Investing Terms We Should All Know

The more people I speak to about investing, the more I recognize that many of us do not understand the various financial terms we hear in the media. The terms and the concepts all seem so confusing, overwhelming and complicated. Many of us are mesmerized as the media tries to explain what the stock market is and how it works. There’s the Dow Jones, the NASDAQ, the S&P 500, stocks, bonds, mutual funds, index funds, and exchange traded funds. Who could make heads or tails of all of this on their own? Today’s financial jargon is intimidating; and many of us figure that investing is for “other people”. Ironically by not investing, many of us are following the first rule of investing: Do not invest in anything you don’t understand.

With this blog post, I hope to convey a base level of information that will allow you to move one step closer towards investing in the stock market. But first, let me address a couple of the requirements people outlined to me about investing their money:

I want to invest in something that is safe and something that will never go down in value.

1. When people say, “something that is safe and something that will never go down in value,” what they typically mean is that they want to invest is something in which their money will never go down. This tells me that they do not understand how money, or the stock market works. If they did, they would realize that having money in a bank account that’s getting 1% interest is losing buying power. This is also known as losing value.
2. $10,000 in the bank and getting 1% would grow to $11,046 over a 10 years period. That is before you factor in inflation. What is inflation you ask
   • Inflation is the cost increase of items and services over time. Not to date myself, but a simple example of inflation is the cost of candy. When I was a kid, Snickers bars cost 25 cents apiece. More than 30 years later, that same Snickers bar now costs $1.40. That is an increase of more than 500%.
   • Factoring in 3% for inflation the $11,046 sitting in the bank, looking pretty, would have a buying power of $8,219.
   • To summarize, over a ten-year period the money in the bank grew by $1,046 but the buying power of the money will be decreased by $2,827.
3. The bottom line: There are no investments that will never go down in value from time to time regardless of how safe they are. Sadly for many of us, our savings are going down in value due to inflation and we don’t know it. As the old saying goes “A dollar ain’t what it used to be.

I want to invest in something that will allow me to flip (double) my money in a short period of time.

1. This statement is sometimes said by the same people who say they want to invest in “something that is safe and something that will never go down in value.” The two statements are in stark contrast with each other. How can you flip your money quickly without having a possibility of the value going down? You cannot. First of all, investing is for the long term, 10 plus years. Even 10 years, there is no guarantee that you will double your money. Let’s use the $10,000 example from above to further study flipping money.
   • Based on the rule of 72, with a 1% interest rate it would take 72 years to turn $10, 000 into $20,000. And after adjusting for 3% inflation over 72 years, the spending power of that $20,000 is $2,437.
2. The bottom line: If you want to flip your money in a short period of time do not it invest in the stock market.

Now that I have addressed those misconceptions, let’s get into the basic investing terms we all need to know to overcome our fear of the stock market.

• STOCK – Represents a small portion of a corporation that you can buy that gives you claim to a percentage of the companies’ assets and earnings. The return/interest received from stocks are based on the companies’ profits. If a corporation has a very profitable year, the return/interest received will be higher. Also, if the corporation has an unprofitable year, the return/interest received will be lower or negative.
• BOND – A debt device used by governments and corporations to raise capital (money). Buying a bond means you are loaning a company or government money. A bond typically has a defined payback period and a fixed rate of return.
• STOCK MARKET – Basically it is a place where equities (stock and bonds) are bought and sold. Think of it as a supermarket where you can buy or sell your share of companies you want to own or get rid of.
• MARKET INDEX – The combined value of several stock that’s used to reflect the activity and value of the total stock market.
  • DOW JONES – A market index that expresses the combined value of 30 of the largest companies in the United States.
  • S&P 500 (Standard and Poor) – A market index that expresses the combined value of 500 of the largest companies in the United States.
  • NASDAQ (National Association of Securities Dealers) – A market index that expresses the combined value of the more than 3000 technology companies in the United States.
  • Any company can be listed on multiple indexes. For example, Apple is currently listed on the Dow Jones, S&P 500 and the NASDAQ. Nike and Walmart are both listed on the Dow Jones and S&P 400 but not the NASDAQ.
  • There are additional market indexes such and NYSE (New York Stock Exchange) Russell 2000 and the Wilshire 5000. For this blog post, I’m just cover the primary indexes covered by the media.

• MUTUAL FUND – A device that pools money from large number of investors to invest in various stocks and bonds. The various stocks and bonds that make up a mutual fund are called a portfolio. The portfolio is managed by a professional fund manager who sets the direction and makeup of the fund. Mutual funds are typically designed to outperform the returns provided by the market index. (Investors such as Warren Buffet and John Bogle believe that it is waste of time to try to outperform the market index. They both believed that the average investor should invest in index funds).
  • INDEX FUND – A type of mutual fund that is designed to track a market index. The goal of these funds is to match the returns of a chosen index. So, if you invest in a S&P 500 index fund and the S&P provides a 10% return, you should expect a return of about 10% from your index fund.
    • ETF (EXCHANGE TRADED FUND) – A type of index fund that can be bought and sold like a stock (day traded). Mutual funds typically have a minimum investment amount which can range from $1,500 to $10,000 if not more. These minimum investment amounts keep some people out of the market. But with the introduction of ETF’s you can now buy as many shares as you can afford.

I understand that there are things that I did not cover in this blog such as fees and cost associated with investing, investing strategies and having a professional financial advisor. But I hope this base level information helps you gain a better understanding of the stock market and how it works. Hopefully you can use this information to get yourselves one step closer to investing.

Feel free to send me any questions you may have.

The Broke Architect

($3,250)