Investment Terms and Definitions You Should Know
You don't have to know everything to start investing. In fact, if you wait until you know everything before you get started, you'll probably never start investing at all! But there are some basic terms you might want to have in your investing arsenal.
These terms will be helpful to understand, so you don't miss something you should know or veer away from your financial goals. It never hurts to learn the basics!
The Most Common Investing Terms and Definitions
Ask: This is the lowest price an owner is willing to accept for an asset.
Asset: Something that has the potential to earn money for you. It is something you own that can reasonably be expected to produce something for you. They include stocks, bonds, commodities, real estate, and other investments.
Asset allocation: One of the ways to divide up the holdings in your portfolio is to do so by asset class. The idea is that different assets perform opposite to each other. You can limit some of your risks by allocating your portfolio according to your asset type.
Balance sheet: A statement showing what a company owns, the liabilities the company has, and the outstanding shareholder equity.
Bear market: This is a market that is falling. A bear market has a downward trend. Someone who believes the market is headed for a drop is often called a “bear.” Bear markets can last for a few weeks or years.
Bid: This is the highest price a buyer is willing to pay when buying an investment. Today, electronic trading makes the ask and bid possible to match up automatically and almost instantly.
Blue chip: You might hear reporters and others refer to “blue-chip stocks.” Blue chips are companies that have a long history of good earnings, sound balance sheets, and even regularly increasing dividends. These solid companies may not be exciting, but they will likely provide reasonable returns.
Bond: This is an investment that represents what an entity owes you. Essentially, you lend money to a government or a company and are promised that the principal will be returned plus interest.
Book value: If you take all a company's liabilities and subtract them from the company's assets and common stock equity, you would have the book value left over. Most of the time, the book value is part of an evaluative measure rather than truly related to a company's market value.
Broker: This entity that buys and sells investments on your behalf. Usually, you pay a fee for this service. In the case of an online discount broker, you often pay a flat commission per trade. Other brokers, especially if they also manage your assets as a whole, charge a percentage of your assets each year.
Are you looking for an online broker? Read our reviews of TD Ameritrade, Interactive Brokers, Charles Schwab, and Webull. And here's what to do if your broker goes out of business.
Bull market: This is a market that is trending upwards. If you think the market will go up, you are considered a “bull.” Additionally, the term can apply to how you feel about an individual investment. If you are “bullish” on a specific company, you think the stock price will rise.
Further reading >> Bull vs. Bear Market: What Does It Mean For Investors?
Capital gain (or loss): This is the difference between what you bought an investment for and what you sell it for. If you buy 100 shares of a stock at $10 a share (spending $1,000) and sell your shares later for $25 a share ($2,500), you have a capital gain of $1,500. When you sell for less than you paid, you incur a loss. So, if you sell this stock for $5 instead ($500), you have a capital loss of $500).
Diversity: A portfolio characteristic that ensures you have more than one type of asset. You might also buy investments in different sectors, industries, or geographic locations.
Dividend: In some cases, a company will offer to divide some of its income among shareholders. Sometimes, dividends are paid once for a particular siutation. They are also paid at regular intervals, whether that be monthly, quarterly, semi-annually, or annually.
Dollar-cost averaging: Dollar-cost averaging is a technique where an investor buys a fixed dollar amount of a security at set intervals. The goal is to reduce the effects of market volatility on the investment portfolio. By buying securities at fixed intervals, the investor reduces the risk of buying securities at their peak price and incurring losses.
Dow Jones Industrial Average: This average includes a price-weighted list of 30 blue-chip stocks. Many people think of the Dow when they hear that “the stock market” gained or lost. However, there are only 30 companies on the list. Investors often use the Dow to gauge the stock market's health as a whole, even though it is only a tiny portion.
Earnings Per Share (EPS): EPS is a financial ratio that measures a company's profitability in relation to the number of shares outstanding. It's calculated by dividing net income by the weighted average number of shares outstanding.
Exchange: This is where investments, including stocks, bonds, commodities, and other assets, are bought and sold. It's where brokers (buyers and sellers) and others can connect. While many exchanges of “trading floors,” most orders these days are executed electronically.
ETF: Exchange-traded funds, a type of investment fund that trades like a stock. Investors buy and sell ETFs on the same exchanges as shares of stock.
Forex: Forex trading, also known as foreign exchange trading, is the act of buying and selling currencies on the foreign exchange market. The foreign exchange market is a decentralized global market for the trading of currencies. This means forex trading takes place between two parties over the internet without needing a central bank or other financial institution to facilitate the transaction.
Fundamental analysis: Fundamental analysis is a way to value a security by looking at the underlying factors affecting a company's financial health and performance. This includes things like financial statements, economic indicators, and political conditions.
Hedge Fund: This is an alternative investment that uses pooled funds. A money manager or registered investment advisor sets up this type of structure as an LLC or a limited partnership. The manager raises money from outside investors and then invests and manages that money. Hedge funds are aimed at high-income investors since individuals must earn at least $200,000 annually to be considered an accredited investor and eligible to invest with a hedge fund.
Index: A tool used to statistically measure the progress of a group of stocks that share characteristics. This can include a group of stocks, a group of bonds, or a group of other assets.
Index Fund: An index fund is a type of mutual fund that allows an individual to buy investments that mimic the trends of an index. These are generally more passive investments with lower fees than mutual funds.
IRA: This stands for an individual retirement account. It is a tax-advantaged account. There are several types of IRAs. Anyone over 18 with a job can open an IRA for themselves. However, not everyone will have access to every kind of IRA.
Ready to start saving for retirement? Learn more about IRAs here.
Margin: Borrowed money used for investing is called margin. You can get credit from a broker to buy more than you have money for. The goal is to make enough money so that you will be able to repay the borrowed amount from your earnings.
Market capitalization: A company's market cap is its current share price multiplied by the number of shares outstanding. The largest companies have market caps in the billions.
Money Market: A money market account is an interest-bearing account that usually pays a higher interest rate than a bank savings account.
Mutual Fund: A mutual fund is managed by a professional portfolio manager who purchases securities with money pooled from individual investors. The fund can hold individual stocks or bonds. Such funds typically have higher fees than other investments, since they are actively managed.
NASDAQ: This is a U.S. exchange for buying and selling securities. It is based in New York City. Nasdaq is also an index of the stocks purchased and sold on the Nasdaq exchange. (In case you're curious, the initials stand for the National Association of Securities Dealers Automated Quotations.
New York Stock Exchange: This NYSE is one of the most famous stock exchanges. It trades stocks in companies all over the United States and even includes stocks of some international companies.
Options: Options trading involves the purchase and sale of options contracts. They are derivative instruments that give the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a specific date.
Payment for order flow (PFOF): Broker-dealers make PFOF payments to market makers or other liquidity providers to provide order flow. These payments are typically very small, just pennies per share. But can add up significantly when multiplied by the large number of shares traded daily.
Personal Investment Strategy: This is precisely what it sounds like: it's your unique approach and strategy to investments. There's no single right way to invest. Learn about how investing works. Then define and execute your personal strategy. Take a look through some popular investment strategies here.
P/E ratio: This measure reflects how much you pay for each dollar that the company earns. P/E stands for Price/Earnings. A company often reports profits on a per-share basis. So a company might say that it has earned $5 per share. If that same stock sells for $75 a share on the market, you divide $75 by $5 to come up with a P/E ratio of 15. The higher a P/E ratio is, the more expectations are for higher earnings.
Recession: Most economists define a recession as when a country sees negative economic activity for two consecutive quarters. Usually, a decline in Gross Domestic Product (GDP) for two straight quarters indicates a recession.
Registered Investment Advisor (RIA): This financial investment advisor has been through a particular training. They agree to abide by specific rules, including ensuring that recommendations and trades made on your behalf are in your best interest. You can find RIAs near you using a financial advisor search engine like Paladin Registry, the National Association of Personal Financial Advisors (NAPFA), or the Alliance of Comprehensive Planners (ACP).
Required Minimum Distributions (RMDs): RMDs are the minimum amount that you must withdraw from your retirement account each year. The amount is based on your age and the balance of your account. You generally have to start taking RMDs by April 1 of the year after you turn 70½. If you don't take your RMD, you may be subject to a 50% tax on the necessary withdrawal amount.
S&P 500: The Standard & Poor's 500 is a stock market index, similar to the Dow Jones, that tracks the value of 500 companies in the United States. Please read our guide on how to invest in the S&P500 for more information.
Short selling: Short selling is when an investors sells a security they do not own. The seller borrows the security from a broker and sells it. They hope to repurchase the security at a lower price so they can return it to the broker and pocket the difference. If the cost of the security falls as anticipated, the seller makes a profit. However, if the security price rises, the seller incurs a loss.
Stock: A stock represents ownership in a company. Companies divide their ownership stakes into shares, and the amount of shares you purchase indicates your level of ownership in the company. Investors buy stock hoping that the company will be successful, and they can sell their stake later at a higher price than they paid.
Stock split: A stock split is when a company divides its existing shares into multiple new shares. This type of corporate action typically occurs when a company's stock price has reached a level that is too high for new investors, making it difficult for them to buy shares. A stock split can also increase the liquidity of a company's stock.
Read more>> How to Buy Stocks Online for Free.
Taxable Accounts: You can use taxable accounts for trading stocks, bonds, mutual funds, etc. Taxable accounts don't have any tax advantages, which means you incur tax on your investment income.
Tax-advantaged Accounts: These types of investment accounts come with tax advantages of some kind that let you defer or be exempt from taxes on investment income. Retirement accounts — where you can deduct contributions from your taxes, such as an individual retirement account (IRA) — fall into this category.
Technical analysis: Technical analysis is a method of analyzing securities to forecast their future price movements. Trading who rely upon technical analysis use charts and other tools to identify activity patterns.
Yield: In dividend investing, your yield represents the ratio between the stock price and the dividend paid. A stock trading at $100 per share, with a dividend of $5 per year, you divide the $5 by $100 and turn it into a percentage. In this case, the yield would be 5%.
Final Thoughts
Knowing these investing terms should help you understand most beginner articles about investing.
After all, hearing the term “hedge fund” in a Hollywood movie and thinking That it sounds like a good investment is one thing. Knowing you need to earn $200,000 yearly to participate in one is quite another. Continue to expand your understanding of the stock market. It will serve you through a lifetime of investing.
Ready to start investing? Read our guides to figure out which investment option is the best for you:
Readers: what investing term do you hear most often? What's another definition we should add to the list?
