20 Investment Terms You Must Know to Start Investing

You are interested in learning more about investing in your future. Let`s review 20 key terms and concepts you will need to understand to become an investor.

Security

A financial instrument that holds monetary value. Examples: stocks, bonds, mutual funds. There are two different types of securities: debts and equities.

Savings Account

Highly liquid, cash equivalent investment, offers a very low-interest rate. Does not fluctuate in value, highly accessible, great for short-term saving goals.

Debt

The money you owe to someone, funds you borrow to make a large purchase.

Debt Instruments (or debt security)

A written contractual agreement between the lender and the borrower. Debt instruments tend to be less volatile than equities or stock. Offer lower, consistent return, and fixed payment schedule. Examples: certificates of deposit (CDs), notes, bonds, mortgages, loans.

Equity

Ownership, net worth, or capital. Accounting formula: Equity=Assets-Liabilities (Debt).

Scenario: five years ago you bought a house on credit for $300K, and your mortgage is $280K. Today house market value is $400,000. What is your equity in the house? Your House Equity = House Market Value – Your Liability= $400,000-280,000= $120,000

Equity Instruments (or equity security)

Ownership of the company stock. An equity investor is co-owner of the corporation. Equities offer a higher risk of loss, higher volatility, no guaranteed returns, higher growth and profit potential than debt instruments. Suitable for risk-tolerant investors

Liability

Debt, obligation, legal responsibility or potential risk of loss. A liability takes money out of your pocket in the form of periodic payments. Example: you purchased a car on credit. You have a liability to the bank in the form of a personal car loan. You will make monthly loan payments to the bank. In the scenario, you are a borrower, and the bank is the lender.

Assets

Something valuable that earns you a return. Example: a commercial real estate property that produces monthly income.

Actively Managed Funds

Mutual funds are professionally managed security portfolios.

Passively Managed Funds

Index Funds designed to mirror the performance of a specific market standard, such as the S&P 500 Index.

Mutual fund

Portfolio of various securities pulled together and managed by experts. The basket may include hundreds or even thousands of individual bonds or stocks. Example: Vanguard Growth Index Fund Admiral Shares (VIGAX) that holds 309 individual stocks (securities) and represents nine different equity sectors. Main advantage convenience and reduced company risk.

Investment Risk

The degree of uncertainty and financial loss related to an investment decision.
Investment Risk Types:

Company risk is uncertainty and risk associated with a specific firm`s performance
Market Risk is volatility due to political and economic factors affecting the economy as a whole. Examples: national disasters, recessions, terrorist attacks, political unrest

Risk tolerance

Ability to withstand portfolio value fluctuations. Your ability to withstand risk without selling off your investments will define your portfolio return. The more risk you can tolerate the higher will be your returns. To test your risk tolerance, take a Risk Tolerance Assessment Test.

Diversification

The act of including securities from various sectors to reduce company-specific risk. Example: buying a mutual fund, that includes equities from nine sectors of the economy, which will perform in a manner that will eliminate risks related to any individual firms performance.

What is Dollar-Cost Averaging (DCA)

Is an investment technique which involves buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. As a result of the approach, the investor ends up purchasing more shares when prices are low and fewer shares when prices are high. (Investopedia).

Principal Value

Investment: refers to your contribution, the money you invested. Loan: refers to the originally borrowed amount.

Interest Rate

Loan Interest Rate: a fee borrower pays for the loan, typically expressed as an annual percentage of the loan outstanding.
Return on Investment: refers to the percentage of the principal investor earns. For example, 8% return on $1000 investment means you will be paid $80 in interest as a return.

Compounding interest

The interest you earn on your investment is added to your principal value, in other words, you earn interest on interest.

Example: you invested $1,000 that earns 10% annually. The first year you will earn $100, and now your total principal is $1,000+100=$1,100. At the end of second year your balance will be $1,100+(1,100×10%)= $1,210. You are earning compounding interest on your investment.

Account Types:

Brokerage account: is an investment account, all earnings are subject to income taxes.
Retirement account: investment account is a special account for retirement savings

Retirement Accounts:

Pre-tax or Tax-deferred Individual Retirement Accounts (IRAs): 401K.

Allow you to defer paying taxes until the day you withdraw funds.
Offered by employers only.
The option works well for high-income tax bracket families.

After-Tax Individual Retirement Accounts: ROTH IRA.

You invest money after you pay your taxes.
Anyone can open ROTH IRA account and start saving for retirement.

Early withdraw rule

Funds from your retirement account only could be withdrawn after a certain age. There are heavy taxes and the penalty for early withdraw of funds. There are exceptions and loopholes for ROTH IRA contributions, but in general, the rule applies to all withdrawals before after of 59 ½ years old. (Credit: IRS)

Disclaimer: The post is not and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action, including without limitation as those terms are used in any applicable law or regulation. Logio Solutions shall not have any liability for any damages of any kind whatsoever relating to this material. This educational material is was provided to you at no cost.