A Beginner’s Guide To Investment Terms
Sarah Li Cain7-Minute Read
November 19, 2021
Whether you’re just beginning to dip your toes into investing or have done it for a little while, there may be some investing terms you’re confused about. That’s totally normal! As you continue to learn, you’ll find that the overwhelm may start to dissipate. To help you get started, here are some investment terms you may come across.
Investment Terminology For Beginners
Here’s a list of common investing terms that are useful for beginner investors.
Ask And Bid
Investment and asset prices are given through asks and bids. The ask is the lowest price a buyer or investor is willing to accept, whereas a bid is the highest price they will offer.
An asset is a resource or anything owned by a person or company that generates economic value. Some examples include a house, car, stock or gold.
A balance sheet is a summary of the financial balances of a person or a company’s assets. It shows a company’s liabilities and outstanding shareholder equity, if any.
Capital gain is the profit from an increase in an asset’s value that’s realized when that asset is sold. It’s usually taxed upon sale.
Capital loss is when an asset decreases in value. It’s not realized until an investor sells the asset for a lower price compared to the original purchase price.
Investment risk is the probability of losses in an investment. In other words, it’s the level of uncertainty an investor experiences when achieving expected returns.
Net asset is the value of a company’s assets, minus liabilities owed.
Risk tolerance is the degree to which a person can withstand losses when their investments perform poorly. If your risk tolerance is high, you can withstand more losses compared to someone who has a lower risk tolerance.
A share represents a unit of ownership of a legally formed company – the share owner (or shareholder) is owed a portion of the shares of stock. The share’s value is based on how the company divided its equity.
Volatility happens as traded investments or assets fluctuate in price over time. Investors look at a security’s pricing behavior to help estimate the price movement, or expectations on how high or low it’ll fluctuate.
The Different Types Of Investments You Should Know About
Once you’ve got the hang of some investing terms, you’ll find that there’s still plenty to learn, such as different types of investments available. Below are the most common types you’ll probably encounter – understanding the pros and cons of each will help you determine which types are best suited for you.
A bond is a loan given by an investor to a borrower. The bond issuer (usually a business) promises to repay the principal loan amount within a set period. In the meantime, it will pay investors interest. There are different types of bonds, including treasury bonds, corporate bonds, foreign bonds, municipal bonds and government bonds. There are also bond funds, which spread your investment across different individual bonds.
Certificate Of Deposit (CD)
A certificate of deposit or CD is a type of investment held at a bank or credit union which guarantees a rate of return for a specified period of time. Once this time period is over – called the maturity date – the investor gets their principal back with interest.
Exchange-Traded Fund (ETF)
An exchange-traded fund is a pooled investment fund. In other words, an investor purchases shares of the fund rather than shares of the individual investments. Investors can make trades much like someone would with stocks throughout the day, though they may pay more or less compared to the value of the underlying assets.
A hedge fund is a type of investment partnership where the partners combine money to generate profits and earn returns. Hedge funds typically use borrowed dollars (or leverage) to try to increase their returns or to make bets against the market even when it’s down to try to earn more. Because of the complexity of hedge funds, government regulations are in place to protect less experienced investors. Securities and Exchange Commission requirements dictate who can qualify and invest in hedge funds.
A mutual fund is similar to an ETF, when an investor purchases a pool of underlying assets within a fund. The money is invested by a portfolio manager, and investors won't be able to make trades throughout the day like they would ETFs. Instead, trades are executed at the end of the day once markets have closed. Types of mutual funds include equity funds and index funds.
There are many kinds of retirement accounts that investors can open to help them live a comfortable retirement. Depending on the type of plan, they may be either tax deferred (you won’t pay taxes until you make withdrawals) or tax free (investments aren’t taxed even when you withdraw them, with some exceptions).
Here are some common types you’ll encounter:
- Traditional IRA: This individual retirement account (IRA) allows you to put in pretax dollars, and you deduct up to a certain amount of your taxable income. Money grows tax-free but you’ll be taxed when you withdraw funds.
- Roth IRA: This type of account allows you to put in post-tax dollars to grow tax-free. Money you withdraw will be tax-free, as long as these withdrawals fall within the Roth IRA rules.
- 401(k): This is a type of employer-sponsored retirement account, and you can make pre- or post-tax dollar contributions depending on the account’s features. You can contribute up to a certain amount each year, deducted from your paycheck. In many cases, your employer will also contribute a certain amount, usually up to a percentage of your earnings.
- 403(b): This is also an employer-sponsored plan similar to a 401(k), but it’s specifically for nonprofit and other tax-exempt organizations.
A stock gives an investor partial ownership of a traded company – think of it as a measurement of the amount of equity you have in the company. Stock prices are determined by the fluctuations in the market. Different types of stock include common stock (investors have voting rights) and preferred stock (there may be guaranteed dividends but no voting rights).
A trust fund is a type of legal entity in which a person or an organization can hold assets until they’re legally able to give it to another person. For instance, a minor child may not legally be able to inherit stock, so a relative (the trustee) could hold onto it in a trust until the child (the trustor) reaches adulthood.
Investment Strategy Terms To Understand
Now that you know the types of investments as well as some basic terms, you can learn about some common investment strategy and investment objective terms.
Asset allocation is a strategy that determines how an investor splits their portfolio among different assets to help reach their financial goals – these include risk tolerance and the time horizon. Investors can do so with the help of a portfolio manager, do it themselves, or sign up for a robo-advisor platform.
Diversification is a strategy that spreads money across different investments to reach the desired asset allocation. The idea is that you’re not putting all your money into one asset, which could increase your risk of facing extreme losses when one asset doesn’t fare well.
A dollar-cost averaging strategy is when investors distribute the amount they want to invest into equal amounts, then invest it at regular intervals. The point of purchasing investment assets over a period of time instead of a lump sum is so that investors can remove the emotion from investing, and minimize volatility in the market. Most commonly, you’ll see dollar-cost averaging with employer-sponsored accounts.
Important Stock Market Trading Terms
For those who are ready to invest in the stock market, it’s important to understand the following terms. That’s because it’ll help you choose between stocks to select one best suited for your financial goals.
An asset class is a group of investments that have similar characteristics and follow the same rules and regulations. Examples of asset classes include cash, cash equivalents, equities, fixed income, commodities, real estate and currencies.
A bear market is one that has prolonged falling or downward trends. It typically means that securities prices have gone down 20% or more, and may be accompanied by an economic recession. Investors are considered “bearish” when they believe the market is dropping; they may do things like short sell to profit off the declining market.
Broker And Brokerage
A brokerage is a company that helps investors buy and sell securities, whereas a broker is a firm or individual who charges fees and acts as a mediator between the buyer and seller.
A bull market is a financial market that is rising, trending higher, or expected to rise. Typically, it's defined as a 20% increase in stock prices after two dips of 20% or more. When an investor thinks the market is going to grow, they are considered a “bull.” They might invest more aggressively because they assume the market will continue to grow.
Dividends are a company's earnings that are distributed among certain shareholders – the amount will be determined by a company's board of directors. Dividends can be paid monthly, quarterly, semi-annually or annually.
Expense ratio is an annual fee investors pay to cover the operating and administrative expenses of mutual funds and exchange-traded funds.
An index measures the progress (or price fluctuations) of stocks or other types of investments within the securities market.
A margin is borrowed money from a brokerage that investors can use to make investments. Investors will then pay back the borrowed money (sometimes with interest) at a later date.
Market capitalization is the total market value of the outstanding shares of a company’s stock. It’s sometimes referred to as the “market cap” – you can calculate it by multiplying the total amount of the company’s outstanding shares by one share’s current market price.
The stock market buys and sells stocks that trade on a stock exchange or other investment venues.
The yield is the income return on an investment.
The Bottom Line
Learning important terminology can help make you a more informed investor when you begin your investing journey. Once you know what you want to invest in, you can learn how to determine the amount of money you should invest every month.
Viewing 1 - 3 of 3
How To Invest In Stocks: Investing For Beginners
Investing in stocks doesn’t have to be scary. Check out our guide on stocks, why they’re worth investing in, and how to get started on your investment journey.
How Do You Buy Your First Investment Property?
Let’s take a look at the steps you’ll need to take to purchase your first investment property, as well as the challenges you may face along the way.