Beginners looking to invest for the first time can often be overwhelmed to the point of indecision. So many terms are casually tossed about by investment professionals and the financial media that it can be easy to be insecure about taking your first steps.
But the truth is that investing, at its core, is a simple proposition. As long as you consistently contribute to investments with successful long-term track records, you’re likely to do well. But learning the lingo of the investment world also can give you the confidence you need to participate in the first place. With that in mind, here are 18 investing terms that you should really know before you jump in with both feet.
Asset Allocation: Asset allocation refers to the different types of investments you buy with your money. For example, if all you buy is 100 shares of Microsoft, your asset allocation is 100% stocks. But if you mix in some bonds, foreign currencies, Treasury bills and so on, your asset allocation is more diversified.
Diversification: Diversification refers to spreading out your asset allocation among different types and styles of investments to help reduce your overall risk. In other words, diversification is the opposite of “putting all your eggs in one basket.”
Bull Market: A bull market refers to a market that continues to trade higher, particularly over an extended period of time.
Bear Market: The opposite of a bull market, typically characterized by a drop of at least 20% in market prices.
Capital Gain/Loss: Capital gains or losses occur when you sell an investment above or below the price at which you purchased it. Long-term capital gains, or those held for longer than one year, benefit from more advantageous tax treatment.
Momentum Investing: Momentum investing refers to buying stocks or other assets that are rising rapidly in price, without regard to valuation or other fundamental indicators. The belief of momentum investors is that an asset in motion tends to stay in motion.
Bid/Ask Spread: The bid/ask spread refers to the price differential between the highest price a buyer is willing to pay for an asset and the lowest price at which another investor is willing to sell. Once those two prices match, a trade occurs.
Bond: A bond is essentially a loan. Bond issuers take investor money in exchange for the promise of regular interest payments and the return of principal at a specified date in the future, known as the maturity date.
Stock: A stock represents a fractional ownership share in a company. The value of this ownership share fluctuates minute to minute and sometimes second to second on the global stock exchanges.
Exchange-Traded Fund: An exchange-traded fund, or ETF, acts like a mutual fund that can be bought and sold like a stock on an exchange. Typically, ETFs track major indices such as the S&P 500.
Margin: Margin isn’t recommended for beginning investors, but it allows you to leverage your returns by borrowing against your holdings. For example, you can use margin to buy $1,000 of stock with just $500 invested. At this 50% margin level, your gains — or losses — are magnified by 50%. In this example, if your stocks gain in value from $1,000 to $2,000, your net profit is $1,500, not $1,000 ($2,000 sale price minus $500 invested equals $1,500 profit).
Short Selling: Short selling refers to borrowing stock that you then sell, intending to buy it back at a lower price and return it to the lender. Effectively, a short sale is a bet that a stock will go down in value. Short selling requires a margin account and could result in you putting up extra money if the stock goes up in value rather than down.
Real Return: Real return refers to the actual market return of an investment, also known as the nominal return, minus the rate of inflation. Some calculators also subtract other costs, such as taxes. Real return is meant to give investors a more accurate picture of how much additional buying power their investments are providing.
Investment Objectives: Your investment objectives describe what you are trying to achieve with our investments. Common investment objectives include growth, income or capital preservation. Your investment objectives help guide your asset allocation.
Risk Tolerance: Risk tolerance refers to the amount of volatility you are willing to accept in your investments, on a continuum that typically ranges from conservative to speculative. Risk tolerance is another important factor in creating your asset allocation, as it delineates which types of investments you may or may not be comfortable owning.
Rule of 72: The rule of 72 is an easy mathematical formula to estimate how long it will take to double your money with an investment. For example, if you anticipate earning an 8% return, your money will double in about 9 years. You can also reverse the formula, estimating the rate of return you’ll need to double your money in a specified time period.
Dollar Cost Averaging: Dollar cost averaging refers to investing the same amount of money at regularly scheduled intervals. For example, if you have $12,000 to invest, you can add $1,000 to your portfolio every month. This allows you to buy more of an investment if its price is low and a lesser amount when its price is high, thereby giving you a smoother long-term average cost.
Yield: Yield typically refers to the interest rate that a bond, stock or other investment pays as a percentage of its principal value. For example, a common stock might pay a 2% dividend, while a bond might pay a 5% rate of interest. This refers solely to the income component of your return.
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