The investing world can be difficult for beginners because the lingo isn't always self-explanatory
and many terms overlap.
Learning the lingo can help you communicate with others in finance and take better control
of your investments.
In this video, we'll briefly define a few common terms related to the market, investment
types, portfolios, and trading.
Let's start with terms associated with the market.
The word market can be confusing because it can refer to investing in general or a specific
index, like the S&P 500®.
A market simply means a place where buyers and sellers can get together to make transactions.
This might be a physical place, such as the New York Stock Exchange® or an electronic
gathering spot, like NASDAQ®.
People also refer to the market as being bullish or bearish.
This refers to the direction the market is heading up or down.
An easy way to remember the market direction is to picture these animals in battle.
A bull in battle drives his horns upward to gorge the attacker.
So a bull market means that stocks or other investment prices are going up.
While a bear in battle swats his paws downward.
So, a bear market means that prices are trending down.
In addition to market terms, it's important to understand the different types of investments
that can be made . There are four main types of investments, or asset classes, someone
can invest in.
These asset classes are: equities, fixed income, derivatives, and cash.
Let's define each.
Equities typically refer to owning shares in a company.
Some common equities are stocks, mutual funds, and exchange-traded funds.
Stocks are shares of ownership in a company.
This means you own a small piece of this company.
Mutual funds are a pool of investment dollars that can often be professionally managed and
may be invested across several different assets.
In contrast to a stock, if you own one share in a mutual fund, you have a stake in many
companies.
Exchange-traded funds are commonly called ETFs.
An ETF has similar characteristics of a mutual fund, but most can be bought and sold throughout
the trading day similar to a stock and typically have lower management fees.
The next asset class is fixed income.
This class includes assets like bonds, treasuries, and certificates of deposit.
The name, fixed income, tells you a lot about the investment.
Essentially, its payments are fixed, meaning they are consistent and delivered in regular
intervals.
The next asset class is derivatives.
This class includes options, futures, and currencies.
A derivative is a security with a price that is dependent on another asset.
The derivative itself is a contract between at least two people.
Derivatives commonly track other investments like a stock index.
The movement in the underlying security is where the derivative derives its value.
However, derivatives can be risky.
They use leverage, which controls a large asset with a small amount of money, to potentially
create larger returns or to help mitigate risk.
But, if the asset moves in the wrong direction, you could lose all of your investment.
The final asset is cash.
Cash refers to assets like savings and money market accounts.
They're typically valued for two things: their high liquidity and low risk.
When an asset is highly liquid, it means you're able to access it easily, or liquidate
it.
And while they won't grow as much as other assets, it can be important to maintain a
portion of your assets in cash for a rainy day.
When these asset classes are combined, they form a portfolio.
Simply put, a portfolio contains all your investments so you can see them as a whole.
Other terms associated with a portfolio are allocation and diversification.
They're sometimes used interchangeably, but they do have different meanings.
Allocation refers to the percentage of your portfolio in each asset class.
For example, an investor might allocate 50% of a portfolio to equities, 25% to fixed income,
10% to derivatives, and 15% to cash.
The allocation may change over time based on your risk tolerance level and as you approach
retirement.
Diversification refers to having varied types of individual assets within an asset class.
Let's say for example you want to diversify the equities portion of your portfolio.
This means you may want to own many types of stocks, mutual funds, and ETFs in various
sectors, such as Health Care, Technology, and Utilities.
Allocation and diversification are important because they prevent you from placing all
your eggs in one basket, so to speak.
And those are the basic terms related to investing.
There are a lot of new terms to learn and it can feel a bit overwhelming, but you're
headed in the right direction.
With these terms as a foundation, you may be able to participate more effectively in
the market.