The finance industry can be confusing enough without all the jargon and acronyms. Here are 15 common finance buzzwords that we will break down for you and put into layman’s terms.
1. Index – An index is a basket of securities representing a particular market or a portion of it. The S&P/TSX Composite is an example of an index that broadly represents the Canadian stock market.
2. Benchmark – A benchmark is usually made up of an index, or several indices. It is a standard to which you can compare the performance of your portfolio. For example, compared to the S&P/TSX 60, my portfolio did extremely well.
3. Stock – A holder of company’s stock (a shareholder) owns a portion of the company. They have a claim to part of the corporation's assets and earnings. Stocks are a form of equity.
4. ETF – An ETF, or exchange traded fund, is a security that usually tracks an index. An ETF owns the underlying assets (shares of stock, bonds, oil futures, gold bars, foreign currency, etc.) and divides ownership of those assets into shares, which investors can buy. An ETF can be a very efficient way to own a benchmark.
5. Security – A security is a tradable asset of any kind. A stock, a mutual fund and a hedge fund are all examples of securities.
6. Mutual Fund – An investment vehicle that is made up of a pool of capital collected from many investors. Mutual funds are operated by managers, who invest the fund's capital and attempt to produce capital gains and/or income for the fund's investors.
7. Equity – A stock or other security that represents ownership interest in a corporation. Ex. Telus shares are considered equity.
8. Fixed Income – Fixed income can be contrasted to equity. It is an investment that provides income in the form of fixed periodic payments and the eventual return of principal at maturity.
Examples of fixed income products are bonds, GICs, T-Bills and money market type investments. They can be bought individually like stocks or in the form of mutual funds or ETFs.
9. MER – An MER, or a Management Expense Ratio is what is taken out of a fund’s assets for operating costs and lower the return to a fund’s investors. Mutual Funds, ETFs and Segregated Funds (mutual funds sold by life insurance companies) all have MERs. The largest component of operating expenses are often the fee paid to the fund’s investment manager.
10. Being Long – Is when you buy a security with the expectation that it will increase in value.
11. Being Short – Is when you sell a security with the expectation that it will fall in value. This is done by selling an investment you don’t actually own with the hope of buying it back at a lower price – making money by selling high and buying low. This is a very risky practice because technically there is a possibility of infinite loss due there being no limit on how much a stock could appreciate. You most likely want to avoid short selling.
12. Hedge Fund –"Hedging" is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. Like mutual funds, hedge funds are pools of underlying securities, and can invest in many types of investments. However, hedge funds are less regulated than mutual funds. As a result of being relatively unregulated, hedge funds can invest in a wider range of securities than mutual funds, and can use a variety of sophisticated techniques like leverage and shorting.
13. Book Value – The Book Value is often confused with Net Investment. Book value includes distributions (i.e. interest, dividends and capital gains) generated by the securities in your portfolio; and hence often becomes larger as time goes on. The book value of each portfolio is calculated for tax reporting purposes. Therefore, book value is not relevant to most people.
14. ACB – Adjusted cost base is a calculation used to determine the cost of an investment for tax purposes. The Canada Revenue Agency requires investors to use the ACB calculation when determining capital gains or losses for income tax purposes. Activities that will change the ACB include: Additional contributions, reinvested dividends and redemptions.
15. Active vs. Passive Investing – Passive investment approaches seek to “buy the index” and hold it for the long term. The advantage of passive investing is that fees are much lower. Active portfolio managers select individual securities with hopes they will outperform the index. Few active managers outperform the index over time due the added cost of selecting securities. However, a small percentage do outperform over time.
How can you make the right financial decisions if you are baffled by the lingo? If you have a finance term that is mystifying you, give us a call and we will be happy to simplify it for you.