For many people, taking the first step into the world of investing can be an intimidating and overwhelming experience, not the least of which is because it involves a lot of specialized vocabulary. However, there’s no need to panic: once you break it down, all of this financial jargon isn’t as scary or as complicated as it might seem. If you’re a beginning investor, read on for a look at 14 of the most important terms you need to know to get started.
1. Asset Allocation
This is an umbrella term for your investment strategy. In other words, it’s all about what types of investments you’re going to choose and how much money you’re going to put in them. (Remember that an asset is anything of value that you own. This could be a home or a car, or it could be investment instruments such as stocks or bonds.)
A bond is a type of debt instrument. When you buy a bond—usually from a government, a municipality, or a company—you’re essentially loaning that money to the seller (also called the issuer) for a set period of time. When the maturity date of the bond arrives, the issuer pays back the principal (the amount you paid for the bond) to you plus interest.
3. Capital Gain
A capital gain occurs when you sell an asset, like an investment, for a higher price than you paid for it. (Conversely, when you sell an asset at a price that is lower than the purchase price, it’s known as a capital loss.)
In the context of an investment, cash refers to money that is readily accessible, usually in the form of certificates of deposit (also known as CDs, Treasury bills, or money market accounts).
This term is essentially the investment equivalent of the proverb “Don’t put all your eggs in one basket.” When you diversify your portfolio, it means that you include different types of investments in order to mitigate risk.
Equity refers to the difference between the value of all of your assets and liabilities (your liabilities are what you owe). For example, if you own a property worth $200,000 (this is your asset), but you have a mortgage of $100,000 on that property (liability), your equity is $100,000.
7. Expense Ratio
This is an annual fee that mutual funds charge their investors. In other words, it’s the percentage of the money that goes to the managers of the mutual fund to cover aspects such as administrative fees and other expenses.
A fiduciary is a category of investment advisor that is legally obligated to put their clients’ needs above their own financial interest. For first-time investor, working with a certified fiduciary can help to provide a greater sense of trust and confidence.
9. Index Funds
An index fund is a kind of mutual fund that tracks a specific index (an index is essentially a collection of stocks that represent a broad slice of the overall economy). Therefore, when you invest in an index fund, what you’re doing is betting on the success of the collection of companies represented by the index. Index funds tend to be popular with beginning investors because the costs are usually quite low.
10. Mutual Funds
You can think of a mutual fund like a large pool of money to which many different investors contribute. A fund manager then takes this money and uses it to purchase assets such as stocks and bonds. Some mutual funds hold hundreds of different stocks, which helps to spread the risk. The idea behind a mutual fund is that it allows you to have greater purchasing power as a collective than you would have as an individual investor.
A portfolio is the term used to describe all the investments that you own. A portfolio can contain an infinite number and variety of investments, ranging from stocks and bonds to commodities.
When you’re doing your homework about what investments you want to choose, you’ll want to ask your financial advisor (or search online) for a prospectus from each company or fund that you’re considering. This is an important legal document that outlines all the relevant, in-depth details—such as the expense ratio, a list of all the fund’s holdings, tax considerations, purchasing rules, and risks associated with the fund—about the investment in question. This allows you to make an informed decision about whether or not you want to invest.
This term refers to many kinds of investments (such as stocks, bonds, and mutual funds) that have value and can be transferred or sold to another investor. Note that securities are intangible assets. For example, precious metals are not securities, but precious metal stock is.
Stocks are pieces of ownership in a company. In other words, when you buy stock in a company, you’re becoming a partial owner of that company. Stocks are also often referred to as shares.