Annotated Investment Glossary


Synonyms and Quick Reference – Streamlined and Simplified

Appreciation – Growth. A stock portfolio does not earn interest; it appreciates. This term generally applies to the shares themselves increasing in value without increasing in number. (Please see Dividend for the other way stocks can grow in value.)

Asset Allocation – The proportion of asset classes in your portfolio devoted to each asset class. For example, the percentage of the total devoted to bonds, large, medium and small cap equities, domestic vs. international, growth vs. value, and various sectors. (Martha’s note: the asset allocation should match the time horizon of the account. Be wary of those who would compare a shorter-term portfolio that may be used to save for a home improvement or child’s wedding with one to fund your long-term care. This is akin to comparing apples and oranges.

Beta – a measure of volatility. A beta of 1.00 means the investment moves in lockstep with the Standard & Poor’s 500 Index (S&P 500). A beta less than one is less volatile than the S&P 500.  More than one is more volatile.

Think of a seismograph. When the earth’s plates are not moving the needles do not move, but when the plates rub against each other the needles jump. The amplitude of the graph produced gives scientists a measurement of the earthquake; the higher the number more powerful the quake.

Capital Gain/(Loss) – applies only to after-tax accounts. Any money coming out of a pre-tax savings vehicle (such as an Individual Retirement Account or IRA) is taxed as ordinary income in the year in which it is received. A capital gain is realized when an investment is sold for a market value than is higher than the cost basis. A capital loss is realized when the cost basis is higher than the market value. See Tax Lot Harvesting for more information.  

Cost Basis – (usually only applied to after-tax accounts) is the original purchase price of an investment plus the cost of any purchases to date, including those resulting from dividend reinvestment.

Correlation – When assets move at the same time in the same direction, like twin racing roller coasters. Non-correlated assets may move at different time or in opposite directions when stimulated by the same event. For example, stocks and bonds tend to move in opposite directions.  Real estate is generally not correlated with either stocks or bonds.

Coupon – the interest rate a bond pays. In days of old, bonds were issued with a fringe of perforated coupons. The bond holder would literally tear off the coupon and present it for payment at the appointed time.

Debt – Bond, Obligation, Debenture. All names for debt securities.

Dividend – Common stocks can either appreciate, meaning each share increases in value, or they can grow through dividend reinvestment. A dividend is declared by a company’s Board of Directors as reward for shareholders owning an equity stake in the company. When a dividend is produced, the investor can take it, or reinvest it. Dividend reinvestment increases the number of shares owned. It also takes advantage of market downturns to buy more shares at the lower price.

Diversification – Generally, the more varied the portfolio, the less volatile it will become, particularly if assets are in opposition to each other such as growth vs. value and domestic vs. foreign equities and bonds, and stocks vs. bonds.

Dividend Yield – is the annual rate of return generated from dividends on stock. It is calculated by dividing the annual dividend by the stock’s purchase price.

Duration – the time it will take an investor to get back the par value (or maturity value) of a bond.  Bond investors receive both a regular interest payment during the term of the bond (also called the coupon payment), but at the conclusion of the term, they also receive the maturity value.  Typically, the duration is a little shorter than the bond’s term.

Equity – Stock. Common Stock includes voting rights, hence the term equity.

ETF – Exchange Traded Fund. (The following is the definition from Investopedia) with annotation. 

An ETF, or exchange-traded fund, is a marketable security that tracks an index, a commoditybonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.

Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated once at the end of every day like a mutual fund does.

(Martha’s note: By “trades like common stock,” Investopedia is telling you that ETFs trade on the tick of the clock with the price changing with each tick. All the other fancy trading maneuvers like shorting and hedging that can be done with stocks can also be done with ETFs. For this reason and many others, ETFs are best put in the hands of experienced traders who sit in front of their screens analyzing and trading these instruments all day. 

Fortunately, there are many portfolio managers now using ETFs, so individual investors can benefit from the flexibility, variety and low cost of these instruments without having to gain the trading skills that only come with comprehensive financial education, expert supervision, and years of practice.)

Read more: Exchange-Traded Fund (ETF)

Fixed Income—interest-bearing investment with a fixed rate of interest.

Maturity— date when a bond will mature and pay its face (Par)value. (See Term and Par Value below)

Mutual Fund (This definition is from Investopedia) with annotations.

A mutual fund is an investment vehicle made up of a pool of moneys collected from many investors for the purpose of investing in securities such as stocksbondsmoney market instruments and other assets. Mutual funds are operated by professional money managers, who allocate the fund's investments and attempt to produce capital gains and/or income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Read more: Mutual Fund 

(Martha’s Note: Mutual funds are sold in different share classes. They can be sold on a commission or fee basis. Which way you buy them depends on whether you wish to have an on-going relationship with the representative selling you the mutual fund (advisory fee basis), or whether you just need the transaction done and then you are unlikely to ever call this person again (commission).

There are retail mutual funds sold on commission as A or C shares. A-shares have an upfront commission. C-shares have a one year back-end commission, but a much higher maintenance fee. If you plan to exchange or sell the fund in a year and half or so, the C share would be considered appropriate. If you plan to buy and hold for more than five years, the A share would be more appropriate.

The mutual fund could be from a no-load mutual fund family and the A share has no upfront commission. Sometimes no-load families will call the basic share class “I” for “Investor class” shares. To further confuse matters there is another kind of I share, the Institutional share class. This may be reserved for individuals willing to buy $100,000 worth of the mutual fund, or it could be inside an investment that aggregates buyers such as inside a managed portfolio or an employer-sponsored 401K.

Par Value – (with regard to bonds) – The face value of a bond. Bonds trade in the open market.  The par value is the value the bond will pay if held to maturity, assuming the issuer does not default on the obligation or call in the bond prior to the maturity date. The price of the bond will often differ from the par value based on how the market views the bond’s Term, Coupon, and the creditworthiness of the issuer as measured by rating companies S&P, Moody’s, Duff & Phelps, or other specialty rating company.

Most bonds are issued with par values of $1,000. A round lot of bonds is 100 bonds, which means if one wants to buy a round lot of bonds, one needs $100,000. Since diversification is desirable, individual investors often turn to bond funds. The fund (whether ETF or mutual fund) has the resources to fashion a diversified bond portfolio, of which the individual investor can buy shares.  (One doesn’t have to buy all the ingredients to make a pie when all they want is a slice of pie.)

Penny Stock (from Investopedia, the online investment dictionary) with annotations.

The term penny stock has evolved with the market. In the past, penny stocks were stocks that traded for less than a dollar per share. The SEC, however, has modified the definition to include all shares trading below $5.

Penny stocks are more suitable for investors with a high tolerance for risk. (Martha’s Note: This is an understatement, primarily because Penny Stocks are frequently used in nefarious schemes dramatized in Hollywood movies with titles like Boiler Room or The Pump and Dump.) Typically, penny stocks have a higher level of volatility, resulting in a higher potential reward and a higher level of risk. Considering the heightened risk levels associated with investing in penny stocks, investors should take particular precautions. For example, an investor should have a stop-loss order predetermined before entering the trade, knowing where to exit if the market moves opposite of the intended direction.

Although penny stocks can have explosive moves, it is important to have realistic expectations. Typically, gains in the stock market take months and years to materialize. An investor who buys penny stocks with the intention of turning $100 into $50,000 over a week is likely to be deeply disappointed.

Penny stocks are often growing companies with limited cash and resources. In other words, most penny stocks are high-risk investments with low trading volumes.

Read more: Penny Stock  

(Martha’s note:  I want you all to know this definition so you can avoid what it defines. Please see/call me if you ever feel compelled to buy a Penny stock: (704) 502-6649.

Standard Deviation – another measure of volatility. The higher the number for standard deviation, the more volatile the investment. That is, the more widely its individually measured values over any given time period deviate from its average value over that time period.

Think of a pendulum swinging.  If you give the pendulum a forceful shove, it will likely swing wide, measuring the force of your shove.  It will take many swings for it to eventually return to a resting position.  However, if you just tap it gently, it will swing a bit in either direction, and then return to rest quickly.

STRIPS – (with regard to Bonds) stands for “Separate Trading of Registered Interest and Principal Securities. A Zero-Coupon Bond is a U.S. Treasury instrument sold at a dramatic discount from par value, because it has no coupons. Investment houses buy whole Treasury bonds with coupons, then sell the income stream (IO – Interest only) security separate from the maturity value. Thus, the par value is stripped of its coupons and sold at a dramatic discount from the maturity value with the intent of producing the precise par value at some specific date in the future. Because these are U.S. Treasury instruments, they are backed by the full faith and credit of the U.S. government.

Martha’s note:  Until 529 College Savings Plans were established, zero coupon bonds were the favored investment of parents saving for a child’s education. These instruments had a tediously complex tax structure but were about the only investment that could be relied upon to produce a desired sum at the appropriate time. Given their tax structure and reliability, zero coupon bonds could be used inside an IRA or ROTH IRA to produce a particular sum of money at a certain date in the future.

Tax Lot Harvesting (From Investopedia, the online investment dictionary) with annotations.

Tax gain/loss harvesting is a strategy of selling securities at a loss to offset a capital gains tax liability. It is typically used to limit the recognition of short-term capital gains, which are normally taxed at higher federal income tax rates than long-term capital gains, though it is also used for long-term capital gains.

Read more: Tax Gain/Loss Harvesting 

(Martha’s note:  Not everything that appears to be a capital loss is an actual loss of dollars invested. In the case of some investments such as municipal bond funds, the price of the fund doesn’t change dramatically from month to month, or even year to year. Yet municipal bonds pay regular interest payments (see Coupon above), which, in turn, get reinvested in more shares of the bond fund. The additional purchases from interest payments adds value to the cost basis. Over time, the interest payments swell the cost basis, so when the sale happens, the cost basis appears to be higher than the market value. This is a capital loss according to the IRS. However, from the investor’s perspective, the interest payments were gravy, a fortunate by-product of roasting the turkey (investing in the first place).

In an after-tax portfolio, it is important to hold both appreciating assets as well as dividend and interest income producing assets. That way, we can buy and sell judiciously to produce something that looks like a capital loss to the IRS to offset capital gains.

Term – (with regard to Bonds) The period of time between when the bond is issued and when it reaches its maturity value. If one holds a bond from issue to the full term one should receive the maturity value. (See Strips and Coupons above).

Time Horizon – refers to when money will be needed from an invested account. It generally measures from the inception of the account to when the first dollar might be spent, but also when last dollar might be needed. (Martha’s Note: A ROTH IRA started by a 25-year-old may have a tremendous seventy-five-year time horizon, because the last dollar might not be used until the original investor needs Long-Term Care at the end of their life. The same investor may start setting aside money for a new baby’s college fund, and that portfolio will only have a total time horizon of perhaps 23 years with the first dollars needed when the child turns 18. In order to be sufficient to the task, it would need to be funded to last through the child’s undergraduate years.

Turnover – (with regard to mutual funds) – Turnover refers to the percentage of the mutual fund portfolio that is sold and replaced during the last year. Since mutual funds pass along capital gains to the fund shareholders, funds with high turnover (greater than 50%), can generate much taxable income for the shareholder even if the shareholder doesn’t sell their shares.

12(b)(1) fees – This refers to the section of the Investment Company Act of 1940 that allows maintenance fees to be charged to Mutual Fund shareholders. Maintenance refers to the expenses of running a fund such as paying for professional expertise, marketing, sales, providing literature and statements to fund holders. 12(b)(1) fees vary by share class. Retail mutual funds typically have the highest 12(b)(1) fees. Institutional funds typically have the lowest cost.

Advanced Concepts: These are terms the novice investor is unlikely to see, but one may inherit an account with such instruments.

American Depository Receipt - copied verbatim from Investopedia, the on-line Investment Dictionary:

Introduced to the financial markets in 1927, an American depositary receipt (ADR) is a stock that trades in the United States but represents a specified number of shares in a foreign corporation. ADRs are bought and sold on American markets just like regular stocks and are issued/sponsored in the U.S. by a bank or brokerage. 

ADRs were introduced as a result of the complexities involved in buying shares in foreign countries and the difficulties associated with trading at different prices and currency values. For this reason, U.S. banks simply purchase a bulk lot of shares from the company, bundle the shares into groups, and reissues them on either the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) or the Nasdaq. In return, the foreign company must provide detailed financial information to the sponsor bank. The depositary bank sets the ratio of U.S. ADRs per home-country share. This ratio can be anything less than or greater than 1. This is done because the banks wish to price an ADR high enough to show substantial value, yet low enough to make it affordable for individual investors. Most investors try to avoid investing in penny stocks, and many would shy away from a company trading for 50 Russian roubles per share, which equates to US$1.50 per share. As a result, the majority of ADRs range between $10 and $100 per share. If, in the home country, the shares were worth considerably less, then each ADR would represent several real shares. 

Read more:ADR Basics: What Is An ADR?

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