Investment Glossary

Terms you’re likely to come across in Osbon Capital articles and the news

Active management – an investment approach where a money manager tries to pick outperforming securities and/or moves in and out of the market with the intention of beating the market as a whole. Extensive academic research shows that active managers, on average, fail to meet the performance market benchmarks.

Asset allocation – the distribution of a portfolio across different asset classes. Allocations should vary from person to person to match their age, goals, etc. Typically, investors with longer timeframes and higher tolerance for risk will hold more stocks than bonds.

Asset class – a group of securities with similar characteristics that tend to move together. For instance, large US stocks, intermediate term bonds, or emerging market stocks.

Basis point – one one-hundredth of one percent. Basis points are most commonly used in expressing management fees. For instance, if a mutual fund charges an annual management fee of 61 basis points, an investor pays $6.10 in fees for every $1,000 invested.

Capital gain – the profit received when a security that has risen in value is sold. Capital gains are typically taxed at lower rates than ordinary (salary) income, unless the security was held for less than one year.

Cost basis – the amount originally paid for securities. For instance, 20 shares of stock purchased for $20 per share would have a cost basis of $400. Cost basis is used to calculate capital gains and losses when securities are sold.

Diversification – spreading investment dollars across many different stocks and bonds. Diversification reduces the overall risk of a portfolio and often improves expected return. Diversification is easily achieved today using mutual funds or exchange traded funds that hold dozens, hundreds or thousands of securities.

Dividend yield – the annual dividend amount of a stock divided by the stock price. For instance, if a stock priced at $50 per share issues dividends totaling $1.50 per year, the yield is 3 percent. Stocks with higher yields provide greater cash flow to investors, but may grow more slowly than companies that reinvest all profits back into the business.

Exchange traded fund (ETF) – a collection of stocks or bonds that can be bought or sold in one transaction, similar to a mutual fund. ETFs are known for their low management costs and tax efficiency.

Fiduciary – a financial advisor who is held to a legal requirement to provide advice that is in the best interest of his or her client – in all situations. Many investment advisors are subject to this requirement, however many commissioned brokers are not.

Index – An index is a published list of stocks that represent a specific asset class. The best known indexes, the Dow Jones Industrial Average and the S&P 500, are baskets of large US stocks. Indexes are tracked to show the overall direction of markets, and investors can buy mutual funds and ETFs that closely replicate the indexes.

Junk bond – relatively risky bonds issued by companies experiencing financial difficulty or with limited credit history. Also called high yield bonds, junk bonds offer higher interest payments than bonds of more stable companies. In exchange for the higher interest rates, investors assume a greater risk of default.

Leverage – the practice of using borrowed money to make investments, thereby increasing the profit when the investments rise in value. Leverage can be very risky when falling security values make it impossible to repay the loans.

Liquidity – the ability to readily turn investments into cash. Liquidity can be important if an investor has a sudden need for cash. ETFs and stocks trade throughout the day and can be sold quickly. Private equity, angel investing and other sophisticated investments are far less liquid.

Market efficiency – the investing principle that states that any publicly available information is almost immediately reflected in security prices, making it impossible to systematically profit on new information. For example, if a major manufacturer is crippled by a severe flood, the stock price will fall as soon as the information becomes available.

Market timing – the practice of moving in and out of securities hoping to buy before upswings and sell before downturns. Because future security prices are, by definition, unknowable, market timing is a risky and often counter-productive technique.

Passive investing – an investment approach where investors buy and hold large baskets of securities to replicate the performance of specific asset classes. This is most often done using ETFs or mutual funds that track indexes such as the S&P 500.

Rebalancing – adjusting a portfolio’s holdings periodically to bring it back into line with the desired asset allocation. Rebalancing is useful because different investments may grow at different rates, pushing the overall portfolio significantly out of its intended allocation.

Tax Loss Harvesting – a tax mitigation technique where securities that have fallen in value are sold, with the loss being used to offset gains in other securities or regular income.

Volatility – the degree to which a security’s price varies over time. Stocks, especially of small companies, are typically more volatile than bonds. A commonly used measure of volatility for the stock market as a whole is an index called VIX, where higher numbers indicate greater volatility.

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