March 13, 2020
Our society does a miserable job of providing personal financial literacy. As a result, many people feel overwhelmed and lost when it’s time to focus on their own personal financial situation. The prevalence of jargon — especially in the areas of investments and related personal income tax law — adds to the complexity. This can lead to discomfort and panic when the investment markets are turbulent as they have been recently.
Helping clients understand and navigate these complexities is one of the most satisfying aspects of my role as a wealth manager. We’ve compiled the following glossary of investment and tax terms to provide some clarity to you in the hope that you can better track your own personal financial situation. Understanding the lingo is a good first step in taking charge of your financial life.
Volatility. The extent to which the price of a financial asset or market fluctuates, measured by the standard deviation of its returns.
Risk. Generally, the chance of loss or of something bad occurring. In investments, it usually means the uncertainty of outcomes due to one or many causes. Volatile assets tend to have a wider range of possible returns and thus are said to be higher risk.
Standard deviation. A statistical measure of the variability of a distribution. The higher the standard deviation of an investment’s returns, the greater the relative risk because of uncertainty in the amount of return.
Diversification. The process of allocating an investment portfolio to different asset classes (stocks, bonds, real estate, etc.) with the intent of reducing exposure to any one asset class’s level of risk.
Market cap. Reflects the total equity of a company. A company’s market capitalization is determined by multiplying the number of shares outstanding by the current stock price.
Consumer Price Index (CPI). Is published monthly by the U.S. government as an indicator of changes in price levels (or inflation) paid by urban consumers for a representative basket of goods and services.
Liquidity. The ease with which an asset can be bought or sold quickly.
Bond. A security that pays interest. The issuer agrees to pay the bondholder a regular sum based on the amount borrowed and the bond’s coupon, and to repay the principal amount of the loan at a future date.
Coupon. The rate at which a bond pays interest, expressed as a percentage. A bond with a 4% coupon and a principal value of $1,000 would pay $40 annually to the bondholder.
Yield. A bond’s income as a percentage of the bond’s market price.
Credit rating. Rating given by a credit-rating agency, based on its view of the financial strength of a borrower and the likelihood of default. The highest rating is usually AAA, and the lowest is D.
Duration. A measure of a bond’s price sensitivity to changes in interest rates, expressed in years. Duration approximates how much a bond’s price will change if interest rates change by a given amount. For each year of duration, a bond’s price will fall (or rise) roughly one percentage point for each 1% increase (or decrease) in yield.
Equity. Ownership of a company in the form of shares that represent a claim on the corporation’s earnings and assets; another name for stocks.
P/E ratio. The most common measure of a stock’s value, calculated by dividing the market value (price) per share by after-tax earnings per share.
Beta. A measure of the expected change of a security’s or portfolio’s return relative to the market. By definition, the beta of a benchmark index is 1.00. A security with a beta of more than 1.00 tends to rise or fall more than the market; a security with a beta of less than 1.00 tends to rise or fall less.
Alpha. A measure of the incremental return added by an investment manager through active management.
Dow Jones index (DJIA). Is the most frequently quoted measure of the performance of industrial stocks on the New York Stock Exchange. It covers a relatively small number of leading shares, but its movements can influence markets.
S&P 500. U.S. large cap stock market index maintained by Standard & Poor’s. Its 500 companies include the biggest U.S. companies and represents over 80% of U.S. equities by market capitalization.
Russell 2000. The index consists of the smallest 2000 companies in the Russell 3000 Index, representing approximately 8% of the Russell 3000 total market capitalization.
MSCI All Country World Index (ACWI). Like the S&P 500, the MSCI ACWI is also a market capitalization weighted index. However, the ACWI is designed to measure the world’s equity market performance rather than being U.S.-focused. The MSCI ACWI represents 46 countries, comprising 23 developed and 23 emerging market country indices.
Types. Property in land, buildings or housing, as distinct from personal property (e.g. cars); also known as physical property, to distinguish itself from property trusts.
REIT (real estate investment trust). A particular type of pooled fund that invests in the real estate sector.
Cap rate. A valuation measurement for real estate. It’s calculated as the property’s net income divided by its purchase price.
Alts. Investments that do not fit into the mainstream areas of equities, bonds and property. Examples include private equity or venture capital, hedge funds and commodities. They are typically brought into a portfolio to increase diversification.
Interest. Money paid by a borrower or by a financial institution for use of money lent or held on deposit. If the borrower is the federal or a state government, some or all of the interest the investor receives on a bond may not be taxable (tax-exempt); otherwise interest is taxable income to the recipient.
Dividends. A payment to stockholders of company profits; usually paid quarterly. Dividends are taxable income to the recipient.
Qualified dividends. Dividends that are taxed at lower long-term capital gains tax rates, rather than as ordinary income. Qualified dividends must meet specific IRS requirements:
Cost basis. How much you paid for an asset.
Capital gain/loss. Calculated as the fair market value of an asset less what you paid for it (your cost basis). Capital gains and losses are “unrealized” until you sell the asset and “realize the tax result.” A gain or loss is long term if you held the asset for more than 12 months. Otherwise, it’s considered short term. Long-term capital gains are taxed at lower federal tax rates. Realized capital losses offset realized capital gains, thereby lowering your taxable income.
Wash sale. If you sell an investment at a loss, the tax law requires you to wait 31 days to repurchase the investment. If you violate the wash sale rules, you may not realize the loss on the original sale for income tax purposes, and your cost basis in the new position will be adjusted accordingly.
Tax shelter. An investment or type of investment account that minimizes or avoids generating taxable income.
The Down Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry. The S&P 500 is a market-capitalization weighted index that includes the 500 most widely held companies chosen with respect to market size, liquidity and industry. The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. The MSCI ACWI Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. Indices are unmanaged and you cannot invest directly in an index.
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