On this blog, I encourage you to understand how the world works and to take control of your financial destiny.
If you want to become a Do-It-Yourself (DIY) investor, you should understand all these investing terms and more!
This is a collection of investment assets such as stocks, bonds, commodities, other securities, and funds that are managed by a professional manager or investment company.
A mutual fund typically focuses on a specific investment type and pools together money from a large group of investors. A mutual fund is an easy way for an individual investor to buy into diversified portfolios and get access to professional management.
Management and administrative fees are usually levied on your holdings in a mutual fund.
Related: Mutual Fund Basics Explained
This is a type of mutual fund that is designed to match or track a prominent market index such as the Standard and Poor’s 500 index (S&P 500) or the Dow Jones Industrial Average (DJIA).
An index fund is set up not to beat the market index but instead to replicate its performance. The advantages of an index fund include ease of management, lower portfolio turnover, and less operating costs. Management fees are also much less.
Investors in index funds expect to generate close to market returns which are often more than most investors make year in and year out.
Related: Index Fund Options for Beginners
This refers to a share in the ownership of a company. When you own stock in a company, it means that you are one of its shareholders and have a claim to the company’s dividends and voting rights.
You can also make money from price appreciation by selling your stocks (shares) when the price per unit goes up.
Bonds are debt security. Examples include municipal bonds, corporate bonds, savings bonds, and Treasury bills.
When you buy a bond, you are essentially lending money to the borrower (bond issuer) with the hopes of generating income from interest payments (coupon) during the life of the bond and getting the principal (face value of the bond) back at the maturity date.
The farther away from the maturity date, the higher the rate of interest a bond will pay.
Related: How Bonds Work
Exchange-Traded Funds (ETFs)
This is similar to an index fund, however, ETFs trade like stocks on a stock exchange. This means that they can experience price changes and can be bought and sold throughout the day just like stocks.
The advantages of trading in ETFs include flexibility in buying and selling, lower management fees, and opportunities for diversification.
Here’s all you need to know about ETFs.
Simple interest is the interest calculated on a principal amount and does not include interests on any interest already earned.
For example, 10% annual simple interest on $1000 (10% x 1000) is $100 for year 1 and remains $100 for year 2. The $100 interest earned in year 1 is not taken into consideration when computing the simple interest for year 2 and so on.
Compound interest is calculated on the initial amount (principal) and also on the accumulated interest earned to date.
For example, if you make a $1000 investment that earns 10% returns per year. For the first year, interest (simple) is $100 (1.e. 10% x $1000). Assuming returns are re-invested, for the second year, returns (interest) earned will be $110 (i.e. 10% x $1100) and so on.
The rate of growth is now much higher than with simple interest.
Legend has it that Albert Einstein once referred to compound interest as the most powerful force in the universe. It can significantly multiply your investments over time and can do the same with debt.
Compound interest is an investment miracle and is one of the main strategies for building wealth.
Time Value of Money
The time value of money infers that money on hand today is worth more than that same amount of money in the future.
This is based on the premise that money on hand today can be put to work to earn interest and as such will be worth more than the initial value at some point in the future.
So, $10 today is worth more than $10 in a year’s time. This is why some people say “Time is money.”
This is a market condition where securities prices are falling because sellers (bears) have overwhelmed buyers (bulls) and the market outlook is pessimistic (bearish).
This is a market condition where securities prices are rising because buyers (bulls) have overwhelmed sellers (bears) and the market outlook is optimistic (bullish).
This is when an investor buys a stock or security and holds it with the hope that the price will rise.
The is a trading technique in which a trader sells a stock/security that they have borrowed through their broker with the expectation that the stock’s price will decline and they can then buy the stocks back at a lower price, return the stocks to the lender and keep the difference as profit.
It is a very risky technique and not for the faint of heart.
This is a risk management technique in which you spread your investments over different asset classes (stocks, bonds, commodities, real estate, currencies) so as to reduce the exposure you have to any single asset and reduce the risk of your entire portfolio.
Diversification may help to prevent total loss if the market experiences an upheaval.
This is a strategy utilized in portfolio diversification in which an investor spreads out their investments over a variety of asset classes.
The proportion of funds invested in each asset class is reflective of the risk appetite/tolerance, goals, and time frame for investing set by the investor.
Risk tolerance is the level of financial risk or uncertainty an investor is willing to take. Risk tolerance may be influenced by an investor’s background, age, investment horizon, financial capacity, investing knowledge, and many other factors.
On the scale of risk tolerance, an investor may be very risk-averse or they may be risk-loving. A risk-averse investor prefers a conservative investing approach with limited risk and return.
You can assess your risk tolerance here by completing a risk profile questionnaire like this one by Vanguard Canada.
Financial risk refers to the uncertainty of returns and the potential for financial loss. Every investment carries a level of risk, but some investments are riskier than others.
In investing, there is a relationship between risk and return. The higher the risk, the greater the potential for higher returns or larger losses. The lower the risk, the greater the probability of lower returns or smaller losses (comparatively).
Market volatility is the rate of change in the price of a stock or security. Stock prices normally move up and down.
Volatility is high when the price changes rapidly over a short period of time.
Is the ability to convert an asset into cash quickly enough without suffering slippage or loss in value. Liquidity is usually dependent on the availability of ready market participants to fill the other side of the transaction.
Investing a fixed amount of money at regular intervals over a period of time regardless of the share price. This is a smart investing strategy as it avoids trying to pick tops and bottoms in the markets.
Expense ratio refers to the annual fees paid for the professional management of your money. It usually includes management fees, administrative fees, and other fees.
High expense ratios can cut deep into the overall returns investors make on their investments. Minimizing the costs of investment over the course of your investing life can mean the difference between average and above-average returns.
Dividend refers to money paid out by a company to its shareholders from its profits.
Taking control of your finances and your life includes understanding some of these financial terms and concepts you will come across now and again.
Annual Percentage Rate (APR)
This is the total amount of interest plus fees paid on an annual basis on a loan expressed as a percentage. APR is a broader measure of the costs of borrowing money and is also referred to as “Effective interest Rate”.
A financial arrangement where you make one or multiple payments in return for fixed regular payouts for a specified period of time in the future. Annuities can be utilized as a part of your retirement investment planning.
Regular installment payments of a debt over a period of time.
Also known as Statement of Financial Position. This is another financial statement produced by a firm that gives us a snapshot of the company’s financial position at a specific point in time. It summarizes the company’s assets, liabilities, and equity at a specific point in time.
A balance sheet works around the formula: Total Assets = Total Liabilities + Owner’s Equity
Liabilities: These are the financial obligations or debts owed by a person or business to creditors or suppliers for products or services.
Assets: Is anything of economic value (tangible or intangible) that is owned or controlled by a person or business including cash, inventory, equipment, and receivables.
Equity: Is an owner’s or shareholder’s stake in a business.
Cash Flow Statement
Also known as Statement of Cash Flows. Describes a company’s cash inflows and cash outflows over a specified time period. It is one of the financial statements produced by a company.
This is a summary of your use of credit and debt including credit cards, personal loans, and mortgages.
It details when you opened your credit facilities, how much you owe, whether you make payments on time or miss payments, how much you use from the credit available to you, credit inquiries on your accounts, and much more.
A credit report is used to assess a person’s creditworthiness. You can order a free credit report from Equifax Canada and Transunion Canada once a year. The free report will not include your credit score.
This is a 3 digit number that captures your creditworthiness and is based on your history of managing credit and debt. In Canada, credit scores range from 300 to 900 points.
The higher your credit score, the better your creditworthiness and you may have a better chance at qualifying for new credit at more competitive interest rates.
This is money set aside to be used when emergencies arise such as a job loss, medical emergency, or a major expense. It is advised that you have at least 3 months’ worth of your normal monthly living expenses stashed away in an emergency fund.
Emergency funds should be saved in an account where it is readily accessible at short notice such as in a savings account.
This refers to sustained increases in the prices of goods and services over time. Inflation results in loss of purchasing power meaning that a dollar may not be able to purchase in one year what it can purchase today.
The higher the rate of inflation, the lower your purchasing power.
Is the money you pay for the privilege of using money borrowed from a lender or the money earned for taking on risk by giving others the opportunity to use your money either via loans, investments in stocks, bonds, etc.
Also known as “Profit and Loss Statement”. It is one of the financial statements produced by a company and shows the company’s revenues and expenses over a particular period.
The difference between revenues and expenses reflects the profitability of the firm over that specified period of time.
Can be used in various ways. A popular use is in reference to the initial amount borrowed through a loan, not including the interest owed on the loan.
It can also refer to the initial funds you invest in the markets, not including interest or returns earned on your investment. It may also be used to refer to the face value of a bond.
What is left after you deduct your total liabilities from your total assets.
Net worth = Total Assets – Total Liabilities.