Investment terms you need to know.

How and where you invest your money is an important decision. However, fully understanding your investments can require a crash course in terminology. The following investment definitions for a few key terms can help increase your understanding of the investment process and enable you to make more informed financial decisions.

Types of investments

The most common terms that are related to different types of investments:

• Bond: A debt instrument, a bond is essentially a loan that you are giving to a governmental entity or a company in exchange for a pre-set interest rate. Typically, the bond pays periodic interest (coupon payments) during its term, and it matures on a specific date. Most bonds are denominated in $1,000 face-value increments, though they can sell above or below that price, particularly in the secondary market. Upon maturity, the bondholder will receive the face value of the bond—no matter what price he/she paid for it. Depending on what price you paid, you may experience a gain or loss on the price of the bond itself (however, considering interest payments, you may experience a positive total return and there are return metrics that can estimate such total returns).
• Stock: A type of investment that gives you partial ownership of a publicly-traded company. Such ownership entitles you to any dividends that may be paid and you may experience gains or losses on your holdings over time.
• Mutual fund: An investment vehicle that allows you to invest your money in a professionally-managed portfolio of assets that, depending on the specific fund, could contain a variety of stocks, bonds, or other investments.
• Exchange-traded fund (ETF): Funds – sometimes referred to as baskets or portfolios of securities – that trade like stocks on an exchange. When you purchase an ETF, you are purchasing shares of the overall fund rather than actual shares of the individual underlying investments.

Investment strategies

Once you have a better understanding of the investment choices available, you may come across specialized terms that explain how money can be invested:

• Asset allocation: This refers to how you divide up your portfolio among different asset classes, such as stocks, bonds, and cash alternatives, to help you work toward your financial goals.
• Diversification: Closely related to the concept of Asset Allocation, this is the practice of spreading your money across different investments to reach your desired asset allocation. One should also diversify within asset classes.
• Dollar cost averaging: A strategy that involves purchasing a fixed amount of an investment at a predetermined interval, $500 per month, for example, regardless of the price.

Investment terminology

There are a variety of financial terms that describe gains, losses, and individual investments.

• Capital asset: Anything you own and use for personal or investment purposes. Examples include your home, your car, and stocks or bonds.
• Capital appreciation/depreciation: The amount by which the value of an asset increases or decreases compared to the amount you paid for it.
• Dividends: A distribution of a portion of a company’s earnings, decided by the board of directors, paid to a class of its shareholders.
• Index: A group of securities representing a particular market or industry or a portion of it. An index often serves as a benchmark for measuring investment performance– for example, the Dow Jones Industrial Average or the S&P 500 Index. An index is not managed and is not available for direct investment. However, investors are able to invest in mutual funds and exchange-traded funds that are intended to mimic the performance of the indexes. These types of vehicles enable investors to invest in securities representing broad market segments and/or the total market.
• Margin account: An account that allows you to borrow money using securities and cash held in the account as collateral.
• Prospectus: A document filed with the SEC that describes an offering of securities for sale to the public. The prospectus fully discloses the risks, policies, and fees of the offering.
• Realized capital gain/loss: Profit or loss from the sale of an asset.
• Yield: The income return on an investment. This refers to the interest or dividend received from a security based on the investment's value or purchase price. For example, an annual dividend of $1 paid on an investment worth $100 would imply an annual percentage yield of 1% ($1 divided by $100).

By taking the time to learn about the common types of investments and the language that accompanies them, you can become a smarter investor.