To the uninitiated, the world of investing can seem like a complicated place, one with a language all its own. The financial industry is filled with acronyms and arcane terminology, and just deciphering it can seem like a full-time job.
If you are new to investing, getting educated, and learning about the terminology should be your first course of action. An educated investor is an effective investor. The faster you go down the learning curve, the sooner you can start investing. Here are some common investing 101 terms and what they mean.
What are Stocks?
Whether you put money away in a 401(k), invest in an IRA, or open a brokerage account, some of the money will probably be in stocks. When you buy a stock, either individually or as part of a mutual fund, you are essentially purchasing ownership in the underlying company.
Publicly traded companies are owned by their shareholders, the ordinary men and women who purchase their stock shares. As part owners of the company, stockholders can vote for board members and play a part in other comp
ETFs vs. Mutual Funds – What Are the Differences?
Investing in individual shares of stock can be risky. The need for a lower risk method of investing led to to the popularity of mutual funds. Mutual funds are are professionally managed collections of stocks. Instead of focusing on a single company, mutual funds invest in dozens, hundreds, or even thousands of different companies. This spreads the risk around and provides a host of other benefits.
Exchange-traded funds (ETFs) are similar to mutual funds – with one key difference. While mutual funds are priced at the end of each trading day based on the values of the underlying investments, exchange-traded funds fluctuate throughout the day. They rise and fall with the stock market in real-time. This allows investors to get in and out of an ETF when they wish, even setting a limit order to buy or sell shares at a specific price.
What is a limit order?
There are many ways to buy and sell a stock, including market and limit orders. Market orders are just what they sound like; you purchase or sell based on the current market price when your order goes through. A limit order works differently.
When you put in a limit order, you specify the price you want to buy or sell a stock. The order only goes through if that specific price is met. For instance, you could set a $10 limit order for a stock currently trading at $12 or $13 a share; if the stock falls to the $10 price, you buy the stock. If not, the order expires, and the stock is never purchased.
What is a Dividend?
When a publicly-traded company makes money, the board of directors may pay out some of that cash in the form of a dividend. The dividend is essentially a return of profits. The amount will depend on several factors, including how profitable the company is and how fast it is growing.
Not all stocks pay dividends. Many fast-growing companies choose to reinvest their profits into future growth instead of paying it out. This is true of many of the high flying tech stocks like Facebook and Google. Suppose you want to benefit from dividend-paying stocks. In that case, you can purchase the dividend-paying stocks individually or choose a mutual fund that specializes in companies with a strong track record of dividend payments.
What is an Expense Ratio?
When you invest in a mutual fund, you will receive a number of disclosures, including one that details the investment's expense ratio. The expense ratio is the amount of money you will pay to own the fund, and it can range from a fraction of a percent to well over two or three percent.
Passive investments like index mutual funds, which simply buy and hold all the stocks in a given stock market index, are typically the cheapest to own, with expense ratios that can be as low as two-tenths of a percent. Mutual funds that buy and sell frequently tend to have much higher expense ratios. It is essential to weigh the potential for higher earnings against the increase in investment costs.
Investing 101 Wrap-up
The world of investing can seem mysterious, but once you know what all those acronyms mean, it becomes much more straightforward. Now that you know what those terms mean, you can go forward and invest with confidence.