Investing can sound intimidating to the uninitiated, and for good reason. There’s a lot of jargon involved; some of it useful, but much of it not necessary at all for the average person. In this post, I’ll go through 20 investing terms you need to know.
These are all terms that are actually helpful.
But wait! Before you get ahead of yourself, be sure you are ready to invest. Check out our guide on the eight things you should do before investing.
Risk Tolerance
This relates to the amount of risk you are willing to take with your money. This will dictate what investments you buy, and how much of your portfolio it takes up.
For example, someone with a high risk tolerance will largely own stocks and/or real estate, probably some crypto. On the other hand, someone with a low risk tolerance might prefer to invest in index funds, ETFs or bonds. More on these below.
Every investor is unique, so it’s important to establish your risk tolerance as early as possible. If you take on more risk than you are comfortable with, you may sell at a loss unnecessarily, out of fear.
Generally speaking, the older you are, you are likely to tolerate less risk; which is why retirement funds invest heavier into bonds near retirement. The younger you are, the more time you have on your side, giving you higher long-term upside potential.
Investment Horizon
Your investment horizon is simply the length of time you expect to hold an investment before needing to access that money. The length of time will be specific to your circumstances, but generally speaking, can range from short-term (months) to long-term (years or decades). Your investment horizon will influence your choice in investments; some investment types (for example: stocks and real estate) are considered long-term assets.
Asset Class
An asset class refers to a group of investments that exhibit similar characteristics and behaviour in the financial market. In simpler terms, an asset class is a group of investments that are similar. One such example is real estate; there is a wide range of property that can be purchases, but they are very similar in their nature.
The major asset classes include:
- Cash
- Equities (stocks)
- Fixed income (bonds)
- Real estate
- Commodities (e.g., gold, silver)
- Alternative investments, such as cryptocurrencies
Portfolio
One of the most common words you’ll hear in the investing world. A portfolio is simply a collection of investments owned by an individual or business. From stocks and bonds, to real estate, to crypto.
Technically speaking, by merely having savings or investments, you automatically have a portfolio.
How much of the portfolio each asset class takes up, will be unique to the investor’s financial goals, risk tolerance, and investment horizon/strategy.
Diversification
One of the most important words when it comes to investing.
Diversification refers to the range of assets you have. In other words, the wider the variety of your investments, the more “diversified” you are. Having your investments spread across different asset classes provides protection should one asset class experience turbulence or a significant downtrend.
A diverse portfolio could contain a combination of index funds, stocks, real estate and bonds. A less diverse portfolio might contain only stocks.
Capital Gain
In the UK (and many other country), we have what is known as the Capital Gains tax.
A “capital gain” is the profit realised when selling an investment at a higher price than it was purchased for. The key here is the word selling; you only pay tax once the sale has occurred, not as the asset rises or falls in value.
In other words, it is the difference between the selling price and the initial cost of the investment.
When investing in companies, you purchase “shares” of that company, dictated by its share price.
A share represent ownership in a company and are bought and sold on the stock market. When you buy shares, you become a partial owner of the company; you own a “piece” of the business. Depending on how you purchase your shares, you may also have voting rights (you can vote on decisions made at the company’s annual conference).
If the company grows, and its share price increases, you also benefit from that appreciation, as the value of your shares increase.
Blue Chip Stock
There are certain long-standing companies that have been dubbed “blue chip” stocks.
This refers large, well-established companies with a history of stable earnings and a strong market position. Blue chip companies are often leaders in their respective industries and are considered relatively “safer” investment options.
With that safety, however, often comes a lower rate of return due to the sheer size of the company. This is because, as a company gets to the size of, say, Apple or Microsoft, it becomes much harder to grow the business at the same rate as it once did.
Index Fund
Simply put, index funds are investible “baskets” of stocks and/or bonds, which mimics/follows a particular financial “index”, such as the S&P500, FTSE100, and so on.
Put another way, an index fund is a pre-made, diversified portfolio that an investor can purchase. This allows them to avoid worrying about buying individual stocks. In the case of the FTSE100, the investor can own the top 100 UK companies.
The best part? If one company within the index goes bankrupt, or no longer meets the index’ requirements, it is replaced with a new company.
Indexes generally tend to outperform individual investors (of course, there are always exceptions; but they are rare).
Exchange Traded Fund (ETF)
ETFs are similar to index funds and function in pretty much the same way.
While some ETFs simply mimic an index (essentially, they are an index fund), many ETFs include a smaller batch of stocks/bonds to follow a specific industry or ethos.
For example, there are ETFs which focus solely on tech companies, others green energy, or “ethical” companies in general. Meanwhile, there are ETFs around defence, or even marijuana companies!
The Half Way Mark
We’re now half way through our list of the top 20 investing terms you need to know. The first ten entries are likely somewhat familiar to you…
This may change moving forward! We’re now delving into the more savvy terms. But stay with me; this is where the fun begins (yes, I just made an Anakin Skywalker reference. Not even sorry).
Dividend
Some companies pay what are known as dividends to their investors. For each share you own of a particular company, a portion of the company’s profits are paid to you directly.
These payments can come monthly, quarterly, bi-quarterly, or yearly.
Not all companies pay dividends. Paying dividends is usually a sign that a business has become so large, that there are fewer opportunities for it to grow. Instead, because they don’t know where to spend their cash, they will distribute profit back to investors instead. This incentivises new investors to buy shares in the company.
Yield
The term “yield” refers to the income generated by an investment. Whether it comes in the form of dividends from stocks, or interest payments from bonds.
The yield of an investment is most commonly expressed as a yearly percentage, reflecting the income relative to the investment’s price.
Example:
Let’s suppose a company has a share price of £100, and it pays dividends to investors equal to £2 per share, per year.
In this case, the company pays a 2% “dividend yield”. At the end of the year, assuming the share price does not change, your position will grow by 2%; £100 per share, plus £2 in cash received per share.
Dollar-Cost (Pound-Cost) Averaging
These are terms thrown around a lot by the retail investing community. Dollar-cost (or Pound-cost) averaging is a simple, yet often effective investment strategy.
Essentially, this is where an investor systematically invests a fixed (or variable depending on available funds) amount of money at regular intervals, regardless of market conditions.
In simpler terms; whether the stock is up or down, you invest the same amount every week/month/year. Whichever fits your income schedule.
Over the long-term, this approach can help reduce the impact of short-term market volatility, because you’re “averaging” out how much you pay per share. This strategy has historically been particularly effecting when buying index funds.
Volatility
During times of uncertainty and/or fear in the stock market, we see a lot of “volatility”.
Volatility refers to the extent – and speed – in which the price of an investment fluctuates. A stock moving up or down 1-2% per day would be considered to have low volatility. Conversely, a stock that frequently experiences price swings of 5% or more in a single day, is highly volatile.
So, investments that exhibit high volatility tend to experience larger price swings. This suggests that there are both potentially higher risks, but also higher rewards.
Volatility may affect an individual investment if unexpectedly positive (or negative) news breaks regarding that investment. In some cases, however, volatility can be seen across an entire asset class.
A great example would be during the 2008 banking crisis, or the 2020 Covid-19 pandemic. In both of these years, stocks across the board fell by a significant amount. Though, this was only for a short period of time.
“Bear” or “Bull” Market
These are terms which often confound new investors, because they sound almost childish. However, these two words have surprisingly impactful meanings behind them.
For instance, a “bear” market is where a particular index (e.g., S&P500) falls 20% or more. Conversely, a “bull” market refers to an index increasing 20% or more.
But that’s not all. The term “bear” and “bull” are also used to describe a particular investor’s – or institution’s – current frame of mind regards to an investment, or the economy as a whole.
As you may have guessed, a “bear” is considered “bearish” if they believe a company, index or the economy will continue to decline. On the other end of this, a “bull”, who is optimistic around an investment or the economy, is considered “bullish”.
Market Capitalisation
Also called the “market cap” of a company, this term refers to the overall “value” of said company. Though, it’s worth noting that this is a value decided upon by investors; not by any meaningful or independent evaluation of the business.
The market cap of a business is calculated by taking the total number of shares that exist, and multiplying it by its share price. Simple!
Price-to-Earnings (P/E) Ratio
More seasoned investors will be very familiar with this term, and for good reason. The price-to-earnings ratio is a quick and easy way to assess whether or not a company could be overvalued, fairly priced, or undervalued compared to other companies.
In other words, investors use this figure to estimate how expensive a particular stock might be, relative to its peers.
To calculate the P/E ratio, we divide a stock’s share price by the company’s yearly earnings per share*.
*Earnings Per Share = Net Profit ÷ Number of Shares
When a company initiates a share buyback, it uses its spare cash reserves to repurchase its own shares from existing shareholders, either on the open market or directly.
Similarly to with dividends, share buybacks are most common at larger companies with more cash than they know what to do with. It is used as a tool to return excess cash to shareholders.
This has a direct impact on the number of shares available of that company. By purchasing shares, the company essentially “destroys” them, reducing the share count available to buy.
In turn, this increases the ownership stake of investors, often increasing both the share price and the earnings per share. Share buybacks also prevent share dilution (issuing new shares via compensation to employers).
However, share buybacks are not always considered a positive. Some critics will argue that buybacks divert resources from other areas, such as research and development or capital investment, both necessary for long-term growth.
Compounding
Now, this is a term absolutely every investor needs to be aware of. Now, I don’t just mean learning its definition, but being aware of what compounding really looks like in the long-term. It might blow your mind (as it did mine).
Compounding is the process by which an investment return “compounds” onto itself. This could be in the form of interest (ever heard the phrase “interest-on-interest”?), or by re-investing dividends, buying more shares of that same company.
Over time, compounding can accelerate long-term returns beyond what you may expect.
I’ll provide a very simple example. Let’s assume you were able to improve at a hobby by just 1% per day for one year. I.e., each day, you are getting 1% better than the day before.
How much better at that hobby do you think you will be on that 365th day?
The answer? Around 37 TIMES better. Not 3.7, THIRTY SEVEN! Put in financial terms, a £100 investment compounding by 1% per day, would be worth £3,770 in just one year.
This is because of what is called the “compounding effect”. Those small increases have very little impact in the short-term, but increase exponentially over time.
Initial Public Offering (IPO)
An Initial Public Offering is a process where a private company decides to go “public”.
The company offers its shares to the public for the first time, allowing individuals like you and me to invest and become shareholders via stock exchanges.
An IPO can provide opportunities for investors to buy shares at the early stages of a company’s growth. However, the main reason behind an IPO is usually to allow the business to raise a significant sum of money to allow for that growth. It’s a two-way, symbiotic relationship.
That’s it for our breakdown of the 20 investing terms you need to know today.
Are there any terms you’d have liked to have seen in this list? Let me know in the comments!
