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 Investing Basics Terms

401(k) plan A defined-contribution retirement plan that allows an employee to contribute pretax dollars to a company pool that is invested in stocks, bonds, or money market instruments. Named after the section of the Internal Revenue Code that created it.

403(b) plan A defined-contribution retirement plan available to employees of public schools, certain tax-exempt entities (including churches), and educational institutions. Allows an employee to contribute pretax dollars to a company pool that is invested in stocks, bonds, or money market instruments. Named after the section of the Internal Revenue Code that created it.

annuity A series of fixed-amount payments paid at regular intervals over the period of the annuity.

ask price The price a seller is willing to accept for the security; also called the offer price.

asset A resource that has economic value to its owner. Examples of an asset are cash, accounts receivable, inventory, real estate, and securities.

asset allocation Dividing your investment portfolio among the major asset categories such as stocks, bonds, and cash. Determines the risk and return of your portfolio.

balance sheet The firm's financial statement that provides a picture of its assets, debts, and net worth at a specific point in time.

beta A measure of a stock's risk relative to the market, usually the Standard & Poor's 500 index. The market's beta is always 1.0; a beta higher than 1.0 indicates that, on average, when the market rises, the stock will rise to a greater extent and when the market falls, the stock will fall to a greater extent. A beta lower than 1.0 indicates that, on average, the stock will move to a lesser extent than the market. The higher the beta, the greater the risk.

bid price The price a buyer is willing to pay for a security.

blue-chip stock Stock of large, well-known companies with a history of growth and dividend paying and that offer quality management, products, and services.

bond A security that obligates the issuer to repay the principal amount upon maturity and to make specified interest payments over specified time intervals to the bond holder. The issuer can be a corporation or a governmental entity. A bond is a debt obligation; the bondholder is a lender to the issuer and there is no ownership position.

buy-and-hold approach A strategy in which the stock portion of your portfolio is fully invested in the stock market at all times.

capital gain An increase in the value of a capital asset such as common stock. If the asset is sold, the gain is a "realized" capital gain. A capital gain may be short-term (one year or less) or long-term (more than one year.)

capitalization-weighted Weighting the holdings of a fund or index based on market capitalizations (larger companies take a larger position in the portfolio).

cash investment Very short-term (usually 90 days' maturity or less) obligation such as money market fund or very short-term CD that provides a return in the form of interest payments.

certificate of deposit (CD) Savings certificate that entitles the holder to the receipt of interest. CDs are issued by commercial banks and savings and loans (or other thrift institutions).

closed-end fund A pooled investment fund that has a fixed capitalization after the initial issue. Fund shares are traded on an exchange (see open-end fund).

commission Broker's fee for buying or selling securities.

commodity futures A contract to buy or sell a commodity, such as meats, grains, metals, and energy products, in the future at a given price.

common stock A security issued by a corporation that represents ownership.

compound sum of an annuity Constant payments are made at equally spaced time periods and grow to a future value.

compounding The ability of an asset to generate earnings that are then reinvested and generate their own earnings (earnings on earnings).

correlation The relationship between two assets. Correlation coefficients are used to measure how closely a pair of asset classes tends to move in relation to each other. A perfect positive correlation of 1.0 indicates identical fluctuations: both classes tend to move up and down at the same time by similar amounts. The lower the correlation, the better the diversification; -1.0 means perfect negative correlation.

current yield Annual income (interest or dividends) divided by the current price of the security. For stocks, this is the same as the dividend yield. Or, a bond with a current market price of $1,000 that pays $60 per year in interest would have a current yield of 6%.

default risk The risk that a company will be unable to pay the contractual interest or principal on its debt obligations.

discount bond A bond that is valued at less than its face amount.

discount broker A stockbroker who charges a reduced commission and provides no investment advice.

discount rate The interest rate used in discounting future cash flows; also called the "capitalization rate."

diversification The process of accumulating securities in different investments, types of industries, risk categories, and companies in order to reduce the potential harm of loss from any one investment.

dividend A cash payment financed by profits that is designated by a company's board of directors to be distributed among stockholders.

dividend reinvestment plan When company applies shareholder dividends to the purchase of additional shares instead of sending cash. Usually little or no commission is paid.

dollar cost averaging A system of putting equal amounts of money in an investment at regular time intervals to lessen the risk of investing a large amount of money at a particularly inopportune time.

Dow Jones industrial average (DJIA) Price-weighted average of 30 actively traded blue-chip stocks, traditionally of industrial companies.

equity Another word for stock, or similar securities representing an ownership interest.

exchange-traded fund Passively managed portfolio of securities that tracks an index and trades on an exchange.

face value The stated principal amount of a debt instrument.

family of funds A group of mutual funds under the same management company.

financial planner An investment professional generalist who helps individuals delineate financial plans with specific objectives and helps coordinate various financial concerns.

fixed-income security An investment vehicle that provides a return in the form of fixed periodic payments and return of principal; examples are bonds and certificates of deposit.

fundamental analysis The valuation of stocks based on fundamental factors, such as company earnings, growth prospects, and so forth, to determine a company's underlying worth and potential for growth.

general obligation bond (GO) A municipal bond backed by the full faith, credit, and "taxing power" of the issuing unit rather than the revenue from a given project.

GNMA (Ginnie Mae) pass-through certificate Fixed-income securities that represent an undivided interest in a pool of federally insured mortgages put together by GNMA, the Government National Mortgage Association.

going public Selling privately held shares to new investors for the first time.

government bond A debt obligation issued by the U.S. government.

growth stock The shares of a company whose earnings are expected to grow at an above-average rate.

guaranteed investment (interest) contract (GIC) Debt instrument sold in large denominations often bought for retirement plans. The word guaranteed refers to the interest rate paid on the GIC; the principal is at risk.

income statement The financial statement of a firm that summarizes revenues and expenses over a specified time period; a statement of profit and loss.

income stock Those stocks having a history of regular dividend payments that contribute the largest proportion of the stock's overall return.

index A statistical measure of the changes in a portfolio representing a market. The Standard & Poor's 500 is the most well-known index, which measures the overall change in the value of the 500 stocks of the largest firms in the U.S.

individual retirement account (IRA) Personal retirement account that an employed person can set up with a deposit that is tax deductible up to a set maximum per year. Such deposits qualify as a deduction against income earned in that year and interest accumulates tax-deferred until the funds are withdrawn at age 59 1/2 or later. Early withdrawals are subject to a penalty. (See also Roth IRA.)

inflation risk Uncertainty over the future real (after-inflation) value of your investment.

insider trading Trading by management or others who have special access to unpublished information. If the information is used to illegally make a profit, there may be large fines and possible jail sentences.

investment adviser A person who manages assets, making portfolio composition and individual security selection decisions for a fee, usually a percentage of assets invested.

junk bond Bond purchased for speculative purposes. Usually rated BB and lower, and has a higher default risk.

Keogh A tax-deferred retirement account designated for employees of unincorporated businesses or for persons who are self-employed (either full-time or part-time).

limited partnership An arrangement between a general partner and a limited partner. The general partner manages the project, and collects fees and a percentage of profits and income. Limited partners invest in the project but have limited liability; they are not involved in the day-to-day management of the project, and they receive a percentage of the profits and income. In general, they also receive tax benefits.

liquidity The degree of ease and certainty of value with which a security can be converted into cash.

load A sales commission to buyers that a mutual fund may charge.

low-load fund A mutual fund that charges a small commission for investment.

lump-sum distribution A single payment to a beneficiary covering the entire amount of an agreement. Participants in individual retirement accounts (IRAs), pension plans, profit-sharing, and executive stock option plans generally can opt for a lump-sum distribution if the taxes are not too burdensome when they become eligible.

margin The use of borrowed money to purchase securities (buying "on margin").

market capitalization Number of common stock shares outstanding times share price. Provides a measure of firm size.

market risk The volatility of a stock price relative to the overall market as indicated by beta.

market timing Attempting to leave the market entirely during downturns and reinvesting when it heads back up. Requires a crystal ball to be effective.

maturity The length of time until the principal amount of a bond must be repaid.

maturity date The date when the principal amount of a security becomes due and payable.

Medicare A U.S. Social Security Administration program that reimburses hospitals and physicians for certain medical care to qualifying persons over the age of 65.

modern portfolio theory (MPT) Overall investment strategy that seeks to construct an optimal portfolio by considering the relationship between risk and return, especially as measured by alpha, beta, and R-squared. This theory recommends that the risk of a particular stock should not be looked at on a stand-alone basis, but rather in relation to how that particular stock's price varies in relation to the variation in price of the market portfolio. The theory goes on to state that given an investor's preferred level of risk, a particular portfolio can be constructed that maximizes expected return for that level of risk.

money market mutual fund A mutual fund that invests in very short-term financial securities, usually of less than 30 days maturity.

municipal bond Tax-free debt instrument issued by a state or local government.

mutual fund A pool of investors' money invested and managed by an investment adviser. Money can be invested in the fund or withdrawn at any time, with few restrictions, at net asset value (the per share market value of all securities held) minus any loads and fees.

NASDAQ U.S. electronic stock market where trades are executed through a sophisticated computer and telecommunications network.

net asset value The market value of a mutual fund's total assets, after deduction of liabilities, divided by the number of outstanding shares; the per share price of no-load mutual funds.

New York Stock Exchange index A market value-weighted measure of stock market changes for all stocks listed on the NYSE.

no-load fund A mutual fund that sells its shares at net asset value, without the addition of a sales fee (load).

open-end fund A mutual fund that continuously sells shares to investors and redeems shares when investors wish to sell. Open-end funds have no limit to the number of shares they can issue.

over-the-counter market A communications network through which trades of bonds, non-listed stocks, and other securities take place. Trading activity is overseen by the National Association of Securities Dealers (NASD).

par value (bond) The face value of a bond, generally $1,000 for corporate issues, with higher denominations for many government issues.

pension Fund set up by a corporation, labor union, governmental entity, or other organization to pay the pension benefits of retired workers.

portfolio manager One responsible for managing large pools of funds. Portfolio managers may be employed by insurance companies, mutual funds, bank trust departments, pension funds, and other institutional investors.

preferred stock A security representing prior claim to common stock on the firm’s earnings and assets. Preferred stockholders normally forgo voting rights and receive a fixed dividend that takes precedence over payment of dividends to common stockholders.

present value The value today of a future payment, or stream of payments, discounted at some appropriate interest rate.

principal The amount owed; the face value of a debt; the amount invested.

prospectus The written statement that discloses the terms of a securities offering or a mutual fund. Strict rules govern the information that must be disclosed to investors in the prospectus.

REIT Real estate investment trust. Similar to a mutual fund, except it invests in real estate enterprises, primarily the ownership, renting and managing of properties. Characteristically, REITs have higher dividend yields than common stocks.

return Consists of income plus capital gains relative to investment.

revenue bond A municipal bond supported by the revenue from a specific project, such as a toll road, bridge, or municipal coliseum.

risk Possibility that an investment's actual return will be different than expected; includes the possibility of losing some or all of the original investment. Measured by variability of historical returns or dispersion of historical returns around their average return.

risk/return trade-off The balance an investor must decide on between the desire for low risk and high returns, since low levels of uncertainty (low risk) are associated with low potential returns and high levels of uncertainty (high risk) are associated with high potential returns.

RiskGrade A measure that standardizes risk by taking the average standard deviation of all the world's equities and assigning it a standard deviation value of 100. All other standard deviations are expressed as a percentage of that figure. Developed by RiskMetrics Group (www.riskgrades.com).

Roth IRA Individual retirement plan. Contributions are not deductible, but qualified distributions are tax free.

secondary market A market in which an investor purchases an asset from another investor rather than the issuing corporation. An example is the New York Stock Exchange.

sector The broad general industry classification for stocks.

security analyst One who studies various industries and companies and provides research reports and valuation reports.

Standard & Poor’s 500 index A broad-based, market-cap-weighted index based on the average performance of approximately 500 widely held common stock.

standard deviation A measure of the degree to which returns of an asset vary around the mean.

stock dividend A dividend paid in additional shares of stock rather than in cash.

stock split The division of a company's existing stock into more shares. In a 2-for-1 split, each stockholder would receive an additional share for each share formerly held.

stockbroker An agent who handles the public's orders to buy and sell securities for a commission.

technical analysis An analysis of price and volume data as well as other related market indicators to determine past trends that are believed to be predictable into the future. Charts and graphs are often utilized.

ticker Letter or group of letters that designates a security for trading purposes.

time horizon The length of time an investment is held.

Treasury bill Short-term debt security issued by the federal government for periods of one year or less.

Treasury bond Longer-term debt security issued by the federal government for a period of seven years or longer.

Treasury note Longer-term debt security issued by the federal government for a period of one to seven years.

valuation The process of determining the current worth of an asset.

Value Line index The index represents 1,700 companies covered in the The Value Line Investment Survey. It is an equal-weighted index, which means each of the 1,700 stocks, regardless of market price or total market value, are weighted equally.

value stock Stock of companies whose price looks cheap relative to earnings, assets, dividends or cash flow

variability The possible different outcomes of an event. As an example, an investment with many different levels of return would have great variability.

variable annuity A life insurance company investment product that combines a savings plan with a small life insurance component to provide certain tax benefits. The savings portion can be invested in a choice of pooled vehicles, including stock funds.

Wilshire 5000 index A broad-based, market-cap-weighted index of stocks. Includes virtually all liquid securities (about 7,000).

yield The amount of interest paid on a bond divided by the price. A measure of the income generated by a bond. A yield is not a total return measure because it does not include capital gains or losses.

yield curve A curve that shows interest rates at a specific point for all securities having equal risk but different maturity dates. Usually, government securities are used to construct such curves.

yield to maturity The yield on a security assuming that interest payments will be made and reinvested until the final maturity date, at which point the principal will be repaid by the issuer.

zero-coupon bond A bond that generates no periodic interest payments and is issued at a discount from face value. All return is realized at maturity.