You know what I'm tired of hearing? That investing is only reserved for financial 'experts' and the financially secure.
Don't get me wrong, I'll be the first to admit that investing can be intimidating and seemingly complicated, so it can make us want to hit the snooze button on our finances.
We've all been there.
The incredible thing is, investing is a journey. You don’t need to know absolutely everything to start investing.
These days you can start investing armed with as little as $100, and by learning some of the foundational aspects of investing.
Good things you’re here - let’s define some of the most important investing terms you should be familiar with so that you can start investing and join in with the other 55% of Americans who are invested in the stock market.
Related: Investing Guide for Beginners
Key Investing Terms You Should Know To Start Investing
- Certificate of Deposit (CD)
- Mutual Fund
- Index Fund
- Brokerage company
- Capital Gains
- Compound Interest
- Risk Tolerance
- Asset Allocation
- Expense Ratio
Probably the most common investment term, a stock/ share/ equity represents a part-ownership of a particular company. When a private company goes public, you get a chance to buy their stocks. As the value of the company fluctuates, your stocks reflect those changes.
A bond is a loan that you give to a company or government entity in exchange for full interest over a fixed period.
3. Certificate of Deposit (CD)
A CD is a savings account with a fixed maturity date and specified interest. If you would like to benefit from higher interest rates compared to that in a regular savings account and are hesitant to get into the stock market, this might be a good option for you.
Keep in mind that if you withdraw the money before the set maturity date, you will be charged a penalty which varies by institution.
4. Compound Interest
I’m going to take a leap of faith here and guess that you would like your money to work for you.
Well, compound interest does exactly that.
It allows you to earn interest on both your initial principal and on the interest that your money earns over time, assuming you don’t withdraw the money.
30-year performance of $10,000 investment compounded at 10% annually. Source: Nerdwallet
Let's take an example.
Say you start with $10,000 earning 10% compound interest per year. At the end of the year, you will have $1,000 from interest. And because you are good about your finances (wink wink) and are trying to grow your investments over the long-term (WINK ), you leave the $1000 in the account along with the original $10,000, totalling $11,000. In the second year, you will have a $1,100 interest, on the $11,000. And so on. In 30 years, you will have a whooping $198,439!
Boom! See how that works? This, friends, is the power of compound interest.
Related: How compound interest can work for you
5. Mutual Fund
“A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets”, according to Investopedia.
Mutual funds have professional portfolio managers who make decisions about the fund, such as which equities, bonds, and securities should be a part of the fund. These funds are made available to individual investors like you.
6. Index Fund
I have 2 words for you - Warren Buffet!
Now that I have your attention :), you might be curious to know that Warren champions index fund investing as one of the most effective ways to grow your wealth in the long-run.
Ok. So, what is an index fund?
An index fund is a type of mutual fund that tracks a specific market index (eg. S&P 500), typically made up of stocks and bonds. Index funds have fund managers who make sure an index fund performs in the same way as the market index it tracks. They do this by matching the index fund to each component of the market index.
So, to successfully invest in index funds, you have to hold your positions over the long-term and let compound interest do the work for you.
They don't call it the boring way to invest for no reason. And please don't get me wrong. Boring is good.
It really is that simple.
Don't believe me? Well, check out what these index funds millionaires have to say.
7. Brokerage Company
A brokerage company/firm is a middleman that facilitates the buying and selling of securities such as stocks, bonds, and mutual funds. In exchange, brokerage firms charge various fees such as transaction and annual fees.
8. Capital Gains
We all want to see our investment accounts grow. This increase in the investment from the original amount invested is known as capital gains, but it is only realized once you sell your investment.
Do keep in mind that once you sell your investments, you need to pay capital gains tax.
9. Risk Tolerance
You might have heard it said that investing involves risk. This is as true as it is important to think about your risk tolerance before you start investing.
So what is risk tolerance anyways?
Risk tolerance is just a fancy way of saying how much of your investment you can really afford to lose.
For example, if you're young, you're likely to have higher risk tolerance because should your investment have dips, you are likely to weather the market because time is on your side.
You might have guessed it - The higher your risk tolerance, the more aggressive you can be, and the expected rate of return will be higher. But this also means that there will be more ups and downs in your investment over the short-term and that you face a higher chance of losing your investment.
“You shouldn’t put all your eggs in one basket”, said every wise investor! Diversification is basically practicing this saying. It is spreading out your investments into various ‘baskets’ to lower the risk exposure to your portfolio.
11. Asset Allocation
Asset allocation in your investment strategy is how you divide up your investment across different investment vehicles such as stocks, bonds, and mutual funds. The aim is to balance risk and reward based on your risk tolerance and financial goals.
12. Expense Ratio
Pay particular attention to expense ratios when investing in mutual funds, ETFs, and index funds. This is an annual fee expressed as a percentage of your investment and can range from as low as 0.015 (hello Fidelity total index fund) to over 2%.
Expense ratio is expressed as a ratio of the costs of the fund - research, administrative fees, management fees - to the value of the fund.
For example, if a fund has an expense ratio of 0.5%, that means it costs 0.5% of the value of the fund to keep it running for a year.
Here's the thing. These few percentage points might not seem like much but they can substantially lower your portfolio returns - a high expense ratio of 2% could add up to tens, even hundreds, of thousands of dollars over time.
Investing is a journey, not a destination, you're always learning. Get started as soon as possible. Even if you are just starting with $100, and with just a little bit of knowledge, just do it! Then don't just stop there, continue learning, continue investing. You can do it!
What key investment terms would you add to this list? Please feel free to comment below. I love hearing from my readers.
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