Ever felt intimidated by investing? If so, you're not alone. Many investors, from first-timers to well-established investors, experience a pang of anxiety (or a few) when it's time to make financial decisions that involve risk and don't involve guarantees.But that's not the only factor that tends to intimate investors; the jargon commonly used by investment professionals and others associated with the financial industry can add another layer of uncertainty to the financial planning process. From indexes to expense ratios, financial buzzwords can
make investing seem even more mysterious.
Asset Allocation. Asset allocation is simply a fancy way of describing where you choose to assign your investments. Many investors follow a wealth strategy that allocates investments across three asset classes: Stocks, Bonds, and Cash. A truly diversified portfolio depends on proper asset allocation. Now, let's define those three asset classes.
Stocks. If you invest in a company's stocks, it's like you own a little piece of that company. Generally, when the company is doing well, your stock values go up...and vice versa.
Bonds. When you invest in a bond, you're essentially loaning that money to the government or corporate entity that issued the bond. The bond issuer borrows your money at a variable or fixed interest rate for a certain amount of time. When that time period ends, you collect the accrued interest — if any — when you cash in the bond.
Cash. In the financial world, "cash" refers to investments that tend to present less risk and offer less potential for reward. These include money market savings accounts, Treasury bills, or certificates of deposit (CDs).
Price-to-earnings ratio. This figure compares a company's current share price to its earnings per share, showing the amount an investor should expect to invest in order to receive a dollar in current earnings.
Mutual Funds. Mutual funds allow a group of investors to pool their money and and invest it in a collection of stocks or bonds (think your 401(k) plan). This spreads the risk and increases diversification. They're usually maintained by money managers, who charge an annual fee known as an...
Expense Ratio. Investors pay money managers a percentage of their invested funds. The larger the expense ratio, the less return you make. A 2015 fee study from Morningstar found that the average fund's expense ratio is 0.64 percent.
Index Funds. This type of mutual fund offers a way for investors to achieve diversification while enjoying benefits such as lower operating expenses (an average of 0.20 percent, according to Morningstar) and less portfolio turnover. An index fund is a collection of stocks that represents a market index, such as the S&P 500 or the Dow Jones. Index funds track the performance of this group of stocks.
Target-date fund. Think of target-date funds as a type of portfolio that's developed based on your prospective retirement date. Often a part of 401(k) plans, these funds shift from riskier investments further out from your target date, to more conservative investments as retirement draws near.
Prospectus. When considering an investment, investors should read the prospectus. This legal document contains data about stocks, mutual funds and bonds, including important details like expense ratios. Your wealth advisor can provide these for you.
While this isn't a comprehensive list of financial planning buzzwords, knowing these 10 investment terms can help your have better conversations so that you can make well-educated investing decisions.
Fortunately, learning the lingo isn't too difficult. Read on for a primer on the top 10 financial terms every rational investor should know.