If you are a new investor, you are likely to encounter terms that you don’t understand. As you consider the various ways in which to invest your money, continue to use these terms and definitions as a resource. With a greater understanding of these terms, you can feel more confident researching potential investments.
You don’t have to know everything to start investing. In fact, if you wait until you know everything before you get started, you’ll probably never start investing at all! But there are some basic terms you might want to have in your investing arsenal.
- Arbitrage: Arbitrage is basically buying a security in one market and simultaneously selling it in another market at a higher price, thereby profiting from the temporary difference in prices.
- Ask: This is the lowest price an owner is willing to accept for an asset.
- Asset: Something that has the potential to earn money for you. It is something you own that can reasonably be expected to produce something for you. Assets include stocks, bonds, commodities, real estate, and other investments.
- Asset allocation: One of the ways to divide up the holdings in your portfolio is to do so by asset class. The idea is that different assets perform opposite to each other, and you can limit some of your risks by allocating your portfolio according to the type of asset you have.
- Balance sheet: A statement showing what a company owns, as well as the liabilities the company has and stating the outstanding shareholder equity.
- Bear market: A bear market is when a market experiences prolonged price declines. It typically describes a condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment. Bear markets also may accompany general economic downturns such as a recession.
- Bid: This is the highest price a buyer is willing to pay when buying an investment. Today, electronic trading makes it possible to ask and bid to be matched up automatically and almost instantly.
- Blue chip: You might hear reporters and others refer to “blue-chip stocks.” Blue chips are industry leading companies that have a long history of good earnings, good balance sheets, and even regularly increasing dividends. These are solid companies that may not be exciting, but they are likely to provide reasonable returns over time.
- Bond: This is an investment that represents what an entity owes you. Essentially, you lend money to a government or a company, and you are promised that the principal will be returned plus interest.
- Book value: If you take all the liabilities a company has and subtract them from the assets and common stock equity of the company, what you would have left over is the book value. Most of the time, the book value is used as part of an evaluative measure, rather than being truly related to a company’s market value.
- Broker: This is the entity that buys and sells investments on your behalf. Usually, you pay a fee for this service. In the case of an online discount broker, you often pay a flat commission per trade. Other brokers, especially if they also manage your assets as a whole, just charge a percentage of your assets each year. I use Robinhood but M1 and Webull and many others are excellent choices as well.
- Bull market: This is a market that is trending higher, likely to gain. If you think that the market is going to go up, you are considered a “bull.” Additionally, the term, like bear, can be applied to how you feel about an individual investment. If you are “bullish” on a specific company, it means you think the stock price will rise.
- Capital gain (or loss): This is the difference between what you bought an investment for and what you sell if for. If you buy 100 shares of a stock at $10 a share (spending $1,000) and sell your shares later for $25 a share ($2,500), you have a capital gain of $1,500. A loss occurs when you sell for less than you paid. So, if you sell this stock for $5 instead ($500), you have a capital loss of $500).
- Diversification Diversification of a portfolio is a risk management technique. You spread your investments over different asset classes (stocks, bonds, commodities, real estate) such as to reduce the exposure you have to any one type of security, area and domain. Diversification may help to prevent a higher loss if the market experiences an upheaval.
- Dividend: A portion of a company’s earnings that is paid to shareholders, or people that own that company’s stock, on a quarterly or annual basis. Not all companies pay dividends. For a getting started in long term dividend investing consider my book: Beginners Guide to Dividend Investing.
- Dollar Cost Averaging The Dollar Cost Averaging strategies call for investing a fixed amount of money at regular intervals over a period of time regardless of the share price. This is considered a smart investment strategy because the investor does not need to try to pick tops and bottoms.
- Dow Jones Industrial Average: This average includes a price-weighted list of 30 blue-chip stocks. While there are only 30 companies included on the list, many people think of the Dow when they hear that “the stock market” gained or lost. The Dow is often used as a gauge of the health of the stock market as a whole, even though it is only a very small portion.
- Exchange: This is a place where investments, including stocks, bonds, commodities, and other assets are bought and sold. It’s a place where brokers (buyers and sellers) and others can connect. While many exchanges of “trading floors” most orders these days are executed electronically.
- ETF: Exchange-traded funds, a type of investment fund that trades like a stock. Investors buy and sell ETFs on the same exchanges as shares of stock. They are very similar to mutual funds, except that they trade throughout the day on stock
- Index: A benchmark that is used as a reference marker for traders and portfolio managers. A 10 percent return may sound good, but if the market index returned 12 percent, then you didn’t do very well since you could have just invested in an index fund and saved time by not trading frequently. Examples are the Dow Jones Industrial Average and Standard & Poor’s 500.
Are there Benefits of a Bear Market?
Cheap Stocks = Massive Gains Over Time
If you act effectively, by not selling and rather continuing to purchase stocks, the more bear markets you experience as an investor, the higher the probability that you’ll retire with a bigger nest egg. Years of underperformance tend to be followed by years of overperformance and those years of underperformance present a great opportunity to purchase shares inexpensively.
Other Investors Are Scared of the Stock Market
A simple reason why so many investors and even professional money managers are scared of the stock market–in the short term is stock prices can seem arbitrary. Up one day and down the next, watching the ticker every second the market is open can cause one to wonder just what the heck is going on.
In the short term, stock prices reflect all kinds of noise. The Fed Chairman says this or that, unemployment numbers come out, or more recently a virus spreads across the world, any of these cause the stock market to react in many ways. The point is that in the short term (About one year or less), stock prices are often the result of factors that do not necessarily reflect the long-term value of the enterprise.
When viewed long term, however, the market truly does reflect the underlying value of public companies. By long term, I mean really long term (10+ years). Stocks can be undervalued or overvalued for a decade. But given enough time, stocks will reflect the underlying value of the corporation that issued the security.
Boost your savings rate
A stock market crash can have a ripple effect on other areas of your life. For example, you may get laid off from your job, have limited access to credit or have a tough time getting clients for your side hustle. For these reasons and more, it’s important to be prepared and have cash saved up.
Experts recommend saving three to six months of expenses in an emergency fund, others as high as 12 months. While this may take some time, there’s no harm in starting to save more as soon as you can.
With increased savings, this will help you weather a storm if the stock market should crash. See last weeks post on maximizing savings.