Investing money can sometimes be a pretty daunting task and the scarier part is the investing jargon that is involved. There are so many financial terms that investors and advisors use, and for a new investor, sometimes it is pretty hard to comprehend.
The following are the 10 essential financial terms that will help you navigate the world of trading and investments:
1. Asset Allocation: Asset allocation is your investment strategy to balance risks and rewards by apportioning your portfolio’s assets according to your investment goals, risk tolerance and investment horizon. One thing that you need to remember during asset allocation is that risk is directly proportionate to returns. Hence, cash being the least risky option has the least returns.
2. Cash: Since we brought this up in the definition above, cash is money, usually. But if a financial advisor tells you to move part of your portfolio to cash, the advisor is referring to certificates of deposit (CD), treasury bills or money market accounts.
3. Bonds: Bonds are basically loans that you are providing to a company or to the government. If all goes well, you can cash in the bond when it matures and can collect some interest.
4. Stocks: Stocks are tiny units of ownership in a listed company. When you buy stock, you get to own a certain percentage of the firm. If the company is performing well, your stock is worth more, if it isn’t then your stocks are worth less. The value of the stock is dependent on multiple factors like the market conditions, company’s growth forecast, the date you purchased the stock and a bunch of other factors.
5. Mutual Fund: Mutual fund is a pile of money that comes from a number of investors that is invested in stocks and bonds on your behalf by a mutual fund manager. A single mutual fund can hold scores of stocks and it is usually this way to spread the risk through different assets. Mutual fund managers take the decisions regarding buying and selling in mutual funds and you hold mutual fund units, proportionate to your investment.
6. Expense Ratio: Investors have to pay an annual fee so that their mutual funds are operable. This money needed for running a mutual fund is called an expense ratio. It goes to the managers of your mutual fund and bigger the expense ratio, the lesser are your profits.
7. Index Funds: This is a popular type of mutual fund. Its popularity lies in its low cost. But to understand index funds, you need to understand what indexes are. An index is essentially a collection of stocks that represent a part of the economy. You can track indexes and they give you a sense of how the stock or the bond market is performing. So, investing in an index fund will essentially mean that you’re investing in a basket of companies in that fund.
8. Target-date fund: These are designed to serve as all-in-one portfolios, tailored for your retirement. The target date is your expected date of retirement. You can start the investment as early on in your life as you want. In the beginning the investments will be riskier but as you reach the target date they will become mild-mannered and conservative.
9. Price-to-Earnings ratio: This is the ratio between a company’s stock price in relation to its earnings. It gives you a general measure of whether your investments are overvalued or not.
10. Prospectus: If you want to know as much as possible about an investment, you can ask your financial advisor for a prospectus or find one online. It’s a legal document that will contain all the in-depth details that you seek about stocks, bonds, mutual fund etc. you will find that in an investment’s prospectus.