a breakdown of fifteen common investing terms that you’ll need to know.
hello peeps!
Does the idea of investing your money intimidate you? Maybe it makes you so nervous you can’t even fathom starting in the first place! If you’ve been wanting to invest (or are tired of being told by friends and family that “you gotta start!!”) but feel like you don’t quite know enough about it, then this breakdown of common investing terms is for you!
I outlined and defined some of the more common investing terms you’ve probably heard and detailed them below. Here’s hoping that after reading and learning some of these ideas below, that you’ll feel more prepared to dive into the investment world when the time is right and whenever makes sense for you. I know you can do it – you’ve got this!
Portfolio: An investment portfolio is your collection of assets (stocks, bonds, mutual funds, real estate, cash, and other securities).
Asset Allocation: the process of diversifying and reducing risk in your investment portfolio by divvying up (and allocating) portions of your assets according to your overall risk tolerance. For example, one might choose to allocate their assets by investing in 50% stocks, 30% bonds, and 20% cash (as long as this strategy aligned with their investment goals and risk tolerance).
Rebalancing: the act of right-sizing or adjusting your portfolio allocation back to your desired goals. For example, let’s say your ideal asset allocation (based on your goals and tolerance for risk) is 50% stocks, 40% bonds, and 10% cash. If the market has been performing fairly well, you may notice that your allocation shifted a bit in favor of 65% stocks, 25% bonds, and 10% cash. In order to return your asset allocation to the ideal percentages you started out with, you would rebalance accordingly by potentially selling some of your stock to purchase more bonds or investing additional funds into bonds to restore the balance in your portfolio.
Risk tolerance: Your capacity for and ability to tolerate a particular amount of volatility in your investment accounts. As a general rule of thumb, the farther away you are from retirement, the more risk you can afford to experience, whereas an individual on the cusp on retirement would perhaps be significantly more risk averse as they have less time to recover from losses experienced. Despite this general rule, risk tolerance varies greatly by individual and should be adequately discussed and identified prior to engaging in investing.
Diversification: A way to spread around your investment risk or to not put all of your eggs in one basket. Key ways to diversify your investments are to invest in different, uncorrelated sectors as well as different types of asset classes. For example, one might invest in stocks, bonds, and mutual funds (spreading risk across many investment types) and, additionally, choose to invest those securities across many different types of industries (such as healthcare, finance, technology, and energy). This way, if something unfortunate were to happen in one of those sectors, you’d be protected (in theory) by being invested in other, unrelated industries. There are many ways to diversify your investments, but doing so is critical to ensure you don’t end up over-exposed to any particular type of investment risk.
Compound Interest: Interest that accumulates based on the original principal amount plus all of the additional accumulated growth, earnings, and interest.
Dollar Cost Averaging: Happens when an investor makes consistent, routine fixed-amount contributions to their investment account (for example, contributing $100 a month, every month) and therefore is able to buy more shares when prices are low and purchase fewer shares when prices are high. This essentially makes your average cost per share of a stock lower than the normal average stock price.
Here’s an example: say you invest $100/month every month. If the price of the stock you’re interested in buying is $20/share one particular month, you would be able to get 5 shares. If the price goes up to $50/share the next month, you’d only be able to purchase 2 shares with that same $100 investment. So you’d then have 7 total shares, which amounts to an average price per share of $28 for you ($200 investment divided by 7 shares = ~$28/share) while the true average of the price of the stock is at $35 ($20 stock price one month + $50 stock price the next month divided by two = $35).
The true benefit to dollar cost averaging is that it allows you to slowly build wealth even if you’re just starting out with a small amount to invest each month. It’s a strategic way to invest and keep some of the emotion out of it.
Commission-based advisors vs. fee-based advisors: An advisor who makes money by selling or purchasing stocks or other investment products for clients using their investment funds is commission-based. An advisor who charges a flat fee for managing a client’s money is a fee-based advisor (typically this fee is either a specific dollar amount or represents a percentage of the client’s assets under management (AUM)).
Growth Stock vs. Value Stock: A growth stock is typically a stock in a company that is growing quickly and therefore might be putting all earnings back into the company (vs. paying a dividend to shareholders). A value stock is one issued by more stable, slower-growth company that is more likely to distribute dividends to shareholders. Others may also classify a stock as a value stock as one that is affordably priced but poised with potential for opportunistic gains.
Mutual Fund: A fund consisting of multiple stocks and investments all typically professionally managed. A mutual fund is often a more cost-effective way to achieve diversification and broader exposure to the market than just purchasing one type of other investment. Think of these funds as a basket of sorts that contain holdings (stocks, bonds, or other investments) of other companies, typically representative of a particular sector of the market. If you have a limited amount to invest, it can be cheaper to purchase several shares of a mutual fund rather than purchase a small amount of particular stocks. In doing so, you can spread your risk around and do so without spending a large amount on any particular company stock, bond, or security. Note* these funds are very similar to Exchange Traded Funds (ETFs, for short), but tend to be a bit more expensive as these funds are more actively and professionally managed.
Exchange Traded Fund: commonly referred to as an ETF, these funds are traded on the stock market (just like a stock) and often track an index or hold a basket of stocks/funds/etc. ETFs offer a fairly low cost (and tax-efficient) way to invest a specific sum of money and achieve diversification and potential for gains. If you only have a small amount to invest, investing in ETFs can be a great first step and way to make your money work a little harder for you.
Cost Basis: the original price you pay for an investment or security (including the fees and potential commissions).
Capital Gains: In short, capital gains are the profit you can realize on an investment. If you sell a stock for a higher price than you paid for it (your cost basis), you will achieve a capital gain. These gains are then taxed accordingly.
Hope you guys enjoy my writing,
Spread love and positivity.
Kindest regards,
EMIR xx
