries to mirror the performance of a specific index. Index funds are usually characterised by diversification, automatic investment decisions and infrequent transactions. As a result, index funds also tend to have lower expenses and potential after-tax benefits.

Inefficient debt - This type of debt can be characterised by the fact that the assets acquired with it are not income producing (meaning the interest is not tax deductible). The assets may also depreciate in value or be consumed (ie they have no monetary value).

Instalment gearing - A loan that allows you to leverage your regular investments with regular drawdowns on an investment loan.

Interest - The amount a borrower pays to a lender for the use of borrowed money.

Interest Only loan - A loan where the principal is paid back at the end of the term and only interest is paid during the term.

Internally geared share fund - A managed fund which contains internal gearing (eg. the fund borrows money) to leverage the investment in Australian and/or global shares.

Investment loan - A loan with the specific purpose of acquiring investments in order to create wealth.

Life insurance – Insurance policy that provides a cash lump sum in the event of the insured persons’ death.

Limited recourse loan - A gearing arrangement, such as an internally geared share fund, where the investor's liability is limited to the value of the initial investment.

Line of credit - Overdraft facility which is secured by a mortgage over a residential property. With a line of credit it is possible to drawdown over time to the set borrowing limit as required.

Loan to valuation ratio - The ratio of the amount lent (or the credit limit) to the valuation of the security (eg your home).

Managed investment - An investment vehicle (eg unit trust), which pools the assets and money of many investors with a common investment objective and strategy. A sector specific fund invests in only one asset class (eg global shares) while a multi-sector (or diversified) fund invests in a number of asset classes.

Mandatory employer contributions – Superannuation contributions your employer is required to make on your behalf by law. Includes Superannuation Guarantee (SG) contributions and employer contributions required under an industry award or certified agreement.

Margin call - With a margin loan the lender is prepared to lend to a maximum limit (expressed as a ratio of borrowing versus equity). When this limit is exceeded, you will be required to meet a margin call, which means you must either repay part of your loan or increase your loan limit by providing further security.

Margin lending - A means of borrowing money in order to increase your investment in growth assets such as shares. The geared asset (eg the shares) becomes the security for the loan.

Marginal tax rate — The stepped rate of tax that you pay on your taxable income.

Medicare Levy – A levy (currently 1.5%) that is payable on your taxable income on top of normal marginal rates. An additional 1% can be charged for individuals or couples who have no private health insurance and exceed certain income thresholds. Low income individuals and families maybe exempt from the Medicare Levy.

Mortgage - A loan agreement between a borrower and lender, giving the lender a right to the property held as security for the repayment of the money lent. The security is generally released upon repayment of the loan.

Mortgage Broker - A person or company that has access to a panel of lenders and will assist you to find the most appropriate loan for your situation. Mortgage Brokers will usually be paid a commission from the lender.

Non-concessional contribution cap – A cap that applies to certain super contributions. These include (but are not limited to) personal after tax contributions and spouse contributions.

Offset Account – A separate savings account run in conjunction with your home or investment loan. Any money you put in the offset account is deducted from your loan balance before interest is calculated. It can also operate like a transaction account.

Passive investment management – An investment approach that looks to make investments that will remain relatively unchanged over long periods of time. Passive investment management has little reliance upon analytical research, forecasts and individual judgement and experience in making decisions to buy, sell or trade investments. The opposite of passive investment management is active investment management.

Pension Offset – A tax offset of 15% on the taxable income payments received from an income stream purchased with superannuation money between the ages of 55 and 59. The offset is also available before age 60 on death and disability benefits paid as an income stream.

Preservation age – The age at which you can withdraw your preserved superannuation benefits – between 55 and 60.

Preserved benefits – Benefits that must be kept in the superannuation system and cannot be withdrawn until you meet a condition of release.

Principal – For an investment, the principal is the amount of money invested. For a loan, the principal is the amount of the loan upon which interest is calculated and charged.

Real rate of return – The return from an investment after taking account of inflation and increases in the cost of living. For example, if your investment returns were 8% per annum and inflation is 3% per annum, your real rate of return is 5% per annum.

Redraw facility - A loan facility whereby you can make additional repayments and then withdraw these extra funds if and when necessary. They will often have limitations such as a minimum redraw amount and a fee for each withdrawal.

Regular investing – Investing a small amount regularly over a period of time. This strategy can provide discipline, compounding benefits over the long term and reduced risk of investing a lump sum before a market decline.

Reinvestment – Using the dividends from shares or distributions from managed investments to purchase additional shares or units.

Restricted non-preserved benefits – Non-preserved benefits that can only be withdrawn from the superannuation system when you meet a condition of release.

Rollover – When you move your superannuation benefits directly to a superannuation or rollover fund.

Superannuation fund – A fund that provides longer term financial benefits, often for retirement purposes. Complying super funds are those that satisfy the conditions specified for complying funds under the Superannuation Industry Supervision Act. Complying super funds are concessionally taxed.

Tax deduction – An amount that is deducted from your assessable income before tax is calculated. You can claim deductions in your annual tax return or, if your deduction is significant, you can apply to the Tax Office for a variation of PAYG tax.

Taxable component – The remainder of a superannuation benefit after allowing for the tax free component.

Taxable income – Assessable income (including capital gains) minus allowable deductions.

Taxed super fund – A superannuation fund that pays tax on contributions and earnings in accordance with the standard superannuation tax provisions.

Tax free component – That part of a superannuation benefit that is received tax-free.

Tax offset – An amount deducted off the actual tax you have to pay. You may be able to claim a tax offset in your end of year tax return (eg. franking credits).

Term life insurance – Insurance policy that provides a cash lump sum in the event of the insured persons’ death.

Total and permanent disability insurance – Insurance policy that provides a cash lump sum in the event of an insured person suffering an illness or injury which totally and permanently incapacitates them from working.

Transition to retirement pension – An income stream that can be purchased with preserved or restricted non-preserved superannuation benefits after reaching your preservation age (currently 55).

Trauma insurance – Insurance policy that provides a cash lump sum in the event of the insured being diagnosed with a particular medical condition (such as cancer, stroke or heart attack).

Unit Trust - An investment that allows individual investors to pool their funds, by purchasing units, to enable the trustee of the trust to invest in shares, fixed interest and property (eg a property unit trust).

Unrestricted non-preserved benefits – Benefits that have met a condition of release and therefore can be withdrawn from a superannuation fund at any time.

Vanguard Investments – One of the world’s largest funds management companies with a focus on long term investment strategies and returns. Vanguard Investments have a large share of the index fund market.

Variable interest – A type of interest where the rate may go up and or down during the term of the loan.

Voluntary employer contributions – Includes salary sacrifice contributions and contributions made by an employer that are discretionary (not mandatory).

Will – A legal document stating how you wish your possessions to be distributed after your death.

Yield – The annual income from an investment expressed as a percentage of the current market value.