When it comes to money terms, people tend to be intimidated about asking for clarification. They’re afraid it’ll make them look uninformed or stupid, but this isn’t the case: there’s nothing wrong with asking for a definition. (Chances are, someone else in the conversation will be wondering the same thing.)
But just in case you’re not quite ready to admit your newbie status in public, here are the definitions of five terms you might have pretended to understand the last time you heard them:
Okay, you’ve seen Trading Places, and you know stocks are what traders buy and sell on the stock market — but what exactly are they?
A stock is a partial ownership in a company, and the expectation from purchasing stocks is that their value will change. Your goal is to earn money from this changing value. Most people do this by buying a stock now at a low price, then selling it later at a higher price. This is called a long sale.
The other way of buying low and selling high is a short sale (which is what Dan Ackroyd and Eddie Murphy do, albeit illegally, in Trading Places). In a short sale, you sell a stock you don’t yet own (generally loaned to you from your broker) when you anticipate the price will go down. When the price does go down, you buy the stock at the lower price, and make a profit.
Long investments are associated with bull markets (markets that are going up), while short investments are associated with down-leaning bear markets.
Even if you remember receiving savings bonds from your grandmother with your birthday cards, you might still be at sea as to what a bond really is.
Whereas a stock represents partial ownership in a company, a bond represents a company’s (or municipality’s or government’s) debt. In effect, you’re loaning money to the company in exchange for interest payments, plus a promise of repayment at a specified future time (known as the maturity date).
Bonds are more conservative investments than stocks (which is one reason why Granny liked them). Your principal is more likely secure when investing in a bond, but your potential for returns is more limited.
This term refers to how much a particular investment will change in value. High volatility means that the investment’s value can be all over the place, while low volatility investments tend to plod along at about the same value over a long period of time.
This is an important piece of your understanding of investments, since higher volatility offers the potential for higher returns — and for higher losses. You need to find a mix of volatility that fits your risk tolerance.
4. Asset allocation
Your assets are any resources that have economic value, including your home, investments, and computer you’re reading this on. But asset allocation is specifically referring to spreading out your investments over a variety of categories, such as stocks (also known as equities), bonds, and cash. (Note that “cash” doesn’t necessarily mean keeping money in your mattress: savings accounts and CDs are often referred to as “cash equivalents.”)
It’s important to allocate your assets in such a way that you manage potential volatility and risk, meaning you have some of your investments in more aggressive (that’s financial-speak for risky) stocks, some in solidly-performing bonds, and some in cash equivalents — so there’s no chance you’ll lose all of your money to a bad day on the market, or to inflation.
You might know that everything costs more now than it did in the past, but you might not know why. Inflation is the measure of how much the prices of goods and services increase from year to year. Inflation is measured as a percentage; in general, we see about 2% inflation each year, which means something that cost $1.00 last year will cost $1.02 this year.
Inflation is an important concept to remember when thinking about investments, because the “safest” investments — that is, those that guarantee protection of the principal — might not make enough interest to combat inflation. So the money you put aside in a savings account today will be worth less when you access it in a few years, even though the dollar amount has stayed the same.
What are some terms you’ve always wondered about? How do you educate yourself when it comes to financial jargon?
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