With obvious exceptions like brain surgery and rocket science, concepts we might think are extremely complicated from a distance may actually be quite straightforward once you understand the basic vocabulary. While investing can in fact get complicated, the principles that underpin modern investing are oftentimes simpler than you realize once a few common terms are explained in layman’s terms.
Many people are familiar with stocks and bonds and generally what they involve but when even slightly more complex instruments are used, the average person might quickly lose interest. Unfortunately, mutual funds often fall into that category even though they are, one of the most popular forms of investing for the typical American.
Simply put, when you purchase a mutual fund, the money you invest – along with the money from all of the other investors within that particular fund – are placed into a reservoir of sorts where the fund manager scoops up all the money and invests it in a number of different positions. Those positions can be stocks, bonds, commodities, or virtually anything else the fund manager is allowed to invest in according to that fund’s prospectus.
In short, mutual funds are a convenient way for an investor to achieve significantly more diversification without having to individually purchase all of those positions on their own.
Typically associated with stocks, beta is simply a measurement of volatility. The greater a stock’s beta, the wider its prices will swing. Since, generally speaking, volatility and long-term growth work in conjunction with each other, stocks with higher betas will exhibit wider price swings but also superior long-term growth. Furthermore, the stocks of smaller companies tend to have higher betas than those of large companies.
Short for market capitalization, market cap is the total amount of equity owned by a company’s stockholders. If the amount of outstanding stock stays fixed, a company’s market cap will rise when their stock price rises because each share is now worth more. Likewise, when a stock price falls, a company’s market cap will fall along with it.
Most commonly associated with taxes, capital gains are often thought to be far more complex than they actually are. In a nutshell, capital gains are the proceeds from the sale of an investment less the purchase price.
Let’s say for instance you buy 10 shares of stock at $10 per share and sell that stock six months later at $15 per share. Your capital gain would be $5 per share or $50 for the entire transaction. If you sold that stock at $5 per share rather than $15 per share, you would have a total capital loss of $50.
To add one slight wrinkle to the equation, capital gains and losses are often divided by short-term and long-term positions. Short-term positions are those that you’ve owned for less than one year whereas long-term positions are held for greater than one year and must be claimed on income taxes.
Of course, the vocabulary behind investing is vast and we’ve hardly scratched the surface with these examples. We will help define more terminology in the future but, for now, this is a good first step in demystifying the investment vernacular.
Gary Marriage Jr. is the founder and CEO of Nature Coast Financial Advisors, which educates retirees on how to protect their assets, increase their income and reduce their taxes. Marriage is a national speaker, delivering solutions for pre-retirees, business owners and seniors on the areas affecting their retirement and estates. He is an approved member of the National Ethics Bureau, and has been featured in “America’s Top Hometown Financial Advisors 2011” and was selected to contribute to a book with Steve Forbes titled “Successonomics”
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