Like any practice or skill you develop, you must learn the fundamentals and the language of that practice. This is as true for learning to invest and grow your wealth, as it is for learning Opera or IT support.
Understanding terminology is critical to help you navigate through the inner workings of systems, theories and the language of money. So, in this post we will touch on the 6 Investment Terms You Should Know before you invest your hard-earned money.
This post will help you understand common terms used when discussing your retirement accounts such as a 401k, Traditional IRA, ROTH IRA, etc. Of course, there are many more terms to learn, and this is the tippiest tip of the iceberg in personal finance. I will have more posts on this in the future but feel free to check out Investopedia.com and let your curiosity grow your mind.
Security
Let's start with a common term you probably hear everywhere. Security! You know they don't mean mall security or Sears security (RIP Sears). So what does it mean? Basically, it's a broad term that's either a certificate or another financial instrument that has monetary value and can be traded. Your stocks, bonds, debts, etc. Now you know, when someone says security in a financial sense, it's not them asking you to leave. Unless they did and you refused to.
Compounding
Compounding is something so simple, but so magical when investing. Basically, it's interest or dividends that payout based on the balance of your investment and slowly grows over time. For example, if you have $100 in your savings and it pays out 1% a month. Month one you make $1, bringing your savings account to $101. Then, the next month it pays out 1% of the $101 earning you $1.01. Adding that to the balance and it continues to slowly grow over time. It's like friggin magic. Think of it this way, the longer you can take advantage of compounding, the higher the income potential for retirement. Be aware though, compounding works just the same for debt. I have another blog post planned for that one.
ETFs
An ETF, or exchange-traded fund, is a security that tracks an index, a commodity, bonds, or a bunch of assets, similar to a mutual fund. However, unlike mutual funds, an ETF trades like a common stock on a stock exchange and can have far fewer fees or minimum cash requirements. ETFs, go through price changes throughout the day as they are bought and sold just like a stock. A great benefit for ETFs is that you can own a piece of some of the greatest companies, taking advantage of growth across industries and potentially taking on less risk and fewer fees over the long term, depending on the security you purchase. A great example of an ETF is the Vanguard Dividend Appreciation or VIG which includes companies like Microsoft and PepsiCo but also pays out a quarterly dividend.
DIVs 'Derived Investment Value (DIV)'
This is a valuation methodology used to calculate the present value of future cash flows of liquidated assets, fewer expenses associated with the liquidation process blah blah blah. It's simple. These are securities that pay you to invest in their security. Similar to interest in a bond, stocks that pay dividends puts money back into your account the longer you hold onto it. Following Kevin O'Leary's methodology, I don't invest in a paper asset, unless it pays interest or a dividend. It even feels like less risk and you can compound those dividends over time to grow your account. Depending on the stock or ETF, you could receive monthly DIV payments monthly at an annual return of 7-10%. That is just in dividends! I love my dividend-paying assets.
Bonds... James Bonds...
Think of a bond like a loan from the bank, but investors (you) act as the bank. The whole purpose of the bond is for raising capital by borrowing. The US government, states, cities, corporations, and many other types of institutions sell bonds. This is a promise to repay the principal (amount borrowed) along with interest (or coupons) on a specified date (known as maturity). Not all bonds are created equal and some do not pay interest, so be aware of that when investing in bonds. No matter what though, they have to pay back what they owe. Also note that unlike stocks, when an investor buys a bond, they don't get any kind of ownership rights over the entity that is borrowing the money. Bonds are typically low risk and have low return rates compared to stocks, but they are a great equalizer when trying to mitigate risk in your portfolio.
Mutual Funds (Not so funds)
Mutual funds are professionally managed (known as active managed) and are funded by investors. Now, although there can be low-cost mutual funds there are some things to be aware of because financial planners (sales pros) really push people to buy these, even if it is not in the best interest of the client. These buggers can be loaded with hidden fees that eat at your compound growth potential, and if they pick the wrong stocks, you lose out while they still get you with fees. I've heard a lot of experts talk about mutual funds in such a negative light, and there's a lot of facts to support it. To each your own, but I avoid them like the plague.
Of course there are plenty of terms in the personal finance world, and eventually, I plan to cover all of them. However, this is the first step for you and moving in the right direction. Happy investing!