Investing comes with its own lengthy lexicon of words and phrases. If you’re considering working with a financial advisor or wealth manager, or you just want to brush up on your investment vocabulary, get to know these key terms.
This list is by no means exhaustive, but contains several terms that you’ll find useful in understanding your investment and financial picture.
Alpha
A historical measure of portfolio success, alpha is the excess return expected on an investment above and beyond a market index or benchmark. It can be represented as a single number or as a percentage.
Asset classes
A grouping of similar types of investments with different levels of risk and return, such as equities (or stocks), fixed income/debt (i.e., government and other types of bonds), cash and cash equivalents, and real estate and commodities (like gold).
Strategic asset allocation
This is the strategy of divvying up your investments among different asset classes in a way that balances risk and reward. This strategic asset allocation should take into account your risk tolerance (see below).
Beta
This measures the volatility or risk of an investment of portfolio, compared to the market as a whole.
Expense ratio
The annual fee that you’ll pay as an investor (expressed as a percentage) that’s used to cover the operating costs of a mutual fund, exchange traded fund (ETF), or other pooled investment.
Fiduciary
This is someone who manages your assets in good faith, loyalty, and in your
best interest. They are bound by fiduciary duty, a standard that prohibits them from placing their own interests ahead of yours. They must also provide investment advice in the best interest of their client, based on the client’s objectives.
Growth vs. value stocks
Growth stocks are stocks that generally have higher price/earnings ratios, but also have higher growth expectations for the future(think startups). Value stocks, generally have lower price/earnings multiples, but could present lower downside risk and usually come with a higher dividend yield.
Bonus term: A mix of growth and value stocks is called a blend.
Large-cap, mid-cap, small-cap, micro-cap and nano-cap
Each of these terms is used to describe the size of a company’s market capitalization, or market cap, which is the total value of a company’s tradable stock.
Large cap — Exceeds $10 billion
Mid-cap — Between $3 to $10 billion
Small-cap — Less than $3 billion
Micro-cap — Between $50 million and $300 million
Nano-cap — Under $50 million
Prudent investor rule
This is a guideline under which the managing investor or trustee of a portfolio must follow certain principles — including diversification and minimizing fees — to make investment decisions in the client’s best interest.
Rebalancing
This is the process of realigning the way your assets are allocated so your portfolio is in line with your strategic asset allocation (see above). This is usually done on a calendar basis, but is sometimes done in response to the market, when deviations away from your strategic asset allocation become high.
Registered Investment Advisor (RIA)
A firm that advises clients on investments and manages portfolios, working in a fiduciary capacity to serve the clients’ best interests. RIAs are registered with the U.S. Securities and Exchange Commission (SEC) or state securities authorities.
Risk tolerance
This is the combination of your ability (driven by your financial plan) and willingness (driven by personal preference) to lose some or all of an investment in exchange for the potential of greater returns.
Tax-efficient investing (asset location)
The concept of investing and managing portfolios to maximize returns and minimize your tax burden. Investments can be classified as taxable (tax must be paid on income in the year it is received), tax-deferred (the money is sheltered as long as it’s in the account, but will be taxed once distributed out of the account), and tax-exempt (no federal tax must be paid as long as we follow specific rules).
Time horizon
This refers to the period of time — months, years, or decades — that you expect to be investing in order to reach a financial goal.
Are you interested in developing a relationship with a wealth management firm that can create personalized investment strategies that are right for you? Make an appointment to learn more about how Ironwood Wealth Management can help you reach your financial goals.
