Lost in translation (2): how key financial terms are misunderstood by even the savviest clients

In the workforce, diversification refers to a hiring and retention plan for ensuring that a workforce resembles the community in which the company does business or serves. Applying that concept to financial matters just doesn’t compute.

Sometimes a rose isn’t always a rose. Some words or phrases have more than one meaning, and when that happens in the financial world, it can cause confusion for clients and advisors. By watching which terms you use in your newsletters, emails and other communications with clients and their employees you can help ensure the best communication. And great communication makes for happy clients and long-lasting relationships. While the best method of communication is to run your email or marketing materials through the age old test of “Would my grandma understand this?” that can sometimes be impossible in a busy and dynamic environment. Having a list of potentially confusing terms on hand to check before sending information out can be helpful. Here’s our suggestion for where to start, though adding your own terms as they come up is always a good remedy to any potential confusion.

Perhaps the most important term that may not be understood by clients or their employees is risk. Since employees are also investment consumers, we’ll refer to them here as consumers. Many consumers hear the term risk and assume an investment is a poor choice. Instead, the investment market is comprised of balancing risk and return, and of understanding appropriate loads of risk and return.

Cash generated from investments can be either investment incomeor distributions. For the average employee, their focus is on the income itself, not necessarily the method by which the income is generated. But the two have different tax implications (depending on account type and source, as well as other factors).  This also can involve growth versus gains, which can have important capital gains tax implications for employees and clients.

While the scope of who is determined to be a fiduciarymay still not be clear, to clients they may have an unclear understanding of what a fiduciary’s role is and what duties a fiduciary has. They may also be hearing information in the news about the DOL/SEC and state laws on changing definitions of a fiduciary, without understanding that the concept of fiduciary responsibilities is unchanged, but the scope of who falls into specific reporting and other duties has.

Interest and compound interest, as well as annual percentage rate can be remarkably confusing to employees. The fact that so many financial writers have covered the idea of compound interest in every possible permutation means that many employees still don’t grasp how interest from investments can grow, year after year, on itself. This could be because the only other aspect of interest that most consumers encounter is related to credit cards, which discuss their annual percentage rate rather than highlighting that they too compound interest on the debt the consumer holds, year after year. This can also be confusing if a consumer has been searching for information about savings accounts, which discuss annual percentage yield, a closely related term.

Diversificationis also a concept ripe for confusion. In the workforce, diversification refers to a hiring and retention plan for ensuring that a workforce resembles the community in which the company does business or serves. Applying that concept to financial matters just doesn’t compute. In fact, many analysts note that consumers faired so poorly in the 2008 financial crisis because they thought they were diversified and yet didn’t fully understand that concept. Analysts caution that diversification as understood by consumers might involve having accounts at multiple banks or retirement accounts at multiple former employers.  Instead, a properly diversified plan addresses risk and asset mix, not just location of funds. This also holds for investors who think they understand that rebalancing an account means assessing holdings to ensure the highest rate of return, instead of addressing whether assets should change their risk position based on a change in an investor’s life or career.

While many consumers have deeply held principles about life or politics and their children attend schools where the head of administration is the Principal, they may mistake the primary portion of their loan, also known as principal. This may be an area where simple spelling can go far. And this term usually refers to loans, rather than investments, yet still may be confusing for many employees.

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