When I transitioned from my previous job at a mutual fund to my current role as an advisor at Ruedi Wealth, I frequently caught myself needing to take a step back and explain investment terms people in the financial industry use on a daily basis. It didn’t really occur to me until then that financial people use a lot of industry jargon and can easily confuse people simply due to their choice of words. In the hopes that I may help normal, non-financial people avoid this confusion someday, below is a list of 16 commonly used but potentially confusing investment terms and what those terms mean – in plain English.
Asset Class
An asset class is a group of investments with similar characteristics that behave in a similar manner.
Asset Allocation
Asset allocation is the term for how you divide your investment portfolio among the various asset classes, but most commonly refers to the ratio of stocks to bonds in your portfolio.
Equity
Equity is a broad term for the ownership of something. In the financial world, the term equity is most commonly used to describe stocks, which represent partial ownership of companies. Stock prices go up and down a lot in the short run, but also provide the potential for higher investment returns than bonds.
Fixed Income
Fixed income is another term for bonds, which are really just loans to governments and companies. When you buy a bond, you are lending your money to a company or government and they are promising to pay you back over time plus interest. Bond prices tend to go up and down a lot less than stock prices, but also tend to provide lower investment returns than stocks.
Money Market Funds
Money market funds are made up of fixed income investments that are so safe and short-term they provide practically zero return and serve more or less as a replacement for cash.
Small “Cap” and Large “Cap”
Cap is short for “capitalization” – which is a fancy way of saying the total market value (number of shares x price of each share) of a company.
Volatility
Volatility is just a complicated way of describing when the stock market (or any investment) goes up and down a lot.
Standard Deviation
A statistics term used to measure variation. In investing it is commonly used to describe how much a portfolio (or investment) return varies.
Mutual Fund
An investment vehicle in which many investors pool their money for the purpose of investing in a diversified group of stocks, bonds, or money market investments.
ETF
“ETF” is short for Exchange-Traded Fund. An exchange-traded fund is an investment vehicle similar to a mutual fund, the key difference is that ETF’s trade throughout the day, while mutual funds only trade at the end of the trading day.
REIT
REIT is short for Real Estate Investment Trust. REITs are investment funds that invest in real estate companies.
Expense Ratio
The expense ratio is the fee you pay a mutual fund or ETF company to run their investment funds and invest your money accordingly. It is calculated as a percentage of the assets managed by the fund.
Basis Points
A basis point is .01%. When people talk about expense ratios they will commonly use basis points as the unit. For example, instead of saying an expense ratio of “.23%,” a person would say “23 basis points.”
Market Premium
Technically defined as the return of stocks minus the return of bonds, the market premium is the “premium” investors receive for investing in stocks instead of bonds. For example, if stocks returned 10% and bonds returned 2% over the same period, the “market premium” for that period was 8%.
Bull Market
A bull market is when the stock market goes up.
Bear Market
A bear market is when the stock market goes down, and is technically defined as a stock market decline of 20% or more.