If it seems like you are hearing another language when it comes to your investments, then you are not alone. There are many terms used when it comes to investing, some of which you have likely come across already, and others that you may not have. Educating clients is as much a part of an advisor’s job as it is to provide financial advice. There is never such a thing as a dumb question, so if your advisor starts speaking “Greek” to you, don’t be shy to stop and ask them to translate. Below are a number of terms that can help get you started to speak investments fluently.
A strategy of building a portfolio using different asset classes in varying proportions. By varying the proportions, different risk and reward profiles are created – either very risky with potentially high returns (eg. lots of equities and less fixed income) or lower risk but with lower expected returns (eg. lots of fixed income but fewer equities). This is a very basic example and a portfolio’s asset allocation and can involve a variety of asset classes combined with many different sub-asset classes to create more elaborate risk-reward profiles.
A grouping of securities that exhibit similar characteristics. The three traditional asset classes are equities, fixed income and cash. An asset class can be further divided into sub-asset classes. An example of this would be Canadian equities. Comparably, apples can be thought of one asset class and oranges would be another. Apples can be further sub-divided into different varieties – Cortland, Granny Smith, Red Delicious, etc. – these are the sub-asset classes.
RATE OF RETURN (ROR)
This is usually expressed as a percentage and is the money made or lost either on your portfolio as a whole, or on individual securities. When expressed as the rate of return on your portfolio, the percentage will include all fees charged to your account and will be your net return. Calculating a return is not necessarily as easy as calculating the percentage change between the starting and ending values, but involves mathematical formulas to adjust for cash flows, differing time periods and compounding to arrive at an accurate number.
The rise in the value of an asset where the current market price is higher than the purchase price. Capital gains are only taxed when the asset is sold, and are taxed at a lower rate than interest or salary income.
The fall in the value of an asset where the current market value is lower than the purchase price. Capital losses can be realized to offset capital gains, thereby reducing your taxes payable. Losses can be carried back 5 years to claim back taxes already paid on capital gains, or carried forward indefinitely.
TAX LOSS SELLING
A strategy to reduce taxes owing (or that were paid up to 5 years in the past) on capital gains. Securities in non-registered accounts that have significant capital losses are sold and then a similar security is purchased as a substitute for 31 days, after which the original security can be repurchased.
This is a broad term that can refer to a complex investment strategy (compared to a simple strategy of buying and holding bonds and equities), and/or it can refer to a new or unconventional asset classes, such as commodity futures or life settlements. Such investments are typically held by institutional and high net worth investors due to their complex nature; however, alternatives are increasingly becoming available to a wider range of investors, such as through discretionary accounts at portfolio managers.
A loan made by an investor (the lender) to a borrower, typically a corporation or a government. At a basic level, a bond has a maturity date (when the loan must be repaid) and an annual rate of interest.
A broad term (an asset class) used to describe securities that represent loans and which typically give investors predicable interest payments (eg. quarterly, semi-annually, or annually). The terms bonds and fixed income are usually used interchangeably, however, fixed income also includes mortgages, and GICs (Guaranteed Investment Certificates).
Represents a part ownership in a company and is also referred to as stock, common stock or equity. Equities are generally higher risk than bonds because if a company goes bankrupt, the shareholders are only paid after the bondholders (who usually receive only a small portion of their original investment).
EXCHANGE TRADED FUND (ETF)
An ETF is similar to a unit in a mutual fund, except the ETF trades on a stock exchange like a share whose value fluctuates throughout the day. ETFs typically have much lower fees (MERs) than a mutual fund and are used to track a specific index or asset/sub-asset class. The popularity of ETFs has exploded over the past couple of decades to include almost every investment strategy and index imaginable.
An investment vehicle made up of a pool of money from a large number of investors with the objective to invest the pool using a certain investment strategy. A mutual fund can invest in stocks, or bonds, or a combination of both; it can also be an alternative investment that has a very unique and/or complicated investment strategy.
A distribution of a portion of a company’s profits paid to its shareholders. Dividends are typically paid in quarterly cash installments, but special dividends can also be paid in shares of the company.
MANAGEMENT EXPENSE RATIO (MER)
This is expressed as a percentage and represents the majority of costs associated with running a mutual fund or ETF, such as legal fees, audit/accounting, the portfolio manager’s fee, etc. For certain types of funds, this may include trailing commissions which are paid by the fund company to an advisor on a regular basis. Fee-based advisors, like Portfolio Stewards, do not use funds that pay trailing commissions.
TRADING EXPENSE RATION (TER)
This is the cost of trading the securities held by a mutual fund or ETF and is not included in the MER. Total fund costs = MER + TER
The extended period of rising prices in the stock market after a bear market. A bull market typically lasts many years, but it can be as short as only a couple of years.
A period of widespread pessimism and negative investor sentiment where the stock market falls 20% or more in value from its most recent high. A bear market can last anywhere from several months to several years, but the historical average for the S&P 500 is 22 months.
A period of weakness where the stock market falls between 10 to 19.9%; a correction is usually (but not always) shorter than a bear market.
A term used to describe a wide variety of shows generally found on business TV channels that masquerade as expert investment advice but are really just entertainment. Some of the risks of watching include confusing gambling with the process of investing; inaccurately self-assessing one’s time horizon as weeks or months (until the next earnings report), rather than years or decades; directing one’s focus to individual stocks and other securities and ignoring or miscalculating one’s actual risk tolerance and overall portfolio composition. Benefits of watching (while recognizing the aforementioned risks) include learning investment terminology, gaining a certain perspective on the thinking of Wall Street and Bay Street, and gaining an appreciation on how professional portfolio management differs from the stock picking mentality.