Investing is an important part of your well-rounded finances. While you don’t have to know everything about investing before you get started, it’s still a good idea to have an understanding of a few key terms and concepts. As you get ready to invest, here are some of the most important terms for a beginning investor to know:
This is a debt investment. Basically, you loan money to a government or a company, and the organization agrees to repay you with interest. The principal is usually paid at a specific date, and interest might be paid semiannually or annually. With a bond investment, you run the risk that the organization will default on the debt, leaving you without the principal. However, bonds from highly rated companies and governments are considered among the safest investments.
The broker arranges the trading transactions with your investments. You can choose to use a person to arrange your buying and selling of stocks, bonds, and funds, or you can use an online broker. You need a broker of some kind for your investments. Online brokers can execute your trades, usually for less than a more traditional in-person broker. Online brokers charge lower fees, but you won’t get personalized advice; you’ll have to do more research on your own.
Dollar Cost Averaging
This is the investing strategy that involves contributing a set amount of money to an investment account each month. Each month, your investment buys as many shares as possible, including partial shares. Dollar cost averaging works best with an automatic investing plan in which your money is automatically deducted from your checking account and invested in a designated fund. This is also a good strategy for retirement investing. You can have money from your paycheck automatically deducted and contributed to a retirement plan.
A fund is a collection of investments, and often includes bonds or stocks. Often, the investments included in a fund share a characteristic, such as belonging to the same index, or coming from the same country, or belonging to a particular industry.
There are different types of funds you can invest in:
- Mutual funds are collections of stocks or bonds. You have ownership in each asset in the fund. Many of these funds are actively managed, with an expert determining which investments should be included so that the fund achieves certain objectives (such as growth or income).
- Index funds are a type of mutual fund. Rather than having a manager decide which investments to include, these types of funds just invest in everything on a particular index, such as the S&P 500, Russell 2000, Dow Jones 30, or some other index.
- Exchange Traded Funds (ETFs) aren’t funds in the same way mutual funds are. They trade like stocks on the exchanges, and follow investments. There are ETFs that go beyond stocks and bonds, and follow currencies and commodities. It’s important to note that most ETFs are derivative, which means that you don’t actually own parts of the underlying investments, like you do with mutual/index funds.
You can see gains or losses, depending on whether or not your fund increases or decreases in price. Over time, funds often do well, since they are based on large swaths of a market, rather than relying on the performance of a single asset.
This is what you receive from your investments. It’s the amount that your investment grows by. A return can be positive or negative. If your investment rises in price after you buy it, you have a positive return. If it loses in price after you buy it, the return is negative. Your return can be measured over a long period of time, as well as a short period of time. It’s important to consider return in relation to your goals over the long haul, since returns are often choppy in the short term. The stock market, as a whole, shows positive returns when measured over a period of two or three decades.
A stock represents ownership in a company. A stock is sometimes referred to as a share or as equity. When you buy a share of a company, you share in the returns from that company. With a stock, you run the risk of losing money, though, since prices of shares rise and fall. If the stock price falls after you have bought it, you could lose, while you could see gains if the price rises.
While there are other things to learn about investing beyond the above basic concepts, these are enough to get you started for a long term investing plan.