How and where you invest your hard-earned money is an important decision. However, fully understanding your investments can require a crash course in terminology. The following definitions for a few key terms can help increase your understanding of the investment process and enable you to make more informed decisions:
The most common terms that are related to different types of investments:
- Bond: A debt instrument, a bond is essentially a loan that you are giving to the government or a company in exchange for a pre-set interest rate. Typically, the bond pays interest (a coupon payment) during its term, and it matures on a specific date, at which point the total face value of the bond is paid to the investor. If you buy the bond when it is first issued, the face or par value you receive when the bond matures will be the amount of money you paid for it. In this case, the return you receive from the bond is the coupon, or interest payments. If you purchase or sell a bond between the time it is issued and the time it matures, you may experience losses or gains on the price of the bond itself.
- Stock: A type of investment that gives you partial ownership of a publicly traded company.
- Mutual fund: An investment vehicle that allows you to invest your money in a professionally-managed portfolio of assets that, depending on the specific fund, could contain a variety of stocks, bonds, or other investments.
- Exchange-traded fund (ETF): Funds – sometimes referred to as baskets or portfolios of securities – that trade like stocks on an exchange. When you purchase an ETF, you are purchasing shares of the overall fund rather than actual shares of the individual underlying investments.
Once you have a better understanding of the investment choices available, you may come across specialized terms that explain how money can be invested:
- Asset allocation: This refers to how you divide up your portfolio among different asset classes, such as stocks, bonds, and cash alternatives, to help you work toward your financial goals.
- Diversification: This is the practice of spreading your money across different investments to reach your desired asset allocation.
- Dollar cost averaging: A strategy that involves purchasing a fixed amount of an investment at a predetermined interval, $500 per month, for example, regardless of the price.
There are a variety of terms that describe gains, losses, and individual investments.
- Capital asset: Anything you own and use for personal or investment purposes. Examples include your home, your car, and stocks or bonds.
- Capital gain/loss: Profit or loss from the sale of an asset.
- Capital appreciation/depreciation: The amount by which the value of an asset increases or decreases compared to the amount you paid for it.
- Dividends: A distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders.
- Index: A group of securities representing a particular market or industry or a portion of it. Indices often serve as benchmarks for measuring investment performance– for example, the Dow Jones Industrial Average or the S&P 500 Index. Although investors cannot directly purchase an index, they are able to invest in mutual funds and exchange-traded funds that are intended to mimic the performance of the indexes. These types of vehicles enable investors to invest in securities representing broad market segments and/or the total market.
- Margin account: An account that allows you to borrow money using securities and cash held in the account as collateral.
- Prospectus: A document filed with the SEC that describes an offering of securities for sale to the public. The prospectus fully discloses the risks, policies, and fees of the offering.
- Yield: The income return on an investment. This refers to the interest or dividend received from a security based on the investment’s value.