15 Important Terms Every Successful Investor Should Know
Learn the basics of investing before putting any money on the line. There are no do-overs because you were not aware of the risk and reward of the investment. It’s up to you to become educated on what the potential result can be, before a position is taken on. Remember, not understanding the makeup of an investment is considered a gamble in the eyes of the market.
There is ample information available on the internet to educate you about the fundamentals and technicalities of investing analysis. When evaluating whether an investment is a fit for your portfolio, an analysis of its current and future value should be performed.
Fundamental analysis is the process of examining the financials and qualitative and quantitative elements to determine the true value of an investment security. Macroeconomic factors such as the overall economy or industry are evaluated. Often enough, the microeconomics pertaining to a company’s management effectiveness are taken into consideration. The goal of fundamental analysis is to compare the asset’s true value to its current price to determine whether it is overvalued or undervalued.
Technical analysis centers on statistical trends and emotional markets. It is an investing tool used to examine the price movements of a security to understand the triggers which cause such jumps and plunges. A technical analyst will study the statistical trends that are correlated to major economic events in attempt to forecast price movements. Past performance is seen as a crucial indicator for future movements. Fundamental analysis focuses on the asset’s value, while technical analysis is only concerned with the emotional swings of a market.
Most investment platforms offer free educational materials for customers. Whether it’s investing terminology, strategies, important formulas, step-by-step guides, or investor webinars, use the free tools provided to sharpen your knowledge. A critical component to understanding investing is the long-established terms and the always new terms developed based on new financial events. Stay abreast of the fast paced industry standards so you never get lost in the mix.
15 Important Investing Terms:
1. Asset Allocation
Asset allocation is a method of spreading out your investments into different categories of assets. The idea behind this strategy is to spread the opportunities and limit the risks. This strategy is commonly used by advisory firms to attempt to minimize risks of client’s portfolios.
A stock is an investment security that represents part ownership in a corporation. Owning stock in a company makes you a shareholder and provides your stake of a company’s assets and earnings. The two types of stock are: common and preferred. Common stock comes with voting rights, while preferred stock comes with priority on assets in the event of a bankruptcy and liquidation.
A bond is a debt investment issued by corporations and government entities. Essentially bonds are loans to the issuer with the expectation of being paid interest plus the principal over the bond’s term. Normally these are fixed rates.
4. Mutual Fund
A mutual fund is an investment tool made up of stocks, bonds, money market, or other assets. Investors contribute their funds into a pool, which is controlled by a money manager, in order to produce profits and income disbursements. Most mutual funds have fees to either buy in or sell out of the respective fund.
5. Exchange Traded Fund (ETF)
An exchange traded fund (ETF), is similar to a mutual fund, in that it holds investments in bonds, commodities, stocks, or all. What separates it from a mutual fund is that ETFs trade on the stock market like individual stocks do. Being so, they have daily jumps in prices like stocks do, as well as similar trading fees.
6. Index Fund
An index fund is a type of ETF or mutual fund constructed to replicate the performance of a market index, such as the Standard & Poor’s (S&P) 500. It takes a broad market approach in mirroring the outcome of the economy as a whole.
7. Earnings per Share (EPS)
Earnings per share is the amount of profit earned per each outstanding share. EPS is calculated by dividing the total earnings for the period by the number of outstanding shares.
8. Price-to-Earnings Ratio (P/E)
A common investing metric used to measure a company’s value of earnings per each share relative to its current share price. It is calculated as follows: P/E = Current Share Price / Earnings Per Share (EPS)
9. Dividend / Dividend Yield
A dividend, which is determined by a company’s board of directors, is a distribution of a portion of a company’s earnings to its shareholders. Dividends can be issued as cash, shares of stock, or other property.
The dividend yield is a ratio expressing the amount of dividends a company pays out each year in relation to its share price. To calculate, divide the annual dividend dollar amount paid out for each share by the price per share.
10. Book Value
Book value is the net asset value of a company’s securities – stock and bonds. Simply dividing net assets by number of shares outstanding will give the book value per share. This ratio is commonly used to determine if a company’s assets cover its debt and equity obligations.
11. Balance Sheet
A balance sheet is a financial statement that summarizes a company’s assets, liabilities, and shareholder’s equity over a particular period of time. What a company owns and what they owe are displayed on this report. The balance sheet is expressed as: assets = liabilities + shareholder’s equity.
12. Capital Gain
Capital gain is an increase in the value of a capital asset that gives it a higher worth than the purchase price. Once the asset is sold, the gain is realized. Capital gains must be claimed on a person’s income tax filing. There is short-term (less than 1 year) and long-term (greater than 1 year) holding periods.
Diversification is a strategy for risk management that involves spreading out investment dollars into a variety of asset classes. Mixing up a portfolio to include different industries, sectors, or securities such as bonds, stocks, currencies, etc.
14. Compound Interest
Compound interest is interest calculated on the initial principal and also on the accumulated interest of a deposit or a loan. Essentially compound interest is interest building on interest and continues to repeat the trend. It’s the strongest way to exponentially increase an investment.
A 401(k) plan is a retirement investment/savings plan set up by employers so eligible employees may make pretax and/or post-tax salary contributions. Employers may make matching contributions to eligible employee plans. The earnings on a 401(K) plan are federal income tax deferred.
Of all important factors taken into consideration for finding a successful investment, research is right at the top of the list. Conducting the proper research on an asset will unveil whether it is a strong or weak investment. When investors skip this step it more than often leads to losses, and sometimes drastic consequences.
Before you buy a new product online, I’m sure you do some level of research on its quality or whether it’s a worthy item. Without knowing it you are doing research by checking out customer reviews, product specifications, or if the item can be bought cheaper at another retailer. The same goes for investing products. The specifications are similar to financial reports and finding a good sale price is similar to locating an undervalued asset to invest in. You have to do thorough research on any product you put your hard-earned money into. Because in investing, you do not receive a refund due to dissatisfaction.
The brokerage you sign up with will have plentiful research information available. For stock investing, any financial reporting data needed is right at your fingertips Take advantage of what is provided for you as a customer of a brokerage firm. In the event your firm happens to have very little research information available, there is always Yahoo Finance, which is an easy, free source to use.
There’s no excuse for not being informed of the details of an asset’s current condition. The information is available. Don’t be overly anxious to return a profit that you forget to do your homework. Know the investing fundamentals, speak the language, dive deep into an asset’s technicalities before making it a part of your portfolio, and always stay confident in your investment decisions.