Individuals new to investing and personal finance may be overwhelmed by all of the jargon and acronyms. To help, we’ve compiled a list of terms and provided some high-level definitions as introductory materials for the new investor.
Investing for Beginners: Quick Reference Guide for Frequently Used Personal Finance Terms
(In alphabetical order)
401(k): A qualified employer sponsored retirement plan to which eligible employees can contribute on a pretax basis. Employers offering a 401(k) plan may make matching, nonelective, or profit-sharing contributions on behalf of eligible employees.
403(b): A qualified retirement savings plan available for public education organizations, some nonprofit employers, cooperative hospital service organizations, and self-employed ministers in the U.S. 403(b) plans have many similar features to a 401(k), but there are a few key differences. For example, employers sponsoring 403(b) plans are unable to make profit sharing contributions to employee accounts.
Active Management: An investment management strategy which typically aims to pick specific investments or attempt to strategically time trades with the goal of outperforming a benchmark index. Active management tends to be a more expensive strategy compared to passive management.
Appreciation: An increase in the value of an investment relative to the cost basis (typically the purchase price).
Asset Allocation: Establishing a portfolio structure to balance risk and reward according to an individual’s investment goals. Asset allocation includes the percentage of the portfolio that will be invested in stocks and bonds, and the asset classes that will comprise the subgroups, such as the allocation to domestic equity funds and international equities.
Asset Class: A group of securities that have similar characteristics and behave similarly in the marketplace. Three common asset classes are equities (i.e. stocks), fixed income (i.e. bonds) and cash equivalents (i.e. money market funds).
Basis Points: A common unit of measurement for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1% or .01%. A 1% change = 100 basis points. Basis Points is can be abbreviated as BP, BPS, or BIPS.
Benchmark: Unit of measurement; a standard against which an investment’s performance is measured. Passive managers may seek to replicate their benchmarks, whereas active managers may try to beat the benchmark performance.
Bonds: Bonds are a form of borrowing between a corporation or the government and a buyer of the debt, the bondholder. The repayment of the “loan” must be repaid over time to the lender with periodic interest.
Short-term bond: Generally, a bond maturing in less than 3 years from the date of issue.
Intermediate bond: Generally, a bond maturing in 3 to 10 years from the date of issue.
Long-term bond: Generally, a bond maturing in 10 or more years from the date of issue.
Broker: An agent or representative who handles orders to buy and sell securities or commodities. For this service, a commission or fee is often charged. A common example is when an individual calls Fidelity or Schwab to buy or sell a stock.
Broker-Dealer: When acting as a broker, a broker-dealer executes orders on behalf of his/her client. When acting as a dealer, a broker-dealer executes trades for his/her firm’s own account. Broker-dealers can be compensated in several ways, such as through commissions and advisory fees.
Capital Gain: An increase in the value of an asset, generally calculated by the investor’s basis, typically the difference in the purchase price and the sale price. An unrealized capital gain is an investment that hasn’t been sold yet but would result in a profit if sold.
Long-term capital gain: gain on the sale of an asset held more than 12 months (for most types of capital assets)
Short-term capital gain: gain on the sale of an asset held for 1 year or less
Capital Loss: The loss in value of an investment, generally calculated by the investor’s basis, which is typically the difference between the purchase price and the net sale price.
CERTIFIED FINANCIAL PLANNER™ certification: The CFP® marks are financial planning credentials awarded by Certified Financial Planner Board of Standards Inc. (CFP Board) to individuals who must pass a series of exams and enroll in ongoing education classes. Knowledge of estate planning, tax preparation, insurance, and investing is required. The CFP® certification is often considered the most highly regarded financial planning designation.
Cost Basis: Cost basis is used to calculate an investor’s gain or loss for tax purposes. Cost basis is typically the original purchase price, and then adjusted for commissions, stock splits, return of capital, or other types of transactions that affect the tax basis.
Custodian: A person or entity (i.e. bank, trust company, or other organization) responsible for holding financial assets. A third-party custodian can help protect investors by acting as the intermediary between an investment manager and the individual who owns the asset.
Discretionary Account: An account in which the investor gives authority in writing to the representative to exercise his/her own judgement with respect to purchasing or selling securities without obtaining the client’s prior approval on the details of each trade.
Dividend: A payment of cash or stock that is distributed to shareholders. Dividends are usually financed by profits and are announced by the company’s board of directors before they are paid. Not all companies issue dividends and the amount can vary widely between organizations.
Dividend Reinvestment: In lieu of receiving a cash dividend, dividend reinvestment allows investors to use their dividends to purchase additional shares of the same stock or mutual fund. This is selected at the account level with the custodian.
Equities vs. Bonds: Equity ownership (i.e. stocks) is only issued by companies whereas bonds may be issued by governments, companies, and financial institutions. Bonds are generally considered a safer investment compared to stocks, which also means the investor should expect a lower return. Holding both stocks and bonds in a portfolio is a good first step to reduce risk through diversification.
Equity: A stock or any other security representing an ownership interest. Investors can hold equities as single stocks, index funds, mutual funds, or other means.
Exchange Traded Fund (ETF): At a high level, consider an ETF like a mutual fund that is traded like a stock. ETFs can be traded throughout the day and the price, which will vary throughout the day, will be determined by the market. ETFs generally have lower investment minimums and expenses compared to mutual funds.
Expense Ratio: The expense ratio, expressed as a percentage, measures how much of a fund’s assets are used for administrative and other operating expenses. These expenses are ultimately paid by investors, as a reduction of the fund’s assets. The expense ratio can be viewed as a direct reduction of an individual’s expected return; for example, if the expected return is 5% and the expense ratio is 0.5% (50 basis points), the expected return net of fees would be 4.5%.
Fee-Based Advisor: A fee-based financial advisor is typically compensated through multiple revenue streams, such as advisory fees paid by an investor, commissions paid by the investor or a third party, or revenue-sharing agreements with fund companies. Investors should be aware that a fee-based advisor can be financially incentivized to provide certain advice.
Fee-Only Advisor: Fee-only advisors are only compensated by their clients; they do not sell financial products (like insurance or stocks) or receive commissions. This structure helps reduce the potential conflict of interest that other advisors may have when part of their compensation is based on the specific recommendations they provide.
Fiduciary: A fiduciary duty is the highest act of loyalty, trust and care as established by law. Regarding financial advisory firms for individuals, only registered investment advisors have a fiduciary duty to act in the sole benefit and interest of their clients. Many registered investment advisors are also fee-only, but it is not a requirement.
Financial Industry Regulatory Authority (FINRA): A self regulatory organization for brokerage firms doing business in the United States.
Index Funds: An exchange traded fund (ETF) or mutual fund that tries to mimic the performance of a particular index, such as the S&P 500.
Investment Objective: The goal that an investment fund or investor seeks to achieve. Goals could be related to growth or income, time horizon, and so on.
Investment Return: The gain or loss on an investment over a certain period expressed as a percentage. Income and growth are included in calculating the investment return. Returns can be expressed as gross or net of fees and investment expenses.
Traditional Individual Retirement Account (IRA): A retirement account that provides tax advantages for retirement savings in the U.S. Individuals that meet certain requirements may be able to make tax-deductible contributions to an IRA. Growth and earnings in a traditional IRA will grow on a tax-deferred basis until funds are withdrawn in retirement.
Irrevocable Trust: A trust in which the creator names another individual to manage the trust. The terms of the trust cannot be changed without permission of this individual. An irrevocable trust can help protect assets, including property, from damages in a lawsuit and assets will be excluded from the donor’s estate at death.
Joint Tenants with Right of Survivorship (JTWROS): A legal way to hold investment assets in which two or more people share ownership. All tenants have equal rights to property. If one tenant dies, the others receive the decedent’s share.
Liquidity: The ability to quickly convert an investment to cash.
Market Capitalization (large cap, mid cap, small cap): The total dollar value of outstanding tradable shares of a company. It is calculated by multiplying the company’s outstanding shares by the current market price of one share. For example, if a company’s shares are currently trading at $10 share and there are 2 million shares outstanding, the market cap would be $20 million. Market capitalization is important when deciding how to diversify your portfolio and assessing the size of different companies.
Large cap companies: typically greater than $10 billion
Mid cap companies: typically $5-$10 billion
Small cap companies: typically less than $5 billion
Market Risk: Market risk, or systematic risk, is the uncertainty related to the entire market. Also known as volatility, market risk refers to the behavior of the investment rather than the reason for the behavior. Unsystematic risk, known as specific risk, is the type of uncertainty that is inherent to a specific company or industry. An example of unsystematic risk is increased government regulation in the healthcare industry.
Money Market Fund: A mutual fund that invests in short-term, high-grade fixed income securities, and seeks the highest level of income consistent with preservation of capital (i.e. maintaining a stable share price).
Mutual Fund: A mutual fund pools money from investors to buy stocks at a larger scale to achieve a specific investment objective. Mutual funds can be actively or passively managed. Unlike stocks and ETFs, which are priced and traded throughout the day, mutual funds only trade once a day when market closes and the price is based on the net asset value (NAV) of the underlying assets.
Passive Management: Also called a buy-and-hold strategy, this style of investment management often aims to mirror a market index. Passive managers usually believe markets are efficient and it isn’t possible to regularly outperform a benchmark through stock picking or timing trades on an expense-adjusted basis.
Portfolio Manager: The individual, team, or firm who makes the investment decisions for an investment portfolio including the selection of the individual investments.
Principal: The original dollar amount of an investment. Principal may also be used to refer to the face value or original amount of a bond.
Rebalancing: The process of selling outperforming assets and buying underperforming assets in order to maintain a desired asset allocation. Rebalancing is typically done at stated intervals (i.e. 6 months or 1 year) or by a threshold basis.
Registered Investment Adviser: A registered investment adviser is a type of financial advisory firm that has a fiduciary duty to act in the sole benefit and interest of their clients. A fiduciary duty is the highest act of loyalty, trust and care as established by law. Advisors who are not registered investment advisors are held to a suitability standard.
Revocable Trust: A trust that can be changed, amended, or even revoked (terminated) by the grantor at any time before his/her death. This may include such changes as adding or removing assets, beneficiaries, or changing the trustee. A revocable trust can provide better control over what happens to assets at death and is a means to avoid the lengthy, expensive, and public probate process.
Roth IRA: An individual retirement account where qualified withdrawals can be made on a tax free basis. Roth IRAs are not subject to RMDs (required minimum distributions) at age 70 ½. Unlike a traditional IRA, where contributions can be tax-deductible, participants who qualify to participate in a Roth IRA will add funds on an after-tax basis.
Securities and Exchange Commission (SEC): Government agency created by Congress in 1934 to regulate the securities industry and to help protect investors. The SEC is responsible for ensuring that the securities markets operate fairly, orderly, and efficiently. The SEC also regulates registered investment advisors that have $110+ million of assets under management.
Security: a term used to describe a broad range of investment instruments, including stocks and bonds, mutual funds, options, and municipal bonds.
SEP IRA (Simplified Employee Pension Individual Retirement Arrangement): A variation of the individual retirement account used in the U.S. SEP IRAs can be adopted by business owners and the self-employed to save for retirement on a tax-deferred basis. Only employers can contribute to a SEP IRA and funds must be allocated equally across employee-participants.
Stock: An instrument that signifies an ownership position (equity) in a corporation. Equity positions can be private or publicly traded.
Rollover IRA: An account that allows for the transfer of assets from an old employer-sponsored retirement account to a traditional IRA. The purpose of a rollover IRA is to maintain the tax-deferred status of those assets while consolidating an individual’s financial accounts at one institution for ease of management, cost savings, expanded investment options, and so forth.
Trustee: An entity or a person that has a legal obligation to administer funds/estates in a manner consistent with the terms specified in a trust.
Yield: The value of interest or dividend payments from an investment, usually stated as percentage of the investment price.