Investing has a language all its own, but it doesn’t have to be intimidating. The average investor only needs to know the basics, so if you have an understanding of the terms in this glossary, you’re off to a good start.
A contractual financial agreement between you and an issuing company. You give the issuing company a certain amount of money, and in turn the company promises to invest your money and repay you according to the option or payment method that you choose.
The practice of taking advantage of the difference in price of the same security traded on two different markets. For instance, if Nortel Networks were trading at $100 (U.S.) on the Toronto exchange and $99 on the NYSE, an arbitrageur would buy shares on the NYSE and sell them on the Toronto exchange.
Anything you own that has monetary value, including cash, stocks, bonds, mutual funds, cars, real estate, and other items.
The specific distribution of funds among a number of different asset classes within an investment portfolio. Investment funds may be split among a number of different asset classes, such as stocks, bonds, and cash funds, each of which has unique risk and return characteristics. Determining just how to allocate funds depends on the financial plans of the individual investor.
average daily volume
The average number of shares traded per day over a specified period.
A legal process where a party acknowledges that he is unable to pay his debts, and makes arrangements for those debts to be legally (if not financially) settled.
The party declaring bankruptcy either allows his assets to be sold to repay creditors to the extent possible (liquidation bankruptcy), or works with the court to set up a plan to pay all or some of his debt over a period of several years (reorganization bankruptcy).
Someone who believes that the securities market(s) or a specific security will decline in value.
A market in which a group of assets (normally securities) falls in price or loses value over a period of time. A prolonged bear market may result in a decrease of 20 percent or more in market prices. A bear market in stocks may be due to investors’ expectations of economic trends; in bonds, a bear market results from rising interest rates.
A person (or other entity, like a charitable foundation) who is named in a legal document (like a will or a trust agreement) to receive specific assets or to have the right to use specific assets.
A statistical calculation that compares a security’s volatility to a benchmark, usually the S&P 500 Index for stocks, for example. A beta greater than 1 means the security is more volatile than the index. For instance, a beta of 1.5 means the security is historically 50 percent more volatile than the index.
The price a prospective buyer is ready to pay for a security. The term is commonly used by traders who stand ready to buy or sell security units at publicly quoted prices.
A term used to describe companies that have established themselves as reliably successful over time, often by demonstrating sound management and creating quality products and services. Such companies have shown the capability to function in both good and bad economic times, and usually pay dividends to investors even during lean years. Most blue chips are large cap, Fortune 500-type stocks like IBM or General Electric.
Loans from investors to corporations and governments given in exchange for interest payments and timely repayment of the debt. Interest rates are usually fixed.
The search for outstanding performance of individual stocks before considering the impact of economic trends. Such companies may be identified from research reports, stock screens, or personal knowledge of the products and services.
A detailed listing of income and expenses by category, usually prepared with an eye toward the future. Used by households and businesses alike to gain a tighter control over incoming and outgoing cash.
Someone who believes that the securities market(s) or a particular security will increase in value.
An extended period of rising securities prices. Bull markets generally involve heavy trading, and are marked by a general upward trend in the market, independent of daily fluctuations.
The appreciation in the value of an asset that occurs when its selling price is greater than the original price for which the asset was bought. The tax rate on capital gains depends on how long the asset was held, and is often lower than the rate on ordinary income.
capital gain distributions
Payments to the shareholders of a mutual fund based on profits earned from selling securities in the fund’s portfolio. Capital gain distributions are usually paid once a year.
certificate of deposit (CD)
Money deposited with banks for a fixed period of time, usually between one month and five years, in exchange for compound interest, usually at a fixed rate. At the end of this term, on the maturity date, the principal may either be repaid to the depositor or rolled over into another CD. Any money deposited into a CD is insured by the bank (up to FDIC limits), making these very low-risk investments. Most banks set heavy penalties for early withdrawal of monies from a CD.
A mutual fund where investors trade shares on an exchange, rather than buying shares from and redeeming them with the fund itself. Share price is determined by supply and demand for fund shares (as opposed to net asset value for regular mutual funds, also called open-end funds).
A fee charged by a stockbroker (and, in some cases, a financial advisor) who executes securities trade transactions for an investor. This fee is generally a percentage based on either the number of shares bought or sold or the value of the shares bought or sold.
Interest earned on the original investment (or deposit) amount plus any previously earned interest; effectively new interest is paid on already-earned interest.
This helps the investment grow more quickly than it would with simple interest, which is applied only to the original investment amount.
The total original purchase price of an asset, which may include items other than just the asset price, such as sales tax, commissions, and delivery and installation fees. This total amount is subtracted from the sale price of the asset to compute the capital gain or loss when that asset is eventually sold.
Any person (or entity) to whom you owe money.
The risk that the principal you’ve invested through debt securities (like bonds) will not be repaid at all or on time. If the issuer of a debt security fails to repay the principal, the issuer is deemed to be in default.
To fail to repay principal or make timely payments on a bond or other debt investment security as promised. More likely to happen with high-yield corporate bonds (a.k.a. junk bonds) than other types of bonds.
defined-contribution retirement plan
A retirement plan offered by employers that allows employees to contribute to the plan but does not guarantee a predetermined benefit at retirement. Rather, the amount of the contribution is predetermined by the employee, typically as a percentage of pay. Examples of such plans include 401(k), 403(b), 457, and profit-sharing plans.
Brokerage firms that offer cut-rate fees for buying and selling securities, usually online or over an automated tele-service, although some also offer fax trade order options. Among the most prominent are Charles Schwab and TD Ameritrade.
The process of optimizing an investment portfolio by allocating funds to a number of different assets. Diversification minimizes risks while maximizing returns by spreading out risk across a number of investments. Different types of assets, such as stocks, bonds, and cash funds, carry different types of risk. For an optimal portfolio, it is important to diversify among assets with dissimilar risk levels.
Investing in a number of assets allows for unexpected negative performances to balance out with or be superseded by positive performances.
A payment made by a corporation to its shareholders that represents a portion of the profits of the company. The amount to be paid is determined by the board of directors, and dividends may be paid even during a time when the company is not performing profitably. Dividends are paid on a set schedule, such as quarterly, semiannually, or annually. Dividends may be paid directly to the investor or reinvested into more shares of the company’s stock. Even if dividends are reinvested, the individual is responsible for paying taxes on the dividends earned. Mutual funds also pay dividends, from the income earned on the underlying investments of the fund portfolio. Dividends usually are not guaranteed (except with certain types of preferred stock) and may vary each time they are paid.
The current or estimated annual dividend divided by the market price per share of a security. Used to compare dividend-paying shares of different corporations.
Dow Jones Industrial Average
An index to which the performance of individual stocks or mutual funds can be compared; it is a means of measuring the change in stock prices. This index is a composite of 30 blue-chip companies ranging from AT&T and Hewlett Packard to Kodak and Johnson & Johnson. These 30 companies represent not just the United States; rather, they are involved with commerce on a global scale.
The DJIA is computed by adding the prices of these 30 stocks and dividing by an adjusted number that takes into account stock splits and other divisions that would interfere with the average. Stocks represented on the Dow Jones Industrial Average make up between 15 percent and 20 percent of the total market.
dividend reinvestment plan (DRIP)
A plan allowing investors to automatically reinvest their dividends in the company’s stock rather than receive them in cash. Many companies waive the sales charges for stock purchased under the DRIP.
An in-depth examination of a company’s business prospects. Used by investors to analyze prospective investments.
A pattern of increasing rate of growth in earnings per share from one period to another, which usually causes a stock’s price to rise.
Equity is the total ownership or partial ownership of an asset minus any debts that are owed in relation to that asset (like a home with a mortgage). Equity also refers to the amount of interest shareholders hold in a company as a part of their rights of partial ownership. Equity is considered synonymous with ownership, a share of ownership, or the rights of ownership.
Money or other assets held by an agent until the terms of a contract or agreement are fulfilled. For example, many mortgage companies require borrowers to pay prorated property taxes monthly along with their mortgage payments; these funds are held in an escrow account until payment is due to the local government.
exchange-traded fund (ETF)
An investment pool, similar to a mutual fund, whose shares trade over an exchange much like shares of stock. Most ETFs mirror a benchmark index, holding the securities tracked by that index.
A financial planning professional (typically licensed and accredited) who helps people manage their wealth. Functions may include preparing a retirement savings plan, devising tax strategies, and preparing an estate planning strategy, among other financial services.
Any 12-month period designated by a business as its accounting year.
Once declared, a company’s fiscal year does not change, unless it makes a formal change approved by the IRS.
A legal process that terminates an owner’s right to a property, usually because the borrower defaults on payments. Home foreclosures usually result in a forced sale of the property to pay off the mortgage.
Foreign currency exchange markets.
An analysis of a company’s current and past balance sheets and income statements used to forecast its future stock price movements.
Fundamental analysts consider past records of assets, earnings, sales, products, management, and markets in predicting future trends of a company’s success or failure. By appraising a company’s prospects, these analysts assess whether a particular stock or group of stocks is undervalued or overvalued at its current market price.
When a company that has previously been wholly privately owned offers its stock to the general public for the first time.
good for the day
Buy or sell limit order that will expire at close of trading if not executed.
good until cancelled
Buy or sell limit order that remains active until cancelled.
An investment style that emphasizes companies with strong earnings growth, which typically leads to stock price increases. Growth investing is generally considered more aggressive than “value” investing.
Hedging is a strategy of reducing risk by offsetting investments with investments of opposite risks. Risks must be negatively correlated in order to hedge each other—for example, pairing an investment with high inflation risk and low immediate returns with investments with low inflation risk and high immediate returns. Long hedges protect against a short-term position, and short hedges protect against a long-term position. Hedging is not the same as diversification; it aims to protect against risk by counterbalancing that specific area of risk.
A general increase in prices coinciding with a fall in the real value of money, as measured by the Consumer Price Index.
The risk that rising prices of goods and services over time will decrease the value of the return on investments. Inflation risk is also known as purchasing-power risk because it refers to increased prices of goods and services and a decreased value of cash.
A term favored by value-oriented fundamental analysts to express the actual value of a corporation, as opposed to the current value based on the stock price. It is usually calculated by adding the current value of estimated future earnings to the book value.
individual retirement account (IRA)
A retirement account that anyone who has earned income can contribute to. Amounts contributed to traditional IRAs are usually tax-deferred.
Amounts contributed to Roth IRAs are not currently deductible but taxes are never levied on the earnings.
A high-yield bond that comes with a high risk of default. Junk bonds are generally low-rated bonds and are usually bought on speculation. Investors hope for the yield rather than the default. An investor with high risk-tolerance may choose to invest in junk bonds.
An amount owed to creditors or others. Common personal liabilities include mortgage, car payments, student loans, and credit card debt.
The ease with which an asset can be converted to cash at its present market value. High liquidity is associated with a high number of buyers and sellers trading investments at a high volume.
A sales charge or commission paid to a broker or other third-party when mutual funds are bought or sold. Front-end loads are incurred when an investor purchases the shares and back-end loads are incurred when investors sell the shares.
The current market price of a company’s shares multiplied by the number of shares outstanding, commonly referred to as “market cap.” Large-cap corporations generally have over $10 billion in market capitalization, mid-cap companies between $2 billion and $10 billion, and small-cap companies less than $2 billion. These capitalization figures may vary depending upon the index being used or the guidelines used by the portfolio manager.
The risk that investments will lose money based on the daily fluctuations of the overall market. Bond market risk results from fluctuations in prevailing interest rates. Stock market risk is influenced by a wide range of factors, such as the state of the economy, political news, and events of national importance. Though time is a stabilizing element in the markets, as returns tend to outweigh risks over long periods of time, market risk cannot be systematically diversified away.
The value of an asset if it were to be immediately sold, or the current price of a security being sold on the market.
An investment that allows thousands of investors to pool their money to collectively invest in stocks, bonds, or other types of assets, depending on the objectives of the fund. Mutual funds are convenient, particularly for small investors, because they diversify an individual’s portfolio among a large number of investments, more different securities than an individual could normally purchase on her own. Investors share in the profits of a mutual fund, and mutual fund shares can be sold back to the company on any business day at the net asset value price.
National Association of Securities Dealers Automated Quotation (NA SDA Q)
A global automated computer system that provides up-to-the-minute information on approximately 5,500 over-the-counter stocks. Whereas on the New York Stock Exchange (NYSE) securities are bought and sold on the trading floor, securities on the NASDAQ are traded via computer.
The value of all of a person’s assets (anything owned that has a monetary value) minus all of the person’s liabilities (amounts owed to others).
New York Stock Exchange (NYSE)
The largest securities exchange in the United States, where securities are traded by brokers and dealers for customers on the trading floor at 11 Wall Street in New York City.
price-to-earnings (P/E) ratio
A measure of how much buyers are willing to pay for each dollar of a company’s earnings, calculated by dividing the current share price by the stock’s earnings per share. This ratio is a useful way of comparing the value of stocks and helps to indicate expectations for the company’s growth in earnings, most useful when comparing companies within similar industries. The P/E ratio is sometimes also called the “multiple.”
Current market price of a stock divided by its book value, or net asset value. Sometimes used to assess companies with a high proportion of fixed assets or heavy equipment.
The current price of a security, be it either the highest bid price for that security or the lowest ask price. Sometimes also called a “quote.”
real rate of return
The annual return on an investment after being adjusted for inflation and taxes.
The use of capital gains, interest, and dividends to buy more of the same investment. For example, the dividends received from stock shares may be reinvested by buying more shares of the same stock.
return on equity
The amount, expressed as a percentage, earned on a company’s common stock investment for a given period. This tells common shareholders how effectively their money is being employed.
An investor’s ability to tolerate fluctuations (including sharp downturns) in the value of an investment in the expectation of receiving a higher return.
Immediate reinvestment of a distribution from a qualified retirement plan into an IRA or another qualified plan in order to retain its tax-deferred status and avoid taxes and penalties for early withdrawal.
Standard & Poor’s (S&P) 500 Index
A market index of five hundred of the top-performing U.S. corporations. This index, a more comprehensive measure of the domestic market than the Dow Jones Industrial Average, indicates broad market changes.
Securities and Exchange Commission (SEC)
A federal government agency that was established to protect individual investors from fraud and malpractice in the marketplace. The commission oversees and regulates the activities of registered investment advisors, stock and bond markets, broker/dealers, and mutual funds.
Any investment purchased with the expectation of making a profit.
Securities include total or partial ownership of an asset, rights to ownership of an asset, and certificates of debt from an institution. Examples of securities include stocks, bonds, certificates of deposit, and options.
socially responsible investing
Investing in companies that meet an ethical standard, by using a carefully employed screening process before purchasing any securities.
When a corporation increases its number of shares outstanding. The total shareholders’ equity does not change; instead, the number of shares increases while the value of each share decreases proportionally. For example, in a 2-for-1 split, a shareholder with 100 shares prior to the split would now own 200 shares. The price of the shares, however, would be cut in half; shares that cost $40 before the split would be worth $20 after the split.
An ownership share in a corporation, entitling the investor to a pro rata share of the corporation’s earnings and assets.
The use of charts and statistics to predict movements in securities prices. Technical analysis uses manual charts and computer programs to identify and project price trends in a market, security, mutual fund, or futures contract.
An information stream appearing on a movable tape or as a scrolling electronic display on a screen. The symbols and numbers shown on the ticker indicate the security being traded, the latest sale price of the security, and the volume of the most recent transaction.
An investment-selection method in which an investor first looks at trends in the general economy, then selects attractive industries and, finally, companies that should benefit from those trends.
The change in value of an investment over a specific time period, typically expressed as a percentage. Total return calculations assume all earnings are reinvested in additional shares of the investment.
A person (or company) who distributes securities as an intermediary between the issuer and the buyer of the securities. For example, an underwriter may be the agent selling insurance policies or the person distributing shares of a mutual fund to broker/dealers or investors. Generally, the underwriter agrees to purchase the remaining units of the security, such as remaining shares of stocks or bonds, from the issuer if the public does not buy all specified units. An underwriter may also be a company that backs the issue of a contract by agreeing to accept responsibility for fulfilling the contract in return for a premium.
An investment approach that focuses on companies that may be temporarily out of favor despite strong success potential or whose earnings or assets are not fully reflected in their stock prices. Value stocks will tend to have a lower price-to-earnings ratio than growth stocks, and are considered to be currently undervalued, making them good investment ‘deals.’
An indicator of expected risk, categorized by the range of price movement of a security. It demonstrates the degree to which the market price of an asset, rate, or index fluctuates from its average. Volatility is calculated by finding the standard deviation from the mean, or average, return.
The return, or earnings, on an investment. Yield refers to the interest earned on a bond, or the dividend earnings on an equity investment. Yield does not include capital gains.