When it comes to investing, there are a lot of small words with big meanings. Let’s look at some of the more common investing terms and break down what each mean.
Stocks and bonds are both ways for companies to raise money, but they are very different. Stocks are issued as ownership in a company. They generally entitle investors to their share of the company’s assets and earnings, while giving the investors voting opportunities. Companies also can pay dividends, which are distributions of profit, to its shareholders. On the other hand, bonds are issues of debt by a company. In exchange for a stated interest rate, investors loan their cash to companies. Municipalities, organizations and government entities can also use bonds to raise cash. Because bonds have a guaranteed rate of return, they are considered less risky than stocks. But as always, more risk equals a higher potential return.
Outside of the weather and what’s new in life, people love to small talk about what “the market” has been doing lately or how their portfolios have done compared to “the market.” So, what exactly is “the market?” Well, “the market” refers to the stock market but that’s still too broad of a term. There are three major US indices, the Dow, the S&P 500, and the NASDAQ. Each one is made up publicly traded companies and provides a way to monitor how that broad group of stocks has performed.
The Dow Jones Industrial Average tracks 30 large companies and has been around since 1896. Some companies within the Dow are Apple, Boeing, Coca-Cola, Home Depot, IBM, Johnson & Johnson, McDonald’s, Microsoft, Nike, Verizon, Walmart, and Walt Disney. The S&P 500 is made up of 500 large companies, as its name suggests. It has been around since 1926 and is made up of only US based companies. The NASDAQ index currently tracks 3,300 companies and is heavily weighted towards information technology companies. It is possible for companies to be included on all three indices if they meet the criteria.
Mutual funds invest in a basket of stocks and bonds. This provides an opportunity for investors to be diversified by only making one purchase. Mutual funds can invest in all stocks, all bonds or a combination of both. There are some mutual funds that track broad market indices like the Dow, S&P 500, and NASDAQ, some invest in individual sectors like healthcare, consumer discretionary, or utilities, while other invest in companies that have similar features like high dividend payers or growth companies. Mutual funds can also be active or passive managed. As you can guess, active mutual funds are traded frequently attempting to take advantage of the movement of the stock market and their holdings, while passive mutual funds typically follow an index and therefore don’t change their holdings very frequently.
ETFs (Exchange Traded Funds) are very similar to mutual funds but have a few key differences. The main difference is that ETFs are traded throughout the day, moving up and down as trading happens. On the other hand, mutual funds change value once at the end of each day based on that day’s performance of their holdings. The other key difference between ETFs and mutual funds involves how they are taxed but that’s too complicated to cover here.
These were just a few common investment terms but hopefully it helped clear up some of your confusion. [Insert market joke here]