A common maxim amongst financial planners is: “Never invest in what you do not understand”. Yet the world of investing is full of jargon and can be difficult to comprehend, especially for people who are just starting out.
In this guide, our Cumbria financial planners at Vesta Wealth provide some concise explanations of the most common investment terms you are likely to encounter. We hope this is helpful. Please contact us for more information or to speak with a financial adviser:
t: 01228 210 137
e: [email protected]
Asset
An asset is essentially something you own which has a monetary value. This could be a physical item (e.g. a house) or non-physical possession (e.g. shares in a company) which hold value. These assets will potentially generate income for the investor – or, profits if the asset is sold for more than it was originally bought for.
Portfolio
Your “portfolio” describes your collection of assets. For instance, the value of your home (minus the outstanding mortgage) is typically counted as an asset. The cash in your bank account is another asset. You might also have some investments held in your pension and ISA. Together, these comprise your total “portfolio”.
Liability
A liability is often seen as a debt or obligation that you (the investor) owe to a third party. Your outstanding mortgage falls into this category. Loans, credit card balances and contractual commitments also can be classed as liabilities.
Net worth
A person’s “net worth” is the total value of their assets, minus their liabilities.
Estate
This word is typically used to refer to someone’s net worth at the time of death, particularly for inheritance tax (IHT) calculation. An estate plan, therefore, involves making arrangements to protect and distribute your assets, minimise taxes and smoothly transfer wealth to beneficiaries.
Capital gain
When you sell an asset for more than you originally purchased it for (e.g. your family home) you make a “profit” or a “capital gain”. Capital gains tax (CGT), therefore, seeks to tax some of the returns you make when this happens. Tax planning can help you reduce these taxes.
Dividend
When you invest money into a company or investment fund, it might pay you a periodic income (e.g. once every 3 months) called a dividend. This is not obligatory but is typically expected by dividend investors, or income investors.
A dividend could come from a fund or a large public company listed on a stock exchange. Or, you could pay yourself a dividend as a director of a private company.
Stocks & shares
The word “stock” is often used interchangeably with the word “share” to refer to an investor’s ownership in a company. For instance, if a company is valued at £10m and there are 100,000 shareholders, then each share is worth £100.
Sometimes a distinction is made between “stock” and “share”. The former might refer to a unit of ownership for a company listed on a stock exchange (a “public” company, like Amazon). A share, conversely, could refer to the smallest denomination of that company’s stock.
For instance, suppose a publicly-listed company’s stock price is £100. Individual investors may not choose to buy a full £100 share, but instead might pool their money together to buy individual parts of the £100 stake (e.g. using an investment fund).
Fund
Sometimes called a mutual fund or collective investment scheme, an investment fund is a professionally-managed “pool” of money gathered from many different investors.
The money is then invested into multiple assets (e.g. companies) to generate returns on behalf of the investors. You can buy individual shares in a particular fund which then represent your ownership of the underlying investments (and their returns).
As individual shares in some instances can be worth a lot of money, investing in a fund allows investors to access a wider range of companies than they otherwise might be unable to afford. This allows for increased diversification at reduced cost even with investors with smaller sums available to invest.
Bull market and bear market
If stock prices are rising overall in the stock market (e.g. the FTSE 100 in the UK) and investors are generally optimistic about conditions, then this is often called a bull market.
A bear market, by contrast, refers to a period of falling prices and pervasive investor pessimism. For instance, if the stock market falls by 20% or more, then some would call this a bear market.
Bond
This is a type of investment similar to a bank loan – except you (the investor) are the one lending the money and a government, or company, is the party borrowing. When you buy a bond, the latter promises to repay you interest (known as coupons) at set intervals before repaying you the original amount borrowed at a set date, known as maturity.
Asset allocation
This refers to your choice over which assets make it into your portfolio (e.g. stocks, bonds and cash) and the amount of each asset you hold.
This allocation is based on your financial goals, risk tolerance and time horizon. For instance a higher risk investor may allocate more of their portfolio to riskier assets such as stocks.
Diversification
Very closely related to asset allocation, diversification is the process of minimising investment risk by investing in multiple opportunities – both within, and across, asset classes.
For instance, you can diversify the “share” asset class of your portfolio by investing in hundreds (perhaps thousands) of companies rather than just one. In very simple terms, if you held ten shares and one became worthless, this would represent a 10% loss in your portfolio. But if you held 1,000 shares, then one company becoming worthless would only result a loss of 0.1%.
The other main form of diversification is holding a combination of asset classes in your portfolio which each perform differently in different market conditions. For example in a bear market when share prices are falling, it is hoped that bond prices might rise to protect the value of the portfolio. By holding a range of asset classes within your portfolio, the overall level of volatility can be reduced as you are less exposed to specific risks.
Volatility
Sometimes considered a measure of ‘risk’, volatility measures the tendency for the market price of an asset to ‘bounce around’. Essentially this is the upwards and downwards movements of asset prices. Shares are said to be more volatile than bonds as their prices often move up and down more frequently.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.