For many people, one of the most challenging aspects of investing is learning the terminology. When you’re a beginner in the financial markets, you may get hit at first by a barrage of language you don’t understand. Some of the terms, such as “profit” and “loss,” may be easy to decipher, while other terms may seem outright cryptic to new investors. It can be easy to get overwhelmed, so it’s best to take a step-by-step approach to investor education and begin with the basics. Below, we’ll review 10 terms to help you enhance your knowledge and gain confidence as an investor.
Investor Education Terms to Know
These words and phrases correspond to the most common aspects of investor education. Learning them at the start of your investment journey gives you an advantage when you’re ready for more intricate financial concepts:
Asset Allocation
Asset allocation is a method for selecting what makes up your investment portfolio. The strategy involves spreading your investments across different asset classes according to your goals. These could include stocks, bonds, real estate, mutual funds, derivatives, and more. Balance is the goal of asset allocation because, when your portfolio is weighted too far in one direction, you face greater risk.
Diversification
Speaking of risk, diversification is one way to lessen yours. It’s the act of spreading your investments across different kinds of securities. You can diversify your assets, by investing in a mix of stocks, bonds, funds, and other securities. You can also diversify according to market cap, geographic location, or other factors. The aim of diversification is to manage risk, especially across business sectors. For example, if your tech stocks are underperforming, the utility stocks in your portfolio may be doing well enough to offset the loss.
Blue Chip
Stocks held by the biggest, most stable, and most established companies are known as “blue chip” stocks. They’re corporations that have survived decades of market turbulence. They command big market shares and have strong financials. Blue chip stocks maintain long-term stability and generate steady, if unspectacular, income. Some blue-chip companies even pay out occasional dividends. They serve as financial safeguards in rough economic times. Examples include Apple, Coca-Cola, Procter & Gamble, Microsoft, Disney, and Walmart.
Dollar-Cost Averaging
Dollar-cost averaging (DCA) is a practical investment strategy and one you should know as you enhance your investor education. With DCA, an investor makes scheduled contributions of a fixed amount to a certain security. Whether the stock is performing well or not, the investment amount doesn’t change. The point of DCA is to weather market fluctuations. In theory, over an extended time, the “average” of the investment protects against losses. It’s also a way to keep the investor’s share costs lower. DCA investments are commonly made in monthly or quarterly installments.
Index
A stock market index is a list of securities with something in common, and it’s a term you’ll hear often as you work to improve your investor education. An index acts as an indicator of how strongly the stock market is performing by tracking its activity. Investors and analysts use this data to gauge and compare stocks and sectors in the market. A few common examples you’ve likely heard of are the S&P 500, the Dow Jones Industrial Average, and the NASDAQ Composite.
Mutual Fund
Similar to an index, a mutual fund groups together various securities. However, a mutual fund is a real financial instrument, not just a performance tracker. Mutual funds are created and overseen by financial managers. Investors pool their money into the fund, and the manager makes transaction decisions to maximize profits for the group. Mutual funds’ price movements are evaluated at the end of each trading day. Investors have a short window, usually in the afternoon, to execute their transactions in the fund. Exchange-traded funds (ETFs) are variants of mutual funds that can be traded any time the stock market is open.
Realized Capital Gains
Realized capital gains are simply the profits investors make when they sell shares. It’s the difference between the price at which the shares were bought and their selling price. If an investor bought a single share at $25 and sold it for $30, their realized capital gains total $5. Realized capital gains are important to track because they’re taxable. Conversely, a realized capital loss can counteract taxes on gains.
Risk Tolerance
Most successful investors are good judges of their own risk tolerance. Your risk tolerance is a measure of how much market volatility you can comfortably handle. Some investors are more adventurous than others, choosing to invest in higher-risk securities that could realize big profits. Others are more risk averse, preferring to invest in lower-risk but consistent investments. Your risk tolerance often evolves over time as you get closer to retirement, too.
Share
A share is a slice of ownership in a publicly traded company. When a business goes public or needs to raise quick capital, it sells investors “shares” at a given price. Shareholders measure portfolio performance by tracking how much the share price rises or falls. If the price reaches a certain point, they may decide to sell the share to reap profits. Shareholders also have certain rights as company co-owners, like the chance to vote on company matters and receive dividend payouts if available.
Valuation
Valuation is a means of establishing how much a company is worth through analytics. It’s a general term for several methods that measure a company’s fair value and projected performance. Valuation is usually a key step in an investor’s decision to buy, hold, or sell their shares for maximum profit. Some methods of valuation include analyzing a company’s price-to-earnings ratio, its price-to-book ratio, and comparison with competitors.
Take the Next Step in Your Investor Education
Simply understanding these ten investment terms can give you the initial knowledge and confidence you need to begin your investing journey. It will also make learning more complex ideas easier. Of course, you don’t have to go it alone.
