Getting your feet wet in the world of investing can be intimidating. The investment jargon used often sounds like a foreign language. It can be difficult to make decisions about your financial future when you’re trying to remember what some of the technical terms mean.
With that in mind, here is a short list of some commonly-used financial terms. We hope this gives you some background, and confidence, as you enter the world of financial planning.
1. Individual Retirement Account (IRA)
An IRA is a tool to help you save for retirement by setting money aside from your current income. There are different types of IRAs: Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs. Ask your advisor which plan or plans will work best for you. Some IRAs allow you to make tax-deductible contributions if your income level qualifies.
It is important to note that withdrawing funds from an IRA counts as income. Therefore it is critical to plan when you will start using the funds to ensure you are in a favorable tax bracket. It is possible your contributions will put you into a lower tax bracket while you are working, and also allow you to be in a lower bracket when you retire. (source)
2. 401(k) Plan
Another tool to plan for retirement, 401(k) plans are offered by employers who can contribute matching or non-elective funds to your plan. Some plans allow participants to choose from a group of investments and others hire a professional advisor to handle investments.
There are usually penalties involved for withdrawing funds before an agreed-upon age of retirement. There are also restrictions on the amount you can defer to the plan, so review all of your options with your advisor to select the right 401(k) for you.(source)
3. Mutual Fund
A mutual fund is a pooled investment which allows investors without a lot of capital to maximize their returns. Investments from several individuals are handled by a money manager, who distributes the investments across a portfolio of money market accounts, stocks, bonds and other assets.
The biggest benefit of a mutual fund is that it gives you access to a diverse, professionally-managed portfolio of investments even if you don’t have a lot of money to invest. Mutual fund shares can usually be purchased, or redeemed, at their current market value. (source)
4. Growth Fund
Growth funds are riskier than mutual funds and are designed for investors who are in it for the long haul. Growth funds are offered by companies that are expanding and reinvest profits for things such as research and development, rather than paying out dividends to shareholders.
The payouts for growth fund investments can be larger, but the risk is also higher, and there may be a longer holding period (anywhere from 5 to 10 years) before the investment becomes profitable. (source)
Annuities are designed to provide the peace of mind during retirement of knowing that you won’t outlive your savings. Contributions are made and held by the financial institution during an accumulation phase, then paid to the investor in the annuitization phase. Payments to the investor can be scheduled for a fixed period of time (i.e. 20 years,) or they can be set up to continue until the investor dies.
Annuities are not ideal if you like having liquid, or readily accessible, investments. Funds are not available during the surrender period without paying a penalty. The biggest benefit of an annuity is that you can usually modify the payments to ensure consistent income during retirement. (source)
6. Money Market Account
A money market account is an FDIC-insured account that pays a higher interest rate than a traditional savings account. Money market accounts typically require a higher balance than a savings account, but the risk involved is low as those investments are usually in government securities and certificates of deposit.
The benefits of a money market account are twofold. First, the risk involved is low. Second, interest accrues on deposits, not investments, so no shares need to be purchased. The drawback is that funds are not as liquid as they are in a checking account, and any interest accrued is taxable. (source)
A bond is basically an IOU. Governments and corporations issue bonds to raise money, promising the purchaser a return on investment after a specific period of time when the bond “matures.” The bond’s “face value,” is the amount it will be worth when it matures.
8. Junk Bonds
Junk bonds are a riskier alternative to typical investment-grade bonds. The idea is the same, but the corporations that issue these bonds generally have a lower credit rating, hence the name.
Junk bonds appeal to investors because their face value is higher than other bonds, but the risk of losing your entire investment is much higher than with traditional bonds. (source)
9. Book Value
Also referred to as “net book value” or NBV, a company’s book value is the value of all of the company’s assets. Basically, it tells you what the company is worth if it were to be sold today. In terms of a company’s stock, the book value is the price of a share of the stock.
When a stock is sold, gains and losses are calculated by taking the price of the stock and subtracting the book value. (source)
10. Bull Market/Bear Market
Bull markets describe a period of time when investor confidence is high, and prices are on the rise. A bear market refers to a time of low confidence, leading many investors to sell to prevent losing their assets. Bear markets can induce a “perfect storm” of loss, in which the selling of a lot of investments decreases confidence even further, leading to more sell-offs. (source) (source) (source)
This is just a partial list of the terms and buzzwords you will hear as you wade into deeper financial waters. At the very least, knowing the difference between a mutual fund and a money market account should give you the confidence to begin preparing for the future with a financial planner.
Keep your ears open and don’t be afraid to ask your advisor if you have questions.
Are there any other investment terms you need help with? Let us know in the comments section.