Glossary of Investment Terms
401k Plan
A plan that allows employees to defer pretax dollars to an investment account that grows tax-deferred until the dollars are withdrawn. Participants may avoid a taxable event by rolling over their 401K balances to an IRA or other qualified plan that allows such a rollover.
403B Plan
A plan that allows employees of qualifying nonprofit organizations to invest tax-deferred funds for retirement.
IRA
An Individual Retirement Account allows individuals with earned income to invest for retirement in a tax-deferred environment. There are many rules that govern eligibility, contributions, and withdrawals of IRAs. Generally speaking, contributions to an IRA are tax deductible if neither the individual nor his/her spouse are covered by a qualified plan. If the IRA owner is covered by a qualified plan the contributions may still be deductible, subject to income limitations. An IRA may be transferred to another qualified IRA without tax implications. Withdrawals from an IRA, however, are taxable events, and if the IRA owner is younger than 59 ½ there is an additional 10% penalty levied by the IRS. The IRS requires IRA holders to begin withdrawing funds from their IRA at age 70 ½ (minimum required distributions).
Asset Allocation
Blending of assets across different categories of investments, such as stocks, bonds, and cash equivalents. A proper asset allocation that includes exposure to global asset classes is a key component to maximizing return potential and mitigating risk.
Registered Investment Advisor
An investment advisor registered with the Securities Exchange Commission or the individual state where it conducts business. The registered investment advisor (RIA) must disclose certain information about its activities and personnel to the appropriate regulating body and are subject to periodic audits by securities examiners.
Diversification
Spreading of risk by blending assets across several categories in a manner that will reduce the volatility of the overall portfolio.
Index Fund
A mutual fund whose holdings match that of a broad based portfolio. Examples of such a portfolio would be S&P 500 Index, Dow Jones Industrial Average, and Lehman Aggregate Bond Index. Index Funds usually have substantially lower expense ratios than the typical actively managed funds.
Expense Ratio
Mutual Funds expense ratios are somewhat of a mystery to many investors. These expenses range from below .1% for some index ETFs and go up to around 2% from some actively managed mutual funds. These fees are not painful for investors to pay, because they are wrapped into the daily pricing of the funds and are virtually invisible. In other words, an investor never writes a check for these fees nor is there a line item on a statement showing these fees were deducted. The fees generated from the expense ratio of mutual funds are used to compensate many people: money managers, investment advisors, administrative staff, distributors, custodians, and others. In many cases, a mutual fund company will offer several share classes for the same fund with the primary difference between the share classes being the size of the expense ratio. The fund company is required to disclose its expense ratio in its prospectus, so read it carefully.
Mutual Fund
A fund operated by an investment company that accepts money from investors (shareholders) and pools the funds together to invest in a wide range of securities. Mutual funds offer their shareholders greater diversification than investing in individual securities. Shareholders may redeem their funds at Net Asset Value (NAV) which is generally calculated at the end of business each day. Mutual funds come in many varieties with widely different investment objectives and fee structures. You should always read the funds prospectus and it is wise have a discussion with an investment professional prior to investing in a mutual fund.
Exchange Traded Fund (ETF)
Exchange traded funds (ETFs) are similar to mutual funds, but they are traded on an exchange with a bid-ask spread. ETFs primarily track index funds and are passively managed. Generally speaking, ETFs have expense ratios that are lower than mutual funds.
Hedge Fund
A private investment partnership that pools the partners’ funds for investment into a wide array of offerings using a variety of investment strategies and techniques. Many hedge funds, but not all, take large risks on speculative strategies. Hedge Funds require accredited investors to meet significant minimum balance requirements.
Modern Portfolio Theory (MPT)
Nobel Prize winning investment strategy that quantifies the relationship between risk and return and the assumption that investors must be compensated for assuming risk.
Efficient Frontier
A line on the classic risk/return graph that is equal to all the portfolios that offer maximum return potential for a given level of risk. These efficient portfolios are derived mathematically using historical risk, return, and correlation statistics.
Momentum
The velocity of price movements (up and down). There are a number of technical indicators and investment methodologies that incorporate a momentum analysis.
Passive Investing
Placing funds in an index mutual fund or a series of index mutual funds, therefore assuring investment performance no worse (or better) that the market as a whole. The opposite of active investing.
Active Investing
Investment management where the investor or portfolio manager actively make investment decisions, both security specific and timing of when to buy and sell, in an attempt to maximize returns. The opposite of passive investing.
Load
Sales charge paid by an investor that buys shares in a load mutual fund or annuity product. There are a number of different types of loads, but two of the most common are front end loads (sales charge paid at purchase) and back end load (sales charge paid at sale).
Dow Jones Industrial Average
A price weighted average of 30 actively traded blue chip stocks. It is the oldest and most widely known market indicator. Contrary to popular belief, it is not the best indicator of how the U.S. stock market is performing since it only represents 30 stocks. From time to time, there are significant divergences between the performance of the Dow Jones Industrial Average and the broad U.S. stock market.
NASDAQ Composite
A market value weighted index that measures all securities listed on the NASDAQ Stock Market. While the NASDAQ has securities from many industries, it is often referred to as a proxy for technology issues as some of the big names in the technology sector are traded on the NASDAQ.
Rollover IRA
A traditional IRA that accepts the rollover from a qualified plan (i.e. 401K) after an employee terminates employment.
Roth IRA
While Roth IRAs are similar in some ways to traditional IRAs, there are some key differences in terms of eligibility, distributions, and the 70 ½ rule. A key point and the most widely talked about difference between a Roth IRA and a traditional IRA is that Roth IRA holders do not receive a tax deduction upon making a contribution. Instead, the contributed dollars grow tax-deferred and if withdrawn after the IRA holder reaches age 59 ½ all earnings are distributed tax-free.
Standard & Poor’s 500 Index
The S&P 500 is widely regarded as the gauge for the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. This index is best used for following U.S. large company issues. Note: The index that many professional investment managers follow as a better proxy for the entire U.S. equity market is the Wilshire 5000 Equity Index.
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