When it comes to investing, you want to make sure that you are as informed as possible about any investments you are making and that you fully understand what you are investing in. Understanding how investing works begins with learning the basic, most commonly used investing terms and I'm sharing some of them in this blog post!
1. Brokerage Firm
A brokerage firm is a financial institution that manages or facilitates the buying and selling of securities (different kinds of investments e.g. stocks, bonds, funds, etc) between buyers and sellers.
They typically charge commission fees on trades and can provide you with up-to-date research, market analysis and pricing information on various securities. Examples of brokerage firms in the US include Vanguard, Fidelity, Charles Schwab, etc.
A stock is part ownership of a company. Stocks are also called shares or equities and the more you own the bigger your ownership stake is in a company.
In simple terms, a bond is when you loan money to a company or the government who in turn pay you back in full with interest. For example, the government may sell bonds to raise money for a specific initiative.
You can then purchase the bond and the government will pay you back over a fixed period of time with interest.
4. Mutual Fund
A mutual fund is a pool of funds from a group of investors set up for the purpose of buying securities like stock, bonds, etc.
Mutual funds are typically managed by a fund manager or a money manager associated with a brokerage firm. Their job is to make investment decisions for the fund and set the funds objectives.
5. Index Fund
By Investopedia, definition, an index fund is "a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor's 500 Index".
In plain English, this means, an index fund can be set up to buy all the same stocks within a specific index like say the S&P 500; this means you will be invested in every single one of the 500 companies that make up the S&P 500.
Or you can purchase a total market index fund which invests your money in equal ratios across the entire stock market based on a total market index that measures the investment return of the overall stock market.
Wondering about ETFs?
They are similar to index funds however they can actively be traded throughout the day at the current market price (you'll pay commission fees as a result) unlike mutual funds and index funds that are traded at the end of the day, and at the market's closing price.
Other key differences revolve around brokerage fees and tax efficiencies with ETFs and Index funds being more tax-efficient than mutual funds. (An investment advisor can help you break down your best option).
6. Asset Allocation
Investopedia defines asset allocation as "an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance, and investment horizon". It's pretty much your personalized investment plan based on your financial goals.
7. Capital Gains
This is the increase in the value of your investment that makes is higher than your original purchase price. The gains are not realized until the asset is sold though.
8. Expense Ratio
These are the annual fees that funds e.g. mutual funds charge their shareholders. These fees include fund management fees, administrative fees and other fees related to operating the fund on your behalf.
9. Price to Earnings Ratio (P/E)
This is a company's market value per share and a way by which companies are valued. It's calculated by taking the current stock price and dividing it by the company's earnings per share.
The dummies.com website further breaks it down as "The price-to-earnings ratio or P/E indicates how much investors are willing to pay for each dollar of profit they stand to earn per year.
For example, if an investor buys a stock with a P/E of 15, he’s willing to pay $15 for each dollar of profit, or 15 times the earnings for one share of stock. Another way to look at it is that it will take 15 years to earn back your investment in company profits".
In simple terms, this is not putting all your eggs in one basket. It's putting your money in a mix of investments to minimize your overall risk.
A prospectus is a legal document filed with the SEC (Securities and Exchange Commission) that provides details of an investment that is publicly made available for sale.
Investing in the stock market might seem and sound complex but if you make the effort to learn how it works, you'll be surprised at how quickly it all starts to make sense!