Demystifying Basic Investing Terms: Your Guide to Financial Fluency

A description of some commonly used investing terms.


6/16/20235 min read

Investing can be a difficult to understand world, teeming with perplexing terminology and cryptic acronyms. A lot of these are designed to sound complicated, so you’ll use the services of say, a stockbroker, to do your investing for you. The reality is, although these terms sound complicated, they’re actually quite easy to understand.

To navigate this financial realm with confidence, one must first grasp the fundamental investing terms that serve as the building blocks of the market. In this comprehensive guide, we will delve into ETFs, Index Funds, Mutual Funds, Brokerage, Bonds, Stocks, Dividends, Equity, Market Volatility, Capital, Capital Gain, Market Capitalisation, Compound Interest, Hedge Funds, Diversification, Securities, and Commodities.

ETFs - Exchange-Traded Funds

Let's start with ETFs, the darling of modern investors. An ETF is an investment fund and is traded on the sharemarket like a regular stock. Think of it as a bundle of assets, such as stocks, bonds, or commodities, that you can buy and sell just like individual stocks. ETFs provide diversification and flexibility, making them an attractive option for both novice and seasoned investors. The fees on ETF’s are usually very low

Index Funds - Passive Investing Powerhouse

If ETFs are the versatile Swiss Army knife of investing, Index Funds are the dependable workhorse. These funds aim to replicate the performance of a specific market index, such as the S&P 500. They are renowned for their low fees and long-term investment approach, making them an excellent choice for those seeking steady, consistent returns. You chose which market you would like to invest your money in (such as oil, the S&P 500 or Nasdaq) and buy individual shares of the fund. The fees in Index Funds are usually slightly higher than ETF’s but still quite low

Mutual Funds - Pooling Resources

Mutual Funds are collective investment vehicles where investors pool their money to purchase a diversified portfolio of stocks, bonds, or other securities. Managed by professional fund managers, they provide an accessible avenue for individuals to invest in a wide range of assets without the need for significant capital or expertise. If you don’t want to pick and chose your own stocks, this may be an option for you. Do your research on the historical income of the fund before you purchase anything. Because these are actively managed by stockbrokers the fees are much higher than ETF’s and Index Funds, so make sure you factor the costs of the fund into your calculations.

Brokerage - Your Gateway to Markets

To enter the world of investing, you'll need a brokerage account. A brokerage acts as an intermediary between you and the financial markets, facilitating the buying and selling of securities, which could be stocks, commodities such as oil or gold or any number of other securities. Whether you prefer traditional brokerage firms or modern online platforms, choosing the right one is crucial to your investing journey.

Bonds - Fixed-Income Security

Bonds represent debt securities issued by governments, corporations, or other entities. When you buy a bond, you're essentially lending money to the issuer in exchange for periodic interest payments (known as coupon payments) and the return of your principal when the bond matures. Bonds are often considered a safer investment compared to stocks due to their fixed-income nature. They’re only as safe as whoever the money is being lent to, so be aware that if you buy a bond from a company and that company goes bankrupt, you will lose any future coupon payments as well as possibly your principal.

Stocks - Owning a Piece of the Pie

When you purchase stocks, you acquire ownership (equity) in a company. These ownership shares grant you certain rights, such as voting on company matters and potentially receiving dividends, which are periodic payments made to shareholders from company profits. Stocks are the quintessential and traditional investment option for those seeking capital growth.

Dividends - Cash Rewards for Shareholders

Dividends are the icing on the cake for stock investors. They represent a portion of a company's earnings distributed to its shareholders as cash payments. Dividend-paying stocks can provide a steady income stream, making them appealing to income-focused investors. A company doesn’t necessarily have to pay it’s profits out to shareholders though, which is why it is important to look at the historical data of the company and how often they pay out dividends.

Equity - The Ownership Stake

Speaking of ownership, equity is the value that shareholders hold in a company. It's the residual interest after subtracting liabilities from assets. Equity holders have a claim on the company's assets and earnings, making them true stakeholders in the firm's success.

Market Volatility - Riding the Rollercoaster

Investors often encounter the term market volatility when assessing risk. It refers to the degree of price fluctuation in the financial markets. Volatility can present both opportunities and challenges. While it can lead to rapid gains, it can also result in significant losses, emphasising the importance of a well-balanced, diversified portfolio. When you look at say, the bond market compared to the share market, you’ll realise that the share market experiences much higher levels of volatility. You see even higher volatility in the cryptocurrency market.

Capital - The Financial Fuel

Capital represents the financial resources you invest in assets like stocks and bonds. It's the initial sum you commit to your investment journey, and it can grow over time through capital gains, interest, and dividends.

Capital Gain - Profiting from Investments

When the value of your investments increases, you realise a capital gain. This gain can be either short-term (held for less than a year) or long-term (held for more than a year). Depending on your jurisdiction, capital gains may be subject to taxation.

Market Capitalisation - Sizing Up Companies

Market capitalisation is the total value of a publicly traded company's outstanding shares. It's calculated by multiplying the stock's current market price by the total number of outstanding shares. Market cap helps classify companies as small-cap, mid-cap, or large-cap, providing insights into their relative size and potential. Large-cap companies like Coca-Cola are not as likely to go bankrupt as mid-cap or small-cap companies are.

Compound Interest - The Eighth Wonder

Albert Einstein once dubbed compound interest as the "eighth wonder of the world." It's the phenomenon where your money earns interest not only on the initial investment but also on the accumulated interest. Over time, compound interest can turbocharge your investments, leading to exponential growth. Essentially think about your money snow-balling, so the more it grows, the faster it grows.

Hedge Funds - Exclusive Investment Vehicles

Hedge funds are investment partnerships managed by professional fund managers. They employ various strategies, often including complex derivatives and alternative investments, to generate returns for their wealthy and institutional clients. Hedge funds are known for their exclusivity and sometimes high-risk profiles.

Diversification - Risk Management Strategy

Diversification is the age-old adage of not putting all your eggs in one basket. It involves spreading your investments across various asset classes, sectors, and geographic regions to reduce risk. Diversified portfolios are better equipped to weather market turbulence and volatility.

Securities - Tradable Financial Instruments

Securities encompass a wide range of tradable financial instruments, including stocks, bonds, and derivatives. These instruments represent ownership interests, debt obligations, or rights to specific assets, making them the lifeblood of financial markets.

Commodities - Tangible Investments

Commodities are physical goods such as gold, oil, or agricultural products that can be traded in the financial markets. Investing in commodities can serve as a hedge against inflation and provide diversification benefits.

In conclusion, mastering these basic investing terms is a vital step toward achieving financial literacy and success in the world of investing. Whether you're an aspiring investor or a seasoned pro, understanding these concepts will empower you to make informed decisions and navigate the ever-changing financial landscape with confidence. So, dive in, explore, and let these terms become the foundation of your prosperous investment journey.