Imputed interest When the IRS considers interest should have been paid even though no actual interest payment was made, that’s called imputed interest. For instance, let’s say you hold a zero-coupon bond that pays no interest during its term. Income taxes are due annually on the imputed interest, even though you don’t receive the actual payment until the bond matures. In another example, if you lend money to someone without charging interest, the IRS requires you to pay tax as if you had in fact collected at market rates. That’s the case even if the person needs the money, and you have cash to spare.
Index An index reports changes up or down, usually expressed as points and as a percentage, in a specific financial market, in a number of related markets, or in an economy as a whole. Each index — and there are a large number of them — measures the market or economy it tracks from a specific starting point. That point might be as recent as the previous day or many years in the past. For those reasons, indexes are often used as performance benchmarks, against which to measure the return of investments that resemble those tracked by the index. A market index may be calculated arithmetically or geometrically. That's one reason two indexes tracking similar markets may report different results. Further, some indexes are weighted and others are not. Weighting means giving more significance to some elements in the index than to others. For example, a market capitalization weighted index is more influenced by price changes in the stock of its largest companies than by price changes in the stock of its smaller companies.
Index fund An index fund is designed to mirror the performance of a stock or bond index, such as Standard & Poor's 500® Index (S&P 500®) or the Russell 2000® Index. To achieve that goal, the fund purchases all of the securities in the index, or a representative sample of them, and adds or sells investments only when the securities in the index change. Each index fund aims to keep pace with its underlying index, not outperform it. This strategy can produce strong returns during a bull market, when the index reflects increasing prices. But it may produce disappointing returns during economic downturns, when an actively managed fund might take advantage of investment opportunities if they arise to outperform the index. Because the typical index fund's portfolio is not actively managed, most index funds have lower-than-average management costs and smaller expense ratios. However, not all index funds tracking the same index provide the same level of performance, in large part because of different fee structures.
Inflation Inflation is a persistent increase in prices, often triggered when demand for goods is greater than the available supply or when unemployment is low and workers can command higher salaries. Moderate inflation typically accompanies economic growth. But the US Federal Reserve Bank and central banks in other nations try to keep inflation in check by decreasing the money supply, making it more difficult to borrow and thus slowing expansion. Hyperinflation, when prices rise by 100% or more annually, can destroy economic, and sometimes political, stability by driving the price of necessities higher than people can afford. Deflation, in contrast, is a widespread decline in prices that also has the potential to undermine the economy by stifling production and increasing unemployment.
Interest Interest is what you pay to borrow money using a loan, credit card, or line of credit. It is calculated at either a fixed or variable rate that’s expressed as a percentage of the amount you borrow, pegged to a specific time period. For example, you may pay 1.2% interest monthly on the unpaid balance of your credit card. Interest also refers to the income, figured as a percentage of principal, that you're paid for purchasing a bond, keeping money in a bank account, or making other interest-paying investments. If it is simple interest, earnings are figured on the principal. If it is compound interest, the earnings are added to the principal to form a new base on which future income is calculated. Interest is also a share or right in a property or asset. For example, if you are half-owner of a vacation home, you have a 50% interest.
Investment income Investment income may come from earnings the investment produces or from capital gains, which you realize for selling an investment for more than you paid to buy it. Investment earnings include interest from bonds and bank deposits, dividends from stocks and other equity investments, and rent from real estate you may own. Long-term capital gains – profits from the sale of an asset you’ve held for more than a year – and qualifying dividends are taxed at a lower rate than your other investment income.
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