Investment Glossary
Don't let the jargon get in the way. Here' s a list of common investment terms, defined in plain English. Still need help? Smart401k advisors are here to answer your questions.
- How much money can I save in my 401(k)?
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For 2008, the IRS contribution limit is $15,500 for an individual participating in a 401(k) plan. A catch-up contribution limit is $5,000 for individuals 50 years+. Catch-up contributions can be applied to each year for a person over 50. Generally, the contribution limits increase by about $500 each year. Please note that you may be subject to plan limits set by your company.
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- How much money should I save for retirement?
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There is an element of personal choice here, but generally you want to save enough to support the lifestyle to which you are accustomed. Many
experts say that you should save enough to support 70 percent of your current spending levels for your projected retirement years. This
assumes you won't spend as much on work clothes, transportation, kids, etc., when you are retired. But most experts seem to agree
that you should target some percentage of what you are used to spending, then factor in the following: 1) the amount of time you have to save, 2) the number of years you will be
living off of your savings, and 3) inflation. We've included several calculators on the Smart401k website to help you determine what
this means in terms of your savings per year.
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- What types of investments are in retirement plans?
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Retirement plans can contain the following types of investments: Mutual Funds, Money Market Funds, Stable Value Funds, Annuities,
Separately Managed Accounts, Commingled Trust Funds, Exchange Traded Funds (ETF) and Company Stock. Each are discussed in separate
FAQs below.
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- What exactly is a Mutual Fund?
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A Mutual Fund is a product that allows a group of investors to pool their money together with a predetermined investment objective.
The Mutual Fund will have a fund manager who is responsible for investing the pooled money into specific securities (usually stocks or
bonds). When you invest in a Mutual Fund, you are buying shares (or portions) of the Mutual Fund and you become a shareholder of the fund.
Some of the key advantages of Mutual Funds:
- You are invested in many companies at once with a single investment. Thus, you minimize the risk you would have if your money were invested in a single company that ended up having financial problems.
- Your money is with a professional fund manager who has a track record you can monitor, and whose full-time job is selecting companies to invest in (or to sell).
Key things to remember about Mutual Funds:
- Mutual Funds have stated investment objectives that govern how they invest. This will typically limit the range of types of companies that a Mutual Fund manager will choose to invest in. An example of this would be to limit investments to Fixed Income securities (bonds). Another would be to limit the geographic range of investments (e.g. only companies within the United States, or only European countries). See the discussion on Mutual Fund Styles for more information on this topic.
- The Mutual Fund manager has an extremely high influence on the failure or success of a mutual fund. The manager decides which investments to choose and when to buy and sell an investment.
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- What is a Mutual Fund "Style"?
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A Mutual Fund style (also referred to as "category" or asset class) reflects how a fund actually invests. While the investment
objective stated in a mutual fund's prospectus is intended to define how a fund is investing, other third parties such as Morningstar
assign a style to a fund based on their own analysis. Styles help investors make meaningful comparisons between funds by assigning
them into categories based on common category definitions. Mutual Funds can "drift" between styles over time. To maintain a diversified portfolio of investments, it's important to recognize and monitor the current style of your mutual funds.
Styles usually reflect the following characteristics:
- The type of investments. Examples include Bonds or Equities.
- The country or geographic region. Examples include domestic (U.S.) and Foreign (outside the U.S.)
- The economic conditions of the country. Examples include developing countries.
- The size of company to invest in. Examples include “Large”, “Medium” and “Small.”
- The relative value of the company's stock. Examples include "value" (the company's stock is undervalued in relation to its anticipated growth, in the opinion of the fund manager) and "growth" (the company's stock has been growing steadily/rapidly and is expected to continue to grow or grow faster, in the opinion of the fund manager).
- A sector of business. Examples include Energy, Precious Metals and Real Estate.
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- What is a Money Market Fund?
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An investment fund that has the objective of earning interest for shareholders, while maintaining a net asset value of $1 per share.
Portfolios are comprised of short-term (less than one year) securities representing high-quality, liquid debt and monetary instruments.
A Money Market Fund typically is the lowest risk/lowest return option in a retirement plan.
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- What is a Stable Value Fund?
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A Mutual Fund whose holdings include high-quality bonds, as well as interest-bearing contracts bought from banks and insurance
companies. Those contracts have a guarantee, which is called a wrapper, that the principal and interest payments will remain steady.
The wrapper guarantees that the net asset value will remain stable for a certain amount of time, regardless of market conditions.
Stable Value Funds commonly are offered as an alternative to Money Market Funds in retirement plans. Depending on market conditions,
they may return more or less than a Money Market Fund option.
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- What is an annuity (in an employer retirement plan)?
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An annuity is a type of investment that guarantees payment of specific amounts at specific times, or a single lump sum payment.
Annuities are usually sponsored by insurance companies. In a retirement plan, an annuity can be a separately managed account, or a
Mutual Fund with a "wrap" fee added to it. The wrap fee increases the expenses of the underlying investment in return for being
offered as a part of your 401(k) or 403(b) plan. Annuity performance is usually only accessible via your retirement plan provider -
you can't check the actual performance of your annuity investment as you can with a traditional "open-end" Mutual Fund.
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- What is a Separately Managed Account?
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Also known as a "Sub-advised Fund," this type of fund is managed by a management team or firm other than where the
assets are actually held. Sub-advised Funds are often found in wrap programs or variable annuities. Unlike a traditional publicly available
Mutual Fund, a Separately Managed Account is sponsored by a retirement plan provider solely for the provider's retirement accounts.
A Mutual Fund Manager is hired to manage this unique fund. Although these funds may be managed by Mutual Fund Managers of other
funds that are publicly traded, these Separately Managed Accounts have their own unique performance. An investor must consult with
their fund provider to check on the performance of these funds.
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- What is a Commingled Trust Fund?
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A Commingled Trust Fund is managed by a bank trust department for employee benefit plans like 401(k)s. They are a pooling of accounts that
allow a lower operating cost for the bank (and potentially for the employers and participants!) and are offered as an alternative to
Mutual Funds in some retirement plans. Index-based funds offered by bank retirement plans are often Commingled Trust Funds.
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- What is an Index Fund?
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A type of Mutual Fund that matches or tracks the components of a market index such as the S&P 500 Index or Wilshire 5000 (designed
to reflect the performance of the total stock market). These funds can provide you with exposure to a large number of companies
within a specific market segment. Typically, an Index Fund has low management fees, along with returns close to those of the index it
tracks. However, these funds will never outperform the market segment they were set up to track.
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- What is the S&P 500?
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The Standard & Poor's 500 is one of the most commonly used benchmarks for the overall U.S. stock market. It was designed to be a
leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large company universe. The
companies are selected for inclusion in the index based on market size, liquidity, industry grouping and other factors. It is
a market value- weighted index, which means that each stock's weight in the index is proportionate to its market value.
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- What is the MSCI EAFE Index?
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This is an index fund that is generally used in the U.S. to represent a benchmark (standard) for performance for mutual funds
comprised of foreign stocks in developed countries (as opposed to economically developing countries.) The initials stand for Morgan Stanley
Capital Index Europe, Australasia, Far East. Morgan Stanley is the company that puts together the index, which is made up of a
representative collection of foreign company stocks in the regions mentioned. Australasia is a term used to describe a region
including New Zealand, Australia and neighboring islands in the Pacific Ocean. The Far East region includes Japan and Singapore.
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- What are "Target Retirement Date" Funds?
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A Mutual Fund that periodically resets its asset mix (stocks, bonds, cash equivalents) in its portfolio according to a selected time
frame that is appropriate for a particular investor. A Target Date Fund is an alternative for investors who do not want to spend
any time manage their own retirement investments. Keep in mind that these are almost always "funds of funds." In other words, they contain other Mutual
Funds, usually all from the same Mutual Fund Company, and they have additional expenses. Please Note: These funds account for an individual's time
horizon (projected retirement date) only and do not account for an individual's risk tolerance or any other aspect of their personal situation.
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- What is an Exchange Traded Fund (ETF)?
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An ETF is a security that tracks an index, a commodity or a basket of assets like an index fund, but it trades like a stock on an
exchange. The benefits of an ETF are similar to those of an index mutual fund; however, the fees are often lower. Due to the fact
that ETFs trade on an exchange, an investor outside a retirement plan is able to buy and sell an ETF throughout the day and will
pay normal brokerage commissions. In retirement plans, this benefit cannot typically be utilized.
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- What is Modern Portfolio Theory?
- Modern Portfolio Theory (MPT) was developed by Harry Markowitz, who won a Nobel prize for his work. It is the foundation concept underlying most advisor’s approach to developing investment allocation recommendations. To boil it down, MPT demonstrates the value of diversifying across a variety of unlike investments. The chief benefit of diversification is a reduction in the riskiness of a portfolio. MPT quantifies the benefits of diversification, also known as not putting all of your eggs in one basket.
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- What is the "Efficient Frontier?"
- The Efficient Frontier was first defined by Harry Markowitz in his groundbreaking (1952) paper that launched modern portfolio theory. An Efficient Frontier is the maximized expected risk/return alternatives for different combinations of investments. To develop an Efficient Frontier, you would first forecast expected returns and relative risk (or standard deviation) for each of a set of possible investments (like a set of mutual funds in a retirement plan). Next you would create a graph of the combined return and risk of different combinations of those investments. The Y axis would be your investment return and the X (horizontal) axis would be your standard deviation, or risk. If you then plotted a line that would represent the combinations of investments that represented the maximum return for the level of risk you were taking, this line would be the “efficient frontier” for your portfolio. Calculating an efficient frontier is a primary method for utilizing modern portfolio concepts in retirement plan investing.
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- What is Market Risk?
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In the investment world, risk is generally defined as the chance that the value of your investments may increase or decline over a
given time period (also called volatility). Risks in investing can be further explained through grouping them into types of risk.
The three major types of risk in Mutual Fund investing are Market risk, Asset Class risk, and Company risk. Each type of risk can
independently impact your retirement fund investment.
The first level of risk to understand is Market risk, which is the broadest category of risk. In simplest terms, Market Risk is the
risk associated with increases or declines in the overall financial markets and the economy.
Aside from staying out of the financial
markets entirely, or investing in something like commodities (which can act counter to the direction of the stock market), there is
little an individual investor can do to affect his market risk. Many investors try to unsuccessfully counter Market Risk by buying
and selling funds (called Market Timing). Bad timing decisions are a major reason that the average investor typically
does not achieve market average returns on their investments.
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- What is Volatility?
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Volatility can be defined as the "ups and downs" of the market. It is the degree that the performance of the
market, a segment of the market or an individual fund, swings up and down from previous levels over a defined period of time.
See our definition of Market Risk in this section for a description of why it's important to consider volatility in your investing approach.
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