Welcome to the Terminology page of the Getting Started series on Roadmap2Retire. The basics of investing and the definitions have been repeated innumerable times by various entities, but I have decided to do my own version for the sake of completeness. If you are already familiar with the basics of investing and the terminology, you may skip this section.
- Stocks – When you invest in a company and buy its stock on the market, you are owning a portion of the company. Since you are now part-owner, your investment goes up or down depending on the company’s performance.
- E.g.: The fast food chain McDonalds has 1 billion shares. So, purchasing one share of MCD will amount to 1/1,000,000,000th of the company’s ownership.
- Bonds – Bonds are an investment method where an entity (a corporation or government) needs to borrow money. Depending on the credibility of the borrower in the market, a rate and the duration is decided. The purchaser of the bond (the investor who is lending the money) get paid the original amount + the decided rate within the pre-decided duration.
- The Treasury 10 year bond, which are backed by the US government, will pay a fixed rate of distribution every six months and at the end of the 10-year period pays the full face value of the bond to the holder.
- Stock market – When someone refers to the stock market, its a market where you can buy or sell publicly traded companies.
- E.g.: Each country has its own stock markets such as NYSE, NASDAQ, TSX, LSE etc.
- Private vs. public company – Private companies are usually owned by one person or only a handful of people. Outsiders are not allowed to own any part of the company and is not traded on an open market. Public companies, on the other hand, are open to the public and are traded on the open market. Any person who has access to the market can buy or sell a share of the company.
- E.g.: The hotel chain Hilton Worldwide is a private company and does not trade on an open market. You, as an investor cannot buy a share of the company unless you contact the owners directly and strike a deal, not open to the rest of the world.
- E.g.: The fast food chain McDonalds is a public company. You can buy one share of the company off the NYSE for $97.23 (price, as of Jun 21, 2013).
- Dividend – When a company is in a healthy state, it makes profits on a regular basis. The management/board of the company decides whether to share its profits with the rest of the owners or re-invest the profits back into the operations and grow. Companies which are more mature usually tend to share the profits by issuing dividends and companies which are relatively young tend to keep the profits in-house order to grow.
- E.g.: McDonalds pays a dividend of $0.77 per share every quarter.
- Distribution – Distributions are like dividends and depends on the company and how they are taxed. The is the term used by companies which are income trusts, REITs (real estate income trust) or bonds. In this blog, dividends is used as an umbrella term which could also mean distributions.
- E.g.: The rate paid by 10 year Treasury bonds every six months is a distribution.
- Mutual fund – The stock/bond market has thousands, if not millions, of companies publicly traded. A mutual fund is a pool of stocks/bonds grouped together which can be traded as one single entity. By owning one unit of the mutual fund, the investor’s money is divided into the various holdings of the fund. Money managers oversee the fund and decide if stocks/bonds need to be added or deleted or left unchanged.
- E.g.: Vanguard Total Stock Market Index Fund (VTSMX) is a mutual fund which holds 3197 stocks. Each dollar that is used to buy a unit of the fund is divided to the weighting percentage of the holding.
- Exchange Traded Fund (ETF) – An ETF is similar to the mutual fund with one important difference. The fund itself is traded as if it were a stock on the stock market. This difference from the mutual fund makes it easier to buy and sell the fund.
- E.g.: Vanguard Total Stock Market ETF trades on the NYSEArca and holds 3434 stocks.
This list of terminology barely scratches the surface of the investing world. The terminology covered in this article are merely terms that I frequently use in the Getting Started series – for use by new investors getting their feet wet.
Disclaimer: The information provided here is for educational purposes only. All opinions here are my personal opinions and should not be taken as financial advice. I am not qualified to be a financial advisor. Always consult with your financial advisor before investing in any of the companies mentioned on this blog.