Decoding investment-speak

Financial jargon can sound like a foreign language. But you don’t need a degree in economics or a lot of money to start investing. You just need to learn some basics.

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Let's begin with a quick look at some major building blocks of an investment portfolio:

  • Stocks
  • Bonds
  • Short-term investments
  • Mutual funds
  • Exchange-traded funds (ETFs)

Stocks

What are they?

Owning a share of a stock means you own a share of a company. You can buy and sell shares of thousands of publicly traded stocks—and you don't need to be rich to do so. You can purchase some shares for a few dollars or less.

How do you make money?

Some companies pay out profits to shareholders by giving out extra shares or cash, known as dividends. And if the company's stock price goes up—typically because the firm earns more money—you can sell your shares, and pocket any gains. Remember, though, there are fees to trade, so those must be considered. Your total return includes dividends plus price gains, minus commissions and, of course, taxes.

Is my money safe?

Stocks can fluctuate and you can’t predict if they will gain or lose value. Earnings surprises, and world economic events can unsettle stock prices. That’s why you may not want to invest money you’ll need in the next few months or years in just stocks. Historically, over longer periods of time, stocks have consistently grown more than bonds and cash. Investing just a small amount can make a difference. When you invest in stocks for the long term, you can benefit from the power of compounding. Compounding happens when your original investment makes gains, and then you earn gains on those gains, and so on. Stocks can be a good option for long-term goals like retirement or putting a child through college.

Bonds

What are they?

A bond is a loan you make to a company, municipality, or government. They may use the money to fund operations or large building projects, like a corporate plant, school, or sports arena.

How do you make money?

Bonds make interest payments and repay your original investment (principal) on a specific date. This is called the maturity date. The terms may vary. Some bonds pay back your money (or mature) in months, while others take years. Some pay interest monthly, others quarterly or at maturity. In general, the shorter the length of the loan and the more financially sound the borrower, the lower the interest rate.

Is my money safe?

While bonds come with less exposure to loss than stocks, there is a potential for bonds to decline in value. When interest rates rise, bond prices decline. That may not matter if you are holding your bond until it matures, but if you need to sell it in the open market you could lose some money. Also, there is a risk that the borrower might fail to make interest payments or repay the loan. In general, bonds issued by the US government tend to carry less risk than bonds issued by smaller, less-established companies.

Short-term investments

What are they?

Short-term investments include relatively low-risk investments, like savings accounts, money market funds, and certificates of deposit (CDs).

How do you make money?

Most short-term investments pay modest interest rates. You can access a money market fund or savings account at any time—so they're an option for short-term goals like paying bills or saving for your next vacation. CDs pay relatively higher rates since your money is locked in for a period, from months to years. It is important to know when you'll need the money to reach your goal.

Is my money safe?

Short-term investments have a relatively low potential for loss, as long as the financial institution is secure. CDs also offer US government protection up to certain limits.

Mutual funds

What are they?

Think of a mutual fund as a collection of stocks, bonds, or other investments. An advantage of mutual funds is that they can provide you with professional management and a diversified mix of investments. Many 401(k) plans offer the option to have some or all of the money invested into mutual funds.

Most mutual funds let you get broad investment exposure and professional money management, usually without a lot of money or time.

How can I make money?

If the investments within mutual funds generate dividends or rise in price, the fund’s value goes up. Typically, dividends are distributed to you, and when you sell your shares, you gain any price increase.

Is my money safe?

Markets go up and down and so do individual stocks and bonds. Mutual funds carry the same chance of loss as the investments they hold. But because mutual funds invest in a wide variety of stocks, bonds, and other investments, it’s less likely that they would all fall at the same time.

All mutual funds are not created equal

Mutual funds come in many shapes and styles. Some track the broad stock market, others focus more narrowly on foreign stocks or stocks based on their size, region, industry, or even the investment style of the portfolio manager. For example, growth funds focus on fast-growing companies. Still other mutual funds offer ready made, all-in-one strategies. For example, target date funds adjust the investment mix so it becomes more conservative (with more bonds and fewer stocks) as the fund approaches its target date. Asset allocation funds offer a constant investment mix that aligns with different levels of risk from conservative (all bonds) to aggressive (all stocks).

Exchange-traded funds

Exchange-traded funds (ETFs) are like mutual funds with 2 major differences: how and when they are priced. Like a stock, ETFs can be traded throughout the day. A mutual fund is priced after the market closes each day based on the value of all the securities it holds. You may find ETFs as well as mutual funds in your 401(k) investment lineup.

Key takeaways

  • When you buy stock, you're buying a piece of a company.
  • When you buy a bond, you're extending a loan to a borrower, which pledges to pay you back in full with interest.
  • When you buy a mutual fund or ETF, you can get broad exposure to different parts of the market with a relatively small investment of money and time.
  • A target date fund is a diversified investment that adjusts over time to align with the year you'll expect to retire.
  • Mutual funds are priced after market close, while ETFs are priced all day long.
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