Just in case investing isn’t confusing enough, people like to throw around acronyms and nicknames like S&P, bull, bear, NASDAQ, WTF, DOW, IDK. It’s like they have a secret club, with all these secret passwords, and they won’t let you in the treehouse because you don’t know them.
BUT HOW CAN YOU KNOW THE PASSWORD IF THEY WON’T DECODE IT FOR YOU??!
It’s confusing, and you shouldn’t feel dumb for not knowing common investment terms off the top of your head.
Because guess what? You can learn.
If you, like me, feel your brain do this
… reading about anything related to ETFs vs. mutual funds, or Roth vs. Traditional IRAs, I beg of you:
DON’T GIVE UP.
I’m not going to.
Because you know what? I’m smart. You’re smart. There’s no reason why we can’t figure this out.
And to be QUITE frank, it makes me unreasonably angry to think about all the people that are getting rich investing, even though they are no more qualified or smart than you or me.
I don’t want you to feel locked out of their exclusive club with their fancy acronyms.
I’m here to clarify a few commonly used terms that I’ve 100% had to Google before too. Because what’s the point of getting into the secret club if you can’t open the doors to let your friends in?
RELATED READ: How much should you contribute to your 401(k)?
What’s the difference between stocks, bonds, mutual funds & ETFs (and should I even care)?
These definitions skim the surface, but may help at least help you realize what questions you need to be asking.
WHAT ARE STOCKS?
A stock is a piece of a company — a percentage share of the ownership.
In fact, stocks are also sometimes called “shares”, and they are also sometimes called “equity,” because one name simply is not enough for this industry.
For example, Joe wants to open a Grow Your Own Taco Bar, where patrons tend to a community garden of tomatoes, peppers and lettuce, ultimately harvesting their own food to have prepared into tacos.
Joe needs a lot of money to start a restaurant like that, so he invites you and other investors to put stock in his idea and his company. Those investors become stockholders in the taco company.
If the taco bar does extremely well and earns a huge profit, your share (AKA stock AKA equity) can increase in value. On the other hand, if the taco bar tanks, your share can decrease in value. This matters because the actual way you make money with stocks is when you sell them. Obviously, you want to sell your shares at a higher rate than you bought them — and that’s how you turn a profit.
As a stockholder, you have a claim over the taco company’s assets. But, it’s important to note that your “share” of the corporation entitles you to a share of the PROFITS, not the physical assets. If you have a 10% share, you don’t own 10% of that lamp, 10% of that barstool, 10% of that Macbook and 10% of the soap in the breakroom.
This protects you in case the corporation goes belly up (because wow, who thought that a Grow Your Own Taco Bar would be a good idea??). So, even if the corporation is forced to sell all of its assets, you won’t have to pawn your rings and mortgage your home — those are PERSONAL assets, and they’re protected in this instance. Likewise, if you PERSONALLY go bankrupt, the taco bar doesn’t have to bail you out. It’s a separation of church and state ownership and control.
What shares do:
-Give you a vote in shareholder meetings (sometimes this involves major stuff like appointing the board of directors, who ultimately control the company. Typically, your vote counts in equal part to your share value. If you own 51% of a company, guess who’d get their way every time?)
-Pay you dividends (AKA getting dat monayyyyy. If or when the company turns a profit, a portion of the profits, called dividends, is paid to its shareholders. The amount you get is based on your percentage of shares.)
-Allow you to sell your shares to someone else to (theoretically) turn a profit.
Oh cool, I have one share of Apple stock — so you’re saying I have Tim Cook’s ear?
Apple comprises about 5 billion shares, so you’d own roughly 1 / 5 billionth of the total profits.
There are different classes of stocks (preferred stocks, common stocks, etc.), and those affect things like corporation voting rights, right to first dividend payments, and more. But for simplicity’s sake we’re just saying that all stock is a piece of the company’s pie. You can learn more about the different kind of stocks from Investopedia.
So, when you have money “in the market” the * LOOSE * overarching goal is to get a bunch of different, diverse slices of companies with the hopes that over the long run, you’ll own a tiny piece of the profits of each. More on how that works just ahead.
WHAT ARE BONDS?
A bond is actually like a loan, and you’re the lender.
Companies and the federal government can issue bonds like big ol’ I-O-U notes, and then slowly repay them over time.
So, if you buy bonds in a company, they’re essentially borrowing money from you and promising to pay it back with interest. That interest rate is set at the time the bond is issued, and offers a guaranteed “yield” at its maturity date — or, the predetermined date (typically 15 or 30 years down the road) at which the bond will be paid back in full, with interest.
You may have received a savings bond from your grandparents when you graduated middle school. A government savings bond is a commonly-issued loan to the government, which it can use for anything from paving roads to building schools.
Bonds are bought at face value, meaning that your grandparents paid $100 for that $100 savings bond you received in all of your pimple-faced, Hollister-jean-skirt-wearing, 8th-grade glory.
So, if you hold that savings bond until it reaches maturity, you’ll get 100% of the original $100 paid, plus the interest earned on it.
Also, your grandparents sound lovely.
(I’m just now realizing the maturity metaphor imparted to middle schoolers via bonds. Wow.)
That’s a fairly broad overview, as bonds can vary between fixed interest rates and variable interest rate. Those details actually matter very much, because of a little thing called inflation — e.g. the value of a dollar 30 years ago is different than its value today.
But, for our basic working definition, we’re going to go with the following:
Stocks = your share in a corporation’s profits and losses
Bonds = debt repayment to you
Stocks = more volatile, but potential for higher returns
Bonds - more stable, with guaranteed conservative returns
WHAT IS A MUTUAL FUND?
A mutual fund pools the money of several investors and spreads it across stocks, bonds and other assets.
The groovy thing about mutual funds is that even if you don’t have a lot of money to play with, you can still achieve a balanced portfolio. In other words, it allows individual investors (you) to invest in a way you wouldn’t be able to afford otherwise.
So, if you invest in a mutual fund, one sliver of your money may go toward an energy company, one sliver may go to Apple, Inc., one sliver may go into a taco bar, one sliver may go toward a corporate bond.
The beauty of mutual funds is three-fold:
It’s professionally managed and SO EASY. Better yet, there’s a professional handling the buying and selling aspect, so you don’t have to deal with the details. Mine is handled by our pals at Vanguard, and all I have to do is tell them when I want to give them more money to use.
You don’t really have to worry about the value of individual companies’ shares, because your money is diversified across several different investments.
They’re relatively low risk. This, of course, varies based on the type of fund. Generally speaking, mutual funds are a “safer” bet because of the way they diversify your money across a wide range of investment categories.
Much liked boxed wines, not all mutual funds are created equal — the value of a mutual fund depends on the performance of its securities (or, investments). So really, when you invest in a mutual fund, you’re buying a piece of that account’s profits.
In fact, mutual funds, in general, aren’t the actual Thing You Are Investing In. They’re the gift basket that hold the goodies that you ARE investing in.
Some gift baskets are tech themed, featuring new Air Pods and Spotify gift cards.
Others are salty-snack themed, featuring candied pecans and popcorn.
Same for mutual funds: Some have more company stocks, others feature bonds. So, while you can shop around and find a variety of differently arranged or themed baskets, you don’t have to go through the nitty gritty of actually picking out, purchasing and keeping tabs on each individual piece of chocolate and teddy bear in the basket.
Because when it comes to investing, you don’t want to put all of your eggs in one basket.
WHAT IS AN ETF?
An exchange-traded fund, AKA “ETF”, is another basket of investments that have been pooled together, all bundled into one neat and tidy fund. Then, that fund is traded on an exchange (as in, the New York Stock Exchange).
So, if you buy a share in an ETF, you’re claiming a stake of that fund’s total assets.
ETFs generally track an index.
Here’s the gist of what “tracking an index” means:
An index is essentially a group of investments that represent a market segment. That way, investors can gauge the performance of that market segment by using the index as a benchmark, or comparison tool. Based on the indexes, investors make decisions on where to invest their portfolio.
That’s crudely stated, but to be honest I have not found one single simple definition of this anywhere on the internet that doesn’t require a dictionary. This is why I get so frustrated and feel so excluded from the investment conversation. I’m trying very hard, and STILL it is hard to understand in simple terms. SPEAK ENGLISH. GOOD LORD. Do better, investment industry. Do better.
Back to ETFs:
ETFs are known as “marketable securities” — a fancy way of saying that the funds can quickly be liquidated (turned into cash) fast, versus being “tied up.”
According to Investopedia, “the liquidity of marketable securities comes from the fact that the maturities tend to be less than one year, and that the rates at which they can be bought or sold have little effect on prices.”
The universal benefit of ETFs — and what you need to know — is that you can start investing in ETFs with very little money.
You don’t have to be rollin’ in order to join the game, and can still get in on a well-diversified portfolio.
P.S. “Indices” = Index, plural. But apparently only occasionally, because I’ve seen it both ways in all my research.
“Wait, so an ETF is a portfolio comprised of various investments … how are ETFs different than mutual funds?”
Glad you asked, because I spent SO long trying to understand this. Here’s what I found:
Mutual Funds vs. ETFs: A (brief) comparison
Although mutual funds and ETFs are similar in many ways, ETFs trade like common stock on an exchange, while mutual funds are only bought and sold once per day after the exchanges close at 4 p.m EST. As a result, the value/price of an ETF’s shares will change each day, throughout the day, as they are bought and sold — like a common stock’s would.
The other main difference is that ETFs are generally more passive in that they are managed based on a certain market index (remember how it’s tracking a market segment as a benchmark?). Mutual funds, on the other hand, are more actively managed by a fund manager who decides how to allocate the assets in the fund.
To learn more about ETFs, read this article by The Motley Fool, which goes into a lot more detail. The article gives a much deeper insight on the tax implications of ETFs vs. mutual funds, how hands-on each is, and all of those soul-sucking important details. Vanguard also has a helpful guide on choosing the right fund for you.
WHAT ARE INDEX FUNDS?
Index funds are a type of mutual fund (a pool of investor money split up among various assets) that is comprised of a portfolio that matches or a tracks a specific index.
They are a HOT TICKET item because of their simplicity, low cost of entry, and relatively good returns.
Index funds are a passive investment, meaning there are no fund managers actively trying to “beat the market” by frantically buying and selling your stocks all the livelong day. And since you aren’t paying a fund management fee to human research analysts and brokers, index funds have lower costs.
Besides, here’s the kicker: Managed funds only “beat the market” about 1 in 20 times. Index funds offer you lower risk and higher reward. Send your thanks straight to Jack Bogle. He’s the one who made them a thing.
In comes the “passive part” — the funds are designed to mirror the performance of a benchmark index (which is explained in the section above). And that index is going to track UPWARDS in the long run, thanks to the market’s historically upward trend. THAT is what makes index funds an awesome long play.
The simplicity and low cost of index funds make them an ideal investment for people who don't want to spend a lot of time researching stocks and managing their portfolio.
Even Warren Buffet has deemed index funds a safe, solid bet for retirement funds for the average investor (that’d be you, me, and anyone who’s not the Wolf of Wall Street), versus trying to pick out individual stocks.
WHAT IS DOW JONES?
Dow Jones & Company was founded in 1896 and is one of the largest business and financial news companies in the whole world. Believing that the public had a right to clearly understand whether the stock market was rising or falling, Dow Jones & Company created a benchmark: the Dow Jones Industrial Average.
“The Dow,” as it is commonly called, is a stock market benchmark — AKA a stock market performance indicator that gives the public an idea of how good or bad the stock market is doing.
It’s one of the most-watched stock benchmarks, or indexes, in the world. The Dow represents a range of different sectors of the economy, including major corporations like Coca-Cola, General Electric, Microsoft, Exxon, and many more.
In other words, the Dow gives you, the average investor, an idea of whether the market (and your stock market doll hairs) is going up or down, based on the performance of 30 of the world’s most significant stocks.
Fun trivia fact:
Charles Dow founded The Wall Street Journal in 1889 to cover business and financial news.
WHAT IS THE S&P 500?
Standard & Poor’s 500 Index is similar to the Dow, in that it gives the gist of how a select number of companies (in this case, the largest 500 U.S. publicly traded companies) are doing. Again, this gives you, the average investor, an idea of whether your stock market dollars are going up or down.
I could reinvent the wheel, or you could watch this Investopedia video for a simple explanation of the S&P 500.
Obviously, this doesn’t cover everything you need to know to become a gazillionaire. I want to continue to break down investing basics — and I mean baaassicccsss, like “How do I open an investment account … like literally which buttons do I press online?” and “How do I find out what kind of funds my 401(k) is invested in?” and stuff like that.
Hopefully, you can use today’s post as a jumping off point to ask the right questions and learn what kind of investments you already have, and what you’d like to move toward in the future.
So — what questions do you still have? Does anyone have any awesome, easy-to-understand resources for investing basics? A must-read book? A killer podcast? Let me know below — I’d love to get a convo going in the comments section!
And, be sure to stick around for the next few weeks as I continue this Intro to Investing series right here on the blerrggg.