When approaching investing, it is helpful to have a broad understanding of some basic concepts and terminology. Whether you are handling your own investing or working with an advisor, you can be more engaged in the management of your portfolio with a grasp of investment-related terms. Part of an advisor’s role is to educate clients on their portfolios, and that person will be able to work with you to help you achieve a level of comfort with the concepts and terminology.
General Asset Types
Bonds – Loans to governments or corporations that typically pay interest and give the investor a fixed rate of return.
Stocks – Securities that represent ownership of a portion of a company.
Cash – Money that is not invested or is invested in short-term, liquid securities like CDs, treasury bills or money market accounts.
Funds – Money coming from many investors which is invested in many assets. See “Types of Funds.”
Real Estate – Property consisting of land and/or buildings that owners use or charge rent for others to use.
Types of Funds
Mutual Fund – A pooled portfolio that allows exposure to a group of securities such as bonds and stocks to diversify investments and reduce risk. Many have fees.
ETF – Exchange-traded Funds. Similar to mutual funds but are traded throughout the day as if they were individual stocks. ETFs can hold assets like stocks, commodities, or bonds and typically have low fees.
Bond Fund – Also known as Debt Fund. These funds hold bonds and other debt instruments in hopes of generating monthly income and ensuring diversification.
Index Fund – A fund whose portfolio tracks elements of a financial market index, for example an S&P 500 Index Fund. Typically, these funds have low fees.
Target-date Fund – Funds that are tailored to an expected retirement date. Initially, the portfolio will be riskier, then as the retirement date approaches, they will become more conservative.
Hedge Fund – These are pooled funds from high net worth individuals using a variety of investment strategies. They often have high fees, are higher risk, and face less regulation than other funds. Only accredited investors can participate.
REITs – Real estate investment trusts are companies that own a wide variety of income-producing properties. REITs are traded like stock and can be very liquid.
Types of Accounts
Money Market – An interest-bearing savings account that usually pays a higher interest rate than a bank savings account. These are FDIC insured accounts with some features of checking accounts.
Brokerage – These are accounts with licensed brokerage firms that allow investors to buy and sell stocks, bonds and funds with the money they have deposited.
401K – an employer-sponsored retirement plan. Employees contribute pre-tax dollars which are invested in a variety of mutual funds. The contributions grow tax-free until they are withdrawn, typically at retirement. Employers often match contributions. Early withdrawals could be penalized.
529 – An account designed to save for future education costs. Qualified withdrawals, such as K-12 and college tuition are tax free. The account owner maintains ownership of the account until all the money is withdrawn.
UTMA – A Uniform Transfers to Minors Act allows minors to receive gifts such as money, securities, real estate, etc. A custodian manages the account only until the minor reaches legal age for their state of residence.
IRA – An IRA is a tax-deferred or tax-free retirement account. There are several types of IRAs (see “Types of IRAs”).
Trust – an account in which assets are held by the trustee for the benefit of the beneficiary. The beneficiary may be a person or a group. The trustee must act in the best interests of the beneficiary.
Types of IRAs
Traditional IRA – An individual retirement account funded by pre-tax income. Earnings grow tax-deferred until retirement when withdrawals are taxed at the owner’s current income tax rate. RMDs must be taken at age 72 ½. IRAs have limits to contributions.
Roth IRA – An individual retirement account funded by after-tax income. Individuals are not taxed when they withdraw their funds at retirement. Roth IRAs have salary limitations and limits to contributions.
Rollover IRA – An account that allows individuals to move money from their former employer-sponsored retirement plan to an IRA. The account keeps its tax-deferred status and there are many investment options in the IRA.
Simple IRA – An alternative for small business owners to offer retirement savings to their employees without some of the challenges of a 401K.
SEP IRA – A simplified employee pension funded by employers, not employees. These have higher contribution limits than traditional IRAs and employees can determine how their funds are invested.
Terms from Investment Reports
Asset Allocation – The percentage of your assets in different asset categories such as cash, bonds and stocks. The weighting typically depends on your age and your risk tolerance.
Diversification – An investment technique that attempts to reduce risk and overexposure to any one asset or sector of the economy by investing across different financial instruments, industries and companies or issuers.
Realized Gains/Losses – An increase or decrease in the value of an asset that an investor has sold.
Unrealized Gains/Losses – An increase or decrease in the value of an asset that an investor holds and has not yet sold.
Market Value – The price an asset would fetch on an open market.
Margin – Money borrowed from a brokerage firm using the assets held in the account as collateral. Margin loans are often used to purchase securities.
Broker – a general term for one who buys and sells investments for a client, typically for a fee and/or commission.
Registered Investment Advisor – one who gives advice on securities as part of their normal course of business and receives compensation for this advice. They do not receive any compensation for selling financial products. They are held to a fiduciary standard which requires them to: act in their clients’ best interest, trade securities at the lowest cost and highest efficiency, analyze data thoroughly and completely, and show loyalty to clients.
Financial Advisor – A general term for someone who works in the financial services industry and gives advice on investments and securities in exchange for compensation. Financial Advisors can receive compensation for advising clients and for selling financial products. They are held to a suitability standard which means they can sell products that benefit their clients and help their own bottom line.
Stock Market Indexes
There are nearly 5,000 US indexes. Each index is a collection of stocks that represents a slice of the economy. By tracking the performance of a group of stocks, indexes give investors a sense of how the stock or bond market, or a portion of it, is performing.
DJIA – The Dow Jones Industrial Average is the oldest index in the world. It includes 30 of the largest companies in the US. It is a price-weighted index and represents about a quarter of the value of the US stock market.
S&P 500 – The Standard & Poor’s 500 Index is a market-weighted index of 500 of the top US companies chosen by capitalization, liquidity, financial viability and other factors. It is about 80% of the total value of the US stock market.
Nasdaq – The Nasdaq Composite Index primarily includes technology stocks but also includes securities from other industries and some speculative companies.