Investing Terms to Know

There are seemingly infinite terms and phrases that financial industry insiders use.

In fact, many industry terms have completely different meaning in daily speech. We have only included definitions and explanations that relate directly to finance and investment. Hopefully this short list will help you to build a framework of understanding about retirement savings, general investing and the financial industry.

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401(k) – refers to line number 401(k) in the IRS tax code that allows employers to establish a company-sponsored retirement plan; companies establish these plans with rules that may be stricter than the IRS rules; a company’s fiduciaries determine which investment options the plan will offer; see our Education Center article entitled Plan Types for a detailed explanation

403(b) – refers to line number 403(b) in the IRS tax code that allows state and local government organizations and non-profit organizations to establish retirement plans; organizations that establish 403(b)s often have several 403(b) plans through several financial services providers; see our Education Center article entitled Plan Types for a detailed explanation

457 – refers to line number 457 in the IRS tax code that allows state and local government organizations and non-profit organizations to establish retirement plans; organizations that establish 457s often have several 457 plans through several financial services providers; see our Education Center article entitled Plan Typesfor a detailed explanation

aggressive – a descriptive term applied to investors, fund managers or investments; associated with higher levels of investment risk and more volatility; more risk in exchange for the opportunity for a greater return; the opposite of conservative; see our Education Center article entitled Risk Assessment for related information

annuitant - person upon whose life an annuity is based

annuity – a contract between an individual and an insurance company designed to pay an income stream; purchased with either a single payment or a series of payments

annuitize – begin drawing income stream from an annuity

asset allocation – the way an individual investor divides money among asset classes; see our Education Center article entitled Asset Allocation for a detailed explanation

asset class – mutual funds are divided into categories called asset classes based on the characteristics of the underlying investments within a fund; see our Education Center article entitled Asset Allocation for a detailed explanation

asset class risk – the possibility that a given asset class will experience poor performance; for example, rising interest rates negatively affect the value of long-term bonds, and small cap stock values decline more sharply than large cap stock values during a recession; along with company risk, asset class risk is an element of unsystematic risk; see our Education Center article entitled Risk Assessment for a related explanation of risk

  • The level of asset class risk to a portfolio can be reduced by diversifying across multiple asset classes.

cash value – refers to the total value of an investment account and does not consider distribution limits, surrender charges or early-withdrawal penalties

capital gain – earnings on investments; see our Education Center article entitled Capital Gains for a detailed explanation

capital gains tax – some investments are subject to this tax when the owner sells the investment for a profit; only gains (earnings) are taxed – they are called taxable gains; see our Education Center article entitled Capital Gains for a detailed explanation

commingled trust fund – managed by a bank trust department for employer-sponsored plans; a pooling of accounts that allows a lower operating cost for the bank that manages the fund and, potentially, for the employers and participants; offered as an alternative to mutual funds in some retirement plans

company match – money that some employers contribute to their employees’ employer-sponsored plan accounts as a percentage-of-employee-contribution or as a dollar-for-dollar-match; also called an employer match; see our Education Center article entitled Company Match for a detailed explanation

company risk – the possibility that an event will negatively impact a specific company but not have a large impact upon an asset class or the aggregate market; the potential for company stock value loss through competition, mismanagement, and financial insolvency; along with asset class risk, company risk is an element of unsystematic risk; for example, a labor strike will negatively impact the company against which it is directed, and a defective product will negatively impact the company that produced it; see our Education Center article entitled Risk Assessment for a related explanation of risk

  • The level of company risk to a portfolio can be reduced or eliminated by maintaining exposure to a larger number of companies.
  • When a large, integrated, multi-faceted company fails – like Lehman Brothers – the negative impact is not limited merely to the company, or even to the asset class. The failure of a company like this rises to the level of negatively impacting the entire market and economy. Thus, the possibility of failure for this category of company is a market risk rather than a company risk.

compounding – growth of earnings; see our Education Center article entitled Compounding for a detailed explanation

conservative – a descriptive term applied to investors, fund managers or investments; associated with lower levels of investment risk and less volatility; less risk and lower returns in exchange for a greater level of asset protection; the opposite of aggressive; see our Education Center article entitled Risk Assessment for related information

contribution – money an investor places in a retirement savings vehicle; see our Education Center article entitled Contribution Limits for a detailed explanation

cost basis – the total amount of money contributed to an investment, regardless of gains, losses, penalties or fees; often required for tax purposes

distribution – a withdrawal of money from a retirement savings vehicle; there are many IRS and company-specific rules that govern distributions; see our Education Center articles entitled Distribution Options and Hardship Withdrawals for detailed explanations

diversification – the practice of purchasing a wider variety of investments in order to mitigate the risk associated with any single investment

  • asset class diversification – the practice of spreading investments over a variety of asset classes so that a market downturn in one sector will have a smaller effect upon a portfolio; in basic terms: don’t put all your eggs in one basket; strongly associated with Modern Portfolio Theory

dollar cost averaging – a long-term investing strategy in which an investor contributes the same amount of money to an investment account on a dedicated schedule; see our Education Center article entitled Dollar Cost Averaging for a detailed explanation

The Efficient Frontier – a mathematical process is used to calculate

  • the level of risk an investor should expect for a given level of return or
  • the level of return that should be expected for a given level of risk;
Multiple optimum-risk/optimum-return levels are calculated and plotted on a graph, and the resulting line represents The Efficient Frontier; The Efficient Frontier is a major element in Modern Portfolio Theory; see our Education Center article entitled Modern Portfolio and The Efficient Frontier for more details
employer match – see company match

ETF – Exchange Traded Fund; an investment shell that trades throughout the day on an exchange, similarly to stocks; less regulated than mutual funds, so ETFs have the ability to carry more diverse underlying investments; see our Education Center article entitled Exchange Traded Funds for a detailed explanation

fiduciary – any person who exercises any discretionary authority or control over the management of a retirement plan or its assets; legally required to act in the best interests of the plan’s participants

income investing – an investment strategy wherein the goal is to buy investments that will pay an ongoing income; see our Education Center article entitled Income Investing for a detailed explanation

index – a compilation of investments, often stocks, of a particular category that is used as a benchmark to reflect the overall performance of all investments within the designated category; generally, financial services companies create indices; for example, the S&P 500 is an index created using a sampling of 500 large US companies that Standard & Poor’s believe is representative/reflective of all large US companies

index fund
 – type of mutual fund that matches or tracks the components of a market index like the S&P 500 Index or Wilshire 5000; can provide exposure to a large number of companies within a specific market segment; see our Education Center article entitled Active vs. Passive Investing for related information
  • Typically, Index Funds have low management fees and returns similar to those of the indices they track.

market risk – risk associated with overall financial market and economic decline; also called systematic risk; see our Education Center article entitled Risk Assessment for a related explanation of risk

  • Aside from abstaining from investing in financial markets entirely, there is little an investor can do to eliminate market risk.
  • Many investors are unsuccessful in attempting to eliminate market risk by trying to engage in market timing. Among investors who fail to achieve average market returns, poor timing decisions are a major factor.

MSCI EAFE Index – Morgan Stanley Capital Index Europe, Australasia, Far East; the index is a benchmark for equity market performance in developed countries, excluding the U.S. and Canada

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Modern Portfolio Theory – provides numerical evidence that, by owning multiple investments in a portfolio, investors can reduce portfolio risk to a level that is lower than any single investment in the portfolio; uses an equation called The Efficient Frontier to calculate which portfolios at each risk level have the highest expected returns; developed by Harry Markowitz, who won a Nobel Prize for MPT research and writing; see our Education Center article entitled Modern Portfolio Theory and The Efficient Frontier for more details

money market fund – a conservative category of mutual fund that has the objective of earning interest for shareholders while maintaining a net asset value of $1 per share; comprised of short-term (less than one year) securities representing high-quality, liquid debt and monetary instruments

mutual fund – a product that allows a group of investors to pool money together and invest as a group in a wide variety of securities, most commonly stocks and bonds; mutual funds have stated objectives; see our Education Center article entitled mutual funds for more details

option contract – a contract that can be bought and sold on exchanges that entitles the owner to buy or sell 100 shares of a security at a designated price, called the strike price; also called options; see our Education Center article entitled Options for a detailed explanation

options – see option contract

penalty – a fine assessed by the IRS when an employee takes a distribution that is outside the IRS parameters for distributions from that plan type; generally a penalty is 10%; penalties do not eliminate the need to assess regular income taxes on a distribution; see our Education Center articles entitled Plan TypesDistribution Options and Hardship Withdrawals for detailed explanations

pre-tax – refers to money that has not yet incurred income tax; pre-tax contributions are withdrawn from income before it is taxed, which lowers taxable income; a limited number of other items can be paid with pre-tax income, like health insurance premiums

redemption fee
 – some mutual funds charge shareholders when they redeem shares; the fee is used to pay for the costs associated with redemption – it is not a commission payment or broker fee; fo more information, see our Retirement Education Center article entitled Redemption Fees

required minimum distribution – partial annual payments from retirement accounts like 401(k)s and IRAs required by the IRS beginning by the April following the calendar year in which the account owner turns 70½; see our Education Center article entitled Distribution Options for a detailed explanation

risk – uncertainty of achieving a specific result; quantified by standard deviation and associated with volatility; the possibility of loss; see our Education Center article entitled Risk Assessment for a detailed explanation

  • Investment risk can be further explained by delineating the term into three sub-categories: market risk,asset class risk and company risk. Each class of risk can independently impact an investment.

Roth – refers to a portion of tax law that enables individuals to contribute to a retirement account on an after-tax basis; money contributed on a Roth basis will not be taxed upon distribution; the only Roth accounts currently available are Roth IRA and Roth 401(k); named for Senator William Roth Jr. who sponsored the legislation that enabled Roth contributions; see our Education Center article entitled Plan Types for related information

S&P 500 – Standard & Poor's 500; one of most commonly used benchmarks for the overall performance of the U.S. stock market; designed to be a leading indicator of U.S. equities and to reflect the risk/return characteristics of large U.S. company stocks

security
 – According to Section 2(a)(1) of the Securities Act of 1933, unless context otherwise requires, a security includes “any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘security,’ or any certificate of interest of participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.”

  • The definition is constantly evolving, both in general financial industry use and according to SEC regulations.
  • Additional interpretations by the Supreme Court have led federal securities laws to define security as an "investment contract" and as "any instrument commonly known as a ‘security.’"

separately managed account – also known as a sub-advised fund; managed by a management team or firm other than the firm that holds the assets; 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 that provider's retirement accounts. A mutual fund manager is hired to manage this unique fund. Although these funds may be managed by the same managers as some publicly traded funds, they have their own unique performance. An investor must consult their fund provider for performance information.

stable value fund – a mutual fund with holdings that include high-quality bonds and interest-bearing contracts purchased from banks and insurance companies; the interest-bearing contracts have a guarantee, called a wrapper, that the principal and interest payments will remain steady; commonly offered as an alternative to money market funds in retirement plans

sub-advised fund – see separately managed accounts

surrender charge – some financial contracts with cash value, like life insurance and annuities, charge the owner an early termination fee deducted from the cash value upon termination; most surrender chargesgradually decrease over a period of time until they disappear

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systematic risk – investment risk that is tied to the entire, aggregate market and economy; also called market risk; the opposite of unsystematic risk; the possibility that the entire market and economy will show losses, which would negatively impact nearly every investment

target date funds – mutual funds that periodically re-set asset allocation in accordance with a selected time frame, generally becoming more conservative as the target date approaches

taxable gain – see capital gains tax and capital gain

taxable income
 – the amount of income that the IRS taxes; taxable income can be far lower than gross income because the IRS allows pre-tax contributions to some investment accounts and pre-tax payment of some expenses

tax-deferred – not subject to capital gains taxes

tax loss harvesting – the practice of selling securities for a loss to offset capital gains; see our Education Center article entitled Tax Loss Harvesting for a detailed explanation

Thrift Savings Plan
 – established in 1986 by the Federal Employee’s Retirement System Act, the TSP is for civil and military employees of the federal government; functions like a 401(k); see our Education Center article entitled Plan Types for a detailed explanation

unsystematic risk – investment risk that is not tied to the entire, aggregate market and economy; company risk and asset class risk are categories of unsystematic risk; the opposite of systematic risk - also calledmarket risk; the possibility that an investment or a category of investments will decline in value without having a major impact upon the entire market

variable – descriptive term for a non-guaranteed, non-fixed return investment; if returns will vary, depending upon performance, an investment is variable

volatility – the tendency to vary greatly; refers to the frequency with which investments tend to rise and fall in value and the amount of variation in value; part of the measure of risk

wrap fee
 – a charge levied against a client by an investment manager or investment adviser, either a firm or an individual, for providing a bundle of services like investment advice, investment research and brokerage services; generally a percentage of the assets under management

  • Wrap fees allow an investment adviser to charge one straightforward fee to clients, simplifying the process for both the adviser and the customer.