At some point in the last century, leaders from every industry came together and agreed to forego the English language in favor of incomprehensible industry-specific jargon. The main objective was to put up walls around each industry so that “outsiders” would no longer be able to understand what’s going on “inside.” Unfortunately for us, these leaders accomplished their mission and the financial services industry has taken a leadership position in the efforts.
This article is a resource for you – the investor – to decrypt the mumbo jumbo associated with managing your money.
This is everything you need to know about investing…written in plain, easy-to-understand English.
Increase in value or price.
Example: You bought your house for $100,000 and it’s now worth $120,000. Your house appreciated 20%. Or you purchased Walmart’s stock for $40 per share and it’s now selling for $80 per share. Your investment appreciated $40 – or 100%.
A valuable thing that you own. This can be property, possessions, etc.. Rich Dad, Poor Dad defines this as “something that puts money back into your pocket.”
Example: House, land, a Rolex watch, Apple stock, cash in your wallet
The specific mix of assets you own. This is commonly referred to as the MOST IMPORTANT DECISION as it accounts for your goals, the amount of risk you’re comfortable with, and how much time you have to invest.
Example: 60% stocks, 40% bonds
You loan money to someone or something hoping that they give you more money back. The money being paid back to you is called “interest.” It’s important to know that as prices rise, interest rates rise and the value of your bond can fall. On the other hand, as interest rates fall, your bond becomes more valuable.
- Corporate Bonds – you loan money to a company
- TIPS – “treasury inflation protected securities” protect you against inflation
- Treasury Bonds – you loan money to the government (the government, while incompetent, has never not paid someone back). And yes, that was a double negative.
Example: I lend a company $10,000 and they promise to pay me $10,000 back plus 5% interest ($500) over 2 years. If interest rates fall a year from now and companies can now borrow at 2% interest, then an investor may want to buy my bond for more than I paid because of the higher interest they would receive.
A place you can go to buy or sell stocks, bonds and other investment things.
Example: TD Ameritrade, Charles Shwab
Physical resources that people want or need.
Example: oil, corn, sugar, copper, gold, coffee beans, coal, etc.
Money that earns more money or “interest on interest.”
Example: If I give my bank $10,000 and they promise to pay me 1% interest, then after 1 year I’ll have $10,100. The following year, under the same agreement, the bank would pay me 1% interest on the $10,100. So, after 2 years, I would have $10,201. I made an extra dollar in the 2nd year I earned interest on my interest.
Decrease in value or price.
Example: If you pay $20,000 for a brand new car, then decide to sell the car to someone else after 1 month of driving it – they may only want to pay you $16,000 because the car is no longer brand new. In this case, your car depreciated 20%.
A small portion of a company’s earnings that are paid back to whoever owns their stock.
Example: If you buy Wells Fargo’s (a stable company’s) stock for $55, they’ll likely pay you 2.6% ($1.43) of the share price ($55) every 3 months (quarterly) or every year (annually). You can receive this payment in your bank account or use it to buy more shares of the stock.
An “Exchange Traded Fund” is like an inexpensive mutual fund or index fund that trades on an exchange – like a stock. Any combination of assets (stocks, bonds, etc.) can be combined to form an ETF.
Example: I recently purchased an ETF that only buys stock of companies that are buying back their own stock. ETFs have gotten pretty exotic.
A bunch of things that represent a certain market.
- Dow Jones Industrial Average – represents 30 of the largest companies from various industries
- Nasdaq Composite – represents over 3,000 companies – lots of which are technology and internet-related
- S&P 500 – represents 500 large companies
Example: The Dow index includes companies such as American Express, AT&T, Walt Disney, Coca Cola and Exxon.
A mutual fund that tracks a certain index. Since an index doesn’t change very often, this is seen as “passive” investing and results in lower fees.
Example: VFIAX is an index fund offered by Vanguard that tracks the S&P 500 index. It only costs .05% annually whereas many mutual funds cost over 1%.
An increase in the prices of goods and services.
Example: A gallon of milk used to cost 35 cents, it now costs more than $3.50.
A fee that someone borrowing money owes to a someone that’s lending money.
Example: If I give my money to a bank, they are technically borrowing it from me and therefore pay me a small fee. If I borrow money from a bank, I pay them a small fee.
An “individual retirement account” is a place you can set aside some money for whenever you stop working.
- Traditional IRA – The government does not tax what you put in now, but it will tax whatever you take out later. This is great if you think you’ll be in a lower tax bracket when you retire. Since you’re receiving a tax break now, you’ll be penalized if you withdraw your money before 59 1/2 years old.
- Roth IRA – The government taxes what you put it now, but doesn’t tax anything when you take it out later. This is great if you think you’ll be in a higher tax bracket when you retire. Since you’ve already paid taxes on whatever you put it, you can take this money out penalty-free.
Something you owe or, as Rich Dad Poor Dad defines, something that takes money out of your pockets.
Example: A mortgage or car loan
Money that is pooled together and invested in various assets (stocks, bonds, etc.) by a “manager” whose goal is to make you money. This is an “active” form of investing that typically results in high fees.
Example: PIMCO Total Return, one of the largest mutual funds in the world, invests in bonds and costs between .85% and 1.60% annually.
All of your assets (what you own) minus all of your liabilities (what you owe).
Example: If you have $30,000 in your bank account and owe $80,000 on a house worth $100,000; your net worth is $50,000.
A “real estate investment trust” is like a stock that invests directly in properties or mortgages. They’re great because you can buy and sell them very easily – unlike buying actual real estate which is difficult.
Example: You can buy a REIT and own a portion of several shopping malls around the country.
Your ability to handle the ups and downs that come with investing.
Example: If you vomit and swear to never invest again because your investment account value falls from $20,000 to $18,000, then you probably have a “low” risk tolerance.
Part ownership of a company.
- Blue Chip – stock in a large company with a national reputation (usually pays a dividend)
- Growth – stock in a company that is expected to grow more than most other companies (usually doesn’t pay a dividend, but provides appreciation)
- Emerging – typically refers to stock in companies based in countries that are somewhat developed, but still growing (Brazil, Russia, India, China)
- International – stock in companies outside of the US
- Large Cap – stock in companies that are worth more than $10 Billion (Walmart)
- Small Cap – stock in smaller companies worth between $300 Million and $2 Billion
How long until you need your money. The purpose of your money is more important than your age.
Example: A 20-year-old setting money aside for retirement has a long time horizon and can afford to be more aggressive, whereas a 20-year-old setting money aside for a down payment on a house has a shorter time horizon.
Basically an Individual Retirement Account (IRA) that the company you work for is in charge of. The money you put in is not immediately taxed and is very often matched by your employer. This money can move with you if you change jobs, but you’ll be penalized if you touch it before you reach 59 1/2 years old. Just like an IRA has a twin-brother named Roth IRA, some companies offer a Roth 401(k) so your money is taxed now and not taxed later.
Example: If you make $50,000 and your employer matches 100% up to 3%; this means that you can put in $1,500 and your employer will put it $1,500, so you’ll have $3,000 saved after 1 year. Also, since you set aside $1,500 – you’ll only have to pay taxes on $48,500 of your income.
(photo credit: 401(k) 2012)
(photo credit: Brandon Hunt Shamrock Estates)