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Financial Terminology

Alternative investment: An investment that doesn’t fit into traditional categories (stocks, bonds, cash and cash equivalents) such as hedge funds, private equity, options, and futures. Previously restricted to the ultra-wealthy, alternatives are now offered in registered mutual funds.

Asset class: Category of investment: stocks, bonds, cash and cash equivalents, and alternative investments.

Bear market: Market condition where prices of securities are falling and investors are pessimistic and continue to sell. Used when broad market indexes such as the S&P 500 Index and the Dow Jones Industrial Average drop 20% or more for at least two months.

Beta: A measure of a stock or portfolio’s volatility relative to a benchmark that is reflective of a particular market as a whole, such as the S&P 500 Index. A beta above 1 indicates a likelihood that fluctuations in value will be greater than in the benchmark, while a beta below 1 indicates less volatility.

Blue chip: Of the highest quality. A blue-chip company is an industry leader that is well-capitalized and has a history of steady earnings and the ability to weather market adversities better than other companies. For example, companies included in the Dow Jones Industrial Average are considered blue chip.

Bond: An interest-paying debt instrument issued by a company or a government to finance its activities.

Bull market: Market condition where prices of securities are rising and buyers are optimistic. Used more broadly to indicate a prolonged period of rising prices for anything that is bought and sold.

Capital appreciation: An increase in the market value of an asset, such as a security.

Cash equivalent: An asset that can be converted to cash immediately, such as a bank account, money market account, or short-term bond or Treasury bill.

Common stock: Represents an ownership share in the issuing company and allows the owner to vote for board members and on corporate policy.

Diversification: Combining a variety of assets classes and market sectors that typically do not react to market conditions by moving in the same direction, or to the same degree. A diversified portfolio includes a broad range of investments with a goal of reducing overall portfolio risk and providing more consistent performance over time.

Dividend: A share of net profits paid by a company to its stockholders, usually quarterly. Dividends are expressed in two ways: as a dollar amount per share (dividend per share) or as a percentage of the market price (dividend yield). It is usually paid in cash but sometimes in stock.

Estate planning: The ongoing process of deciding how you want your assets to be distributed to the people and organizations you value. Typically includes wills, trusts, powers of attorney, beneficiary designations, healthcare directives, etc. Planning ahead can reduce estate taxes, avoid probate, and ensure that assets go to the parties you intend.

Exchange traded fund (ETF): A security that tracks a benchmark—usually a market index—but trades like a stock (including intra-day trading). Although they usually aim to mirror the performance of their benchmarks, some ETFs are actively managed or even leveraged. ETF fees are usually lower than mutual fund fees.

Fiduciary: A person or entity that holds and manages assets on behalf of another person or entity. A fiduciary must operate in the best interests of the client rather than make decisions that benefit the fiduciary. Accretive Wealth has a fiduciary duty to its clients.

Fundamental analysis: Studies a company’s operations, its market, potential for growth, historical stability, management team, and other factors to determine whether its stock may be undervalued and therefore a good investment.

Hedge fund: An unregistered fund that pursues nontraditional strategies such as leveraged or derivative positions, short-selling, or arbitrage in global markets with a goal of outperforming the markets. Hedge funds follow few regulations, require large investments, are illiquid, and are available only to investors who meet income and net worth minimums.

High-yield corporate bond: A corporate bond with a below-investment-grade rating. Yields more but is riskier than an investment-grade bond. Used to be called a junk bond.

Index: Measures the performance of a particular market or market sector by following the value of a basket of securities considered representative of that market or sector. For example, Standard & Poor’s 500 Index is the most widely used measure of US stock performance, while MSCI EAFE measures performance of many global markets. You cannot invest in an index, but you can purchase an ETF intended to track one.

Individual retirement plan (IRA): A traditional IRA is a tax-advantaged way to save for your retirement. Your contributions are subject to annual limits and are often tax-deductible. The financial instruments you buy within an IRA are not taxed until you withdraw money. A 10% early withdrawal penalty applies for withdrawals made before reaching age 59½; exceptions include withdrawals for educational expenses or a first home.

Irrevocable trust: Assets are put into a trust that cannot be modified without the consent of the beneficiary. This means that the grantor no longer has rights of ownership or control. There are multiple types of irrevocable trusts.

Leveraged investment: An investment that relies on debt to finance some or all of its assets. Potential returns and potential losses are therefore higher than with an unleveraged investment.

Living trust: A revocable trust created while a person is living as a mechanism to pass on assets to the beneficiaries without going through costly probate. The person who creates the living trust is the trustee of the assets for the beneficiaries, can change the terms of the trust, and has full control over the assets until they are passed on to the beneficiaries upon the person’s death.

Long vs. short: An investor takes a long position by buying a stock with the expectation that its price will increase. An investor who thinks a stock’s price is likely to fall can take a short position by borrowing shares of the stock from a broker and then selling them. The investor must later replace the borrowed shares. If the stock indeed went down, then the replacement shares would be cheaper than the borrowed shares and the investor would make a profit.

Market capitalization: The total value of a company’s outstanding shares (number of shares times price). The three common tiers of market capitalization are large cap (more than $10 billion); mid cap ($2 billion to $10 billion); and small cap (less than $2 billion).

Mutual fund: A pool of investor money is used to purchase a portfolio of securities that are actively managed to achieve stated objectives. Shares represent an equity interest in the fund.

Net worth: The value of everything an individual or company owns minus any debt or other liabilities.

Private equity: An equity investment in an asset that is not traded on a public exchange, including venture capital, growth capital, and leveraged buyouts. Investors must meet knowledge, income, and net worth criteria and be willing to hold an illiquid asset.

Qualified retirement plan: Retirement plan established by a business for its employees that meets the guidelines of the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA), such as a 401(k), profit-sharing, or defined benefit plan. Contributions grow tax-free until withdrawn.

Qualitative analysis: Subjective analysis of a company and its stock valuation that looks at non-numerical factors such as the quality of the management, its research and development team, employee morale, brand value, and customer loyalty. Often used in conjunction with quantitative analysis.

Quantitative analysis: Financial analysis of a company and its stock valuation that looks at measurable numerical characteristics such as earnings, debt ratio, cash flow, and market share. Often used in conjunction with qualitative analysis.

Quantitative easing: Monetary policy used by the Federal Reserve or other central bank to increase the money supply by purchasing government securities or other securities from the market, thereby increasing liquidity to financial institutions with the expectation that loans will be easier to get. Used only when interest rates are already very low.

Real assets: Tangible assets or claims on tangible assets such as commodities, real estate, precious metals, infrastructure, equipment, and oil. They add diversification to a portfolio because they have a relatively low correlation to stocks and bonds. Real assets can also provide some protection from inflation because they tend to outperform other asset classes during inflationary periods.

Recession/depression: Technically, a recession is two consecutive quarters of decline in gross domestic product (GDP). A depression is a long-lasting recession characterized by very high unemployment rates, falling prices, deflation, and economic contraction reflected in reduced output and investment.

REITs: A real estate investment trust (REIT) invests money in real estate by purchasing properties directly or by buying mortgages. REITs can be bought and sold just like stocks, so they are very liquid, unlike a piece of real estate. Because price fluctuations are not highly correlated to the movement of stocks and bonds, they can provide diversification to a portfolio.

Revocable trust: When assets put into a revocable trust, the grantor is the trustee and continues to control the assets and receive any income they generate. The grantor can change the terms of the trust until the assets pass on to the beneficiaries upon the person’s death. A living trust is revocable.

Risk/reward ratio: Riskier investments have the potential for greater appreciation but also larger losses. To formally calculate the risk/reward ratio, divide the amount of potential profit by the amount of potential loss. Less formally, investors weigh their desire for growth against their tolerance of losses.

Risk tolerance: A term for the amount of uncertainty an investor can tolerate in the value of assets. An investor with low risk tolerance is not comfortable owning an asset that is likely to have large swings in value. Conversely, an investor with high risk tolerance is willing to assume the risk of sharp price drops in search of greater gains.

Roth IRA: Similar to a traditional IRA except that contributions are never tax-deductible; in accounts at least five years old, withdrawals after age 59½ are not taxed; you can continue to contribute after age 70½; and there are no required minimum annual withdrawals after reaching age 70½.

Sector vs. industry: These terms are often used interchangeably to compare companies that are related by their primary business activities. A sector, however, is typically used to mean a large section of the market economy that incorporates multiple industries. For example, the technology sector encompasses various types of hardware and software companies that are separate industries.

Security: Anything that can be exchanged for value, has an expectation of profit, involves a risk to the holder, and is an investment in an entity managed by a third party.

SEP IRA: Any employer can establish a Simplified Employee Retirement Plan (SEP) IRA for employees. A SEP provides employers with a simplified method to make contributions toward their employees’ retirement and, if self-employed, their own retirement. Contributions are made directly to an Individual Retirement Account or Annuity (IRA) set up for each employee.

Sharpe ratio: A ratio designed to measure the risk-adjusted performance of a portfolio and indicate whether a portfolio’s returns are due to good management or taking on a lot of risk. A high Sharpe ratio indicates better risk-adjusted performance. The ratio is calculated by subtracting the “risk-free rate” (e.g., the return on a 10-year Treasury note) from a portfolio’s expected rate of return and then dividing the result by the portfolio’s standard deviation.

SIMPLE IRA: A Savings Incentive Match PLan for Employees (SIMPLE IRA) is an IRA-based plan that gives employers of fewer than 100 employees a simplified method to make contributions toward their employees’ retirement and their own retirement. Employees may make salary reduction contributions and the employer makes matching or non-elective contributions directly to an Individual Retirement Account or Annuity (IRA) set up for each employee.

Standard deviation: For investments, a statistical measurement of how far the price of a stock or portfolio has moved above or below its average historical value. Wide swings (a high standard deviation) indicate that a stock is volatile and therefore riskier. Although standard deviation is calculated using historical data, some analysts regard it as a predictor of future performance.

Systemic risk (aka systematic risk, market risk): The risk that an entire industry, market segment, country, or the entire global economy will cease to function efficiently.

Technical analysis: Technical analysis assumes that the fundamental value of a company is already built into its stock price and instead takes a statistical approach. It studies historical market activity such as past prices, volume, and trends in order to determine whether the stock is likely to rise or fall.

Trust: A legal document that establishes a formal method of passing on assets to beneficiaries without probate. There are many types of trusts: some are revocable (the grantor retains control until death), while others are irrevocable (terms of the trust can be changed only by the beneficiary). Many trust offer legal avenues to reducing the tax burden on asset transfers.

Volatility: A measure of risk or uncertainty about fluctuations in the value of an asset. The volatility of a stock or portfolio is often measured by its historical swings in value (see standard deviation), but it can also be measured against a benchmark (see beta) or by other means.