Investing Terms Basics
These days—with the explosion in self-managed retirement, education, medical, and other accounts—just about everyone needs to understand a bit about investing. The first hurdle, and one that some find too intimidating to ever quite get past, is getting a grip on investing jargon.
Here’s a brief guide to a few of the most fundamental investing terms. There’s much this doesn’t cover, but the aim is to get you past any initial anxiety about investing, and maybe even inspire your interest! In some cases I’ve simplified and intentionally left out nuances and details. Like most things, you don’t need to know everything to get started. Just dive in!
Stock (or Equity)
Most larger corporations are publicly held, which means their legal owners are individual shareholders—people like you. Publicly held corporations issue shares of stock, or equity, and sell these shares to the general public. The corporation’s managers use the money to make investments to improve or grow the business. The laws of supply and demand dictate the value of a share of a company’s stock. If a company’s prospects are very good, many people will want to buy the stock and the stock price will go up through the competitive bidding process managed by stock exchanges.
A bond documents a loan. It’s a promise to pay, sold to investors by corporations, cities, states, governments, and other entities to raise cash. Bonds typically are sold in $1,000 increments, or “face value.” If you buy a $1,000 General Electric bond with a 5% coupon, or interest rate, that matures on June 30, 2020, then GE will pay you $50 interest (5% of $1,000) each year. Then on June 30, 2020 GE will pay back the $1,000 you lent GE when you bought the bond.
A physical good or product—soybeans, oil, copper, gold, pork bellies—traded on an exchange. (“Exchanges” are just tools the make it easy for buyers and sellers to find each other and agree on a price.)
The price at which a willing buyer and seller agree to exchange an asset at a given point in time.
A mechanism for pooling money from many investors to purchase for the joint benefit of the mutual fund’s shareholders a usually large number of stocks, bonds, or other financial instruments.
Similar to a mutual fund from the individual investor’s perspective, except ETFs may be traded—bought/sold—throughout the day on a stock exchange. (Mutual funds trade only at their closing price at the end of each trading day.)
Mutual Fund or Money Management Company
A firm that organizes and manages mutual funds, exchange-traded funds, and other investments. Some mutual funds are “actively managed,” which means the fund company’s managers research and choose the fund’s investments based on their best judgment. Other mutual funds are “passively managed,” meaning the fund’s cash is invested so the fund’s performance closely mimics the performance of a particular stock index, like the Dow Jones Industrial Average Index or the S&P 500 Stock Index. Passively managed funds require no human judgment for the selection of individual investments.
Money Market account
A bank account or mutual fund that invests only in very liquid, very safe, debt instruments of short maturity. (“Maturity” means how long until the loan underlying the debt is repaid. The shorter the maturity, the less risky the debt, everything else being equal.) Most bank money market accounts are FDIC-insured; money market mutual funds may be uninsured, but generally are considered relatively safe. It’s rare—but not unprecedented—for investors to lose money in a money market mutual fund.
The original amount paid for an investment.
Periodic, usually quarterly, cash payments made to a company’s, mutual fund’s, ETF’s, or other entity’s shareholders. For corporations, dividends are declared by the Board of Directors, paid from the company’s cash reserves, and entirely optional at the Board’s discretion.
The cash stream an asset pays to the investor, as a percentage of the current market value of the asset. For example, a stock that can be bought now on the New York Stock Exchange for $10 that pays a dividend of $0.05 per quarter has an annual dividend yield of 2%:
→ $0.05/quarter dividend for four quarters equals $0.20 annual dividend.
→ $0.20 ÷ $10 = 2%.
The cash paid at regular intervals of time to holders of bonds, Certificates of Deposit, or interest-bearing accounts, as compensation for lending money to the interest payer.
A company authorized by the Securities and Exchange Commission to buy and sell, or broker, shares of stock, bonds, or other other investments on behalf of clients.
A measure of how easily and quickly any particular asset can be sold for cash (liquidated). For example, shares in a money market mutual fund are highly liquid because they can be converted to cash overnight. Real estate and small businesses are very illiquid; months may pass between the owner’s decision to sell and his or her receipt of cash for the property or business.
A measure of how much and how often the market value of an asset tends to move up and down. Assets with market values that regularly and quickly change by relatively large percentages are said to be volatile.
In the investment world, diversification refers to the strategy of spreading one’s savings among several different sorts of investments. Or, colloquially, diversification means avoiding putting all of one’s eggs in a single basket. Studies prove that diversified collections of investments (or “portfolios”) generate higher returns than undiversified portfolios.
Unsure of Any Investment Terms?
This of course is by no means a comprehensive list. What’s an investment term you may be confused about that’s not listed? Do you have any corrections or improvements for my definitions?