Investing has a language of its own, but you don’t need to be a linguist to talk smartly about money. Here are a few terms you’ll need to know.
Stocks, bonds and mutual funds
Stocks, bonds and mutual funds are types of securities for sale to investors. When you buy a corporation’s stock — also called a share or equity — you become an owner, giving you claim to a piece of its earnings. Purchasing a bond means you loan money to a corporation and receive payments back with interest.
A mutual fund is a collection of individual stocks and bonds, available for purchase as a package. When you own a mutual fund, you get a share of the earnings, dividends and interest produced by the fund’s holdings.
Indexes and benchmarks
An index is used to measure the performance of a group of assets, which can be broad-based or track specific sectors/stocks. For example, the S&P 500 Index tracks the performance of the 500 largest U.S. publicly traded companies. Investors cannot buy into an index directly but can buy funds designed to mimic the index. For example, the S&P 500 Index tracks the performance of the 500 largest publicly traded companies in the U.S.
An index is frequently used as a benchmark, a standard to use in comparing how various markets or investments have performed. For example, the S&P 500 Index is frequently used as a benchmark to gauge how well the U.S. stock market is doing in general.
Growth, value and other strategies
When you invest in a mutual fund, you will have to choose from a variety of strategies. For example, a growth strategy typically invests in stocks that are fast growing and high earning — but that also poses a lot of risk. Less risky stock strategies include value, where you prefer relatively cheap stocks, or income, which focuses on securities that pay dividends.
Bond funds have different strategies too. Some invest in short-term (i.e., lower-risk) bonds, while others prefer long-term (i.e., higher-risk) bonds. Treasury and government strategies typically invest in lower-risk, high-quality bonds, while corporate and high-yield funds go for bigger yields and bigger risks. Investors can use one strategy or mix them up to create a style that’s right for them. They can also change strategies as their goals change.
Debt securities are subject to interest rate risk, credit risk, extension risk, income risk, issuer risk and market risk. The value of U.S. government securities can decrease due to, among other factors, changes in interest rates or changes to the financial condition or credit rating of the U.S. government. Investments in asset-backed and mortgage-backed securities are also subject to prepayment risk as well as increased susceptibility to adverse economic developments. High-yield, lower-rated, securities involve greater risk than higher-rated securities.
Equity securities generally have greater price volatility than fixed-income securities. The market price of equity securities may go up or down, sometimes rapidly or unpredictably. Equity securities may decline in value due to factors affecting the issuer or equity securities markets generally. Growth stocks are subject to the risk, among others, that returns on stocks within this style category will trail returns of stocks representing other styles or the market overall over any period of time and may shift in and out of favor with investors generally, sometimes rapidly, depending on changes in market, economic, and other factors. Growth stocks can be volatile, as these companies usually invest a high portion of earnings in their business and therefore may not provide the dividends of value stocks that may have the potential to cushion stock prices in a falling market. Also, earnings disappointments can lead to sharply falling prices because investors frequently buy growth stocks in anticipation of superior earnings growth. Value stocks are subject to the risk that returns on stocks within this style category will trail returns of stocks representing other styles or the market overall over any period of time and may shift in and out of favor with investors generally, sometimes rapidly, depending on changes in market, economic, and other factors. Investments in value securities may be subject to risks, among others, that (1) the issuer’s potential business prospects will not be realized; (2) their potential values will not be recognized by the market; and (3) they will not perform as anticipated.
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