Have you ever returned from a doctor visit and been confused about the physician’s terminology? The financial industry has similar dynamics with its own vernacular.
To help clients decode financial jargon during our meetings I frequently pause client conversations to ask if they understand what was just said. Translating financial vocabulary into plain English is necessary to the process.
I am a financial planner – not a financial advisor. Therefore, I do not manage your money. I do help with strategies to enhance your current lifestyle and manage your future savings.
This article defines “10 Financial Terms Every Investor Should Know” – from U. S. News and World Report web site:
http://money.usnews.com/money/personal-finance/articles/2014/09/05/10-financial-terms-every-investor-should-know
The article is reprinted here for your convenience –
10 Financial Terms Every Investor Should Know
Breaking down investing lingo into layman’s terms is key to understanding your financial picture.
Learning these terms will help you break down the financial language barrier.
By Geoff Williams Sept. 5, 2014 | 10:44 a.m. EDT
For a novice, it can be intimidating to invest money. There’s the anxiety that comes with taking risks and knowing you may not get all of your money back. But arguably, what’s even more intimidating is the investing jargon. There are a lot of buzzwords financial advisors and veteran investors use, like expense ratio and asset allocation, that are important for average investors to understand, yet the language can be a barrier.
So if you’d like to invest but feel like you’re visiting another country where your money may not be welcome, maybe you just need to learn the language first. This isn’t a comprehensive list by any means, but understanding these terms may make you feel more confident about investing.
Asset allocation. This is just a fancy phrase for your investment strategy. There are three general categories where you’re going to put your money: cash, bonds and stocks, says Kemberley Washington, an accounting professor at Dillard University in New Orleans and a certified public accountant. “Cash,” she says, “is the least risky and would provide the least amount of return … Bonds are generally riskier than cash but less risky than stocks.”
Cash. Since Washington brought it up, let’s define cash. It’s money – you know that – but if a financial advisor suggests you move some of your portfolio into cash, Washington says he or she is probably referring to certificates of deposit, also known as CDs, Treasury bills or money market accounts.
Bonds. When you invest in a bond, you are essentially loaning money to a company or government. Provided that nothing bad happens, like a bankruptcy, you cash in the bond on the maturity date and collect some interest.
Stocks. When you buy stock in a company, you’re purchasing a tiny bit of ownership in the firm. Generally, the better the company performs, the more your share of stock is worth. If the company doesn’t do so well, your stock may be worth less.
Mutual fund. In layman’s terms, this is a pile of money that comes from a lot of investors like you and is then invested in assets like stocks and bonds. A mutual fund may hold hundreds of stocks, with the purpose of spreading the risk. In most cases, money managers make buy and sell decisions for mutual funds, which brings us to our next definition.
Expense ratio. It costs money to run mutual funds, so investors can expect to pay an annual fee, expressed as the expense ratio. “That’s the percentage of your money that goes to the managers of the mutual fund you’re investing in,” says Keith Singer, a certified financial planner with a wealth management firm in Boca Raton, Florida. “So the bigger the expense ratio, the less money you’re going to make.” The expense ratio also covers other fund expenses, such as administrative fees, record-keeping fees and even print or TV ads promoting the mutual fund. In 2013, the average stock mutual fund had an expense ratio of 1.25 percent, according to Morningstar.
Index funds. This is a popular type of mutual fund because its costs are generally low – think more like 0.2 percent. But if you really want to understand index funds, you first need to understand indexes, which are essentially collections of stocks that represent a slice of the economy. By tracking the performance of a group of stocks, indexes give investors a sense of how the stock or bond market, or a portion of it, is doing. And by investing in an index fund, you are essentially betting on the success of the basket of companies it contains.
For instance, if you’re interested in investing in technology, you might sink your money into one of the many technology index funds. Or you might want to put your money into some really big, solid companies.
“While there are many indexes, the Dow Jones industrial average and Standard & Poor 500 are both well-known indexes,” Washington says. “The Dow tracks 30 large, blue-chip stocks, which are stocks of well-established and financially sound companies. Whereas the S&P 500 tracks 500 of the most widely held stocks.”
Target-date fund. Often found in 401(k) plans, target-date funds are designed to serve as all-in-one portfolios that are tailored to your expected retirement date. So if you have about 30 years until retirement, you might invest in a 2045 target-date fund. In the beginning, your investments will be riskier and more heavily weighted toward stocks, then as you get closer to 2045, the investments will become increasingly more conservative and will shift to include more bonds.
[Read: How to Navigate the Complicated World of 401(k) Fees.]
Price-to-earnings ratio. Remember in math class when you learned that a ratio is a relationship between two numbers? Here, you’re looking at a company’s stock price in relation to its earnings. “The price-earnings ratio gives you a general measure of whether your investments are overvalued or not,” Singer says.
As a general rule, a low P/E, between 0 and 10, means the company isn’t doing too well, or it’s doing just fine but is undervalued (this is why, when you research stocks, you don’t want to rely only on the P/E). If the ratio is high, over 25, that may be a sign that the company has a lot of growth in its future, but it might also be a sign that the industry is at the top of a bubble that’s about to burst. A P/E between 10 and 17 is generally considered average.
Prospectus. Looking for a go-to source that contains every bit of information about an investment? Ask your financial advisor for a prospectus, or search online to find one. It’s a legal document that contains in-depth details about stocks, bonds, a mutual fund or whatever you’re planning to invest in. If you’re wondering, for instance, what the expense ratio is on your mutual fund, or you would like a list of all the fund’s holdings, you’d find it in the prospectus.