Basic Investment Terms & Definitions for Beginners

Investing terms for beginners is a post to help you understand basic investment concepts and start your journey toward financial security and wealth growth.

Understanding basic investment terms is the first step forward on your journey toward financial security. Investing can be as complex or as simple as you want. There are thousands of people out there whose day job is all about investing others’ money, but it’s also something anyone with money can participate in.

Start investing as soon as you can, especially in retirement accounts. Contributing early and regularly helps grow your wealth over time. When you receive unexpected money and have no debt, investing the windfall (in retirement funds or an investment account) is smart.

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Basic Investment Terms

You don’t have to be a sophisticated, highly educated investor to contribute to a retirement account or buy stocks. There are super complex ways to manage your investments, and there are also very simple ways to invest.

In Investing Terms 101, we’re focusing on the most simple investing terms to increase your financial smarts. This article will help you start investing or understand your existing investments, but you can quickly move beyond these terms with a little research.

Download the free Investing Terms 101 Fact Sheet

Retirement Account Types

Retirement accounts are just a single group of investment accounts. You can invest money without saving for retirement or using a tax-advantaged retirement account. However, a special tax-advantaged account is your best option if your goal is to save for life after work. You can read more about starting to save for retirement and the annual limits for each type of account in Financial Security Step 2b: Begin Saving for Retirement.

Before we get to all of the different kinds of retirement accounts and the salient features of each, let’s learn one fancy term: vesting.

What is Vesting?

Vesting is one of the most important basic investment terms to grasp for those contributing to employer-sponsored plans. You become vested in your employer-sponsored retirement account when you’ve reached a predetermined length of employment and contribution to the plan. At that time, you have full access to all the funds in the account.

Once you’ve worked and contributed to a retirement account until a specific date, you become vested. If you leave your job before you’re vested, you can only take the amount you contributed yourself. Leaving after vesting positively impacts your investment strategy because you can take both your and your employer’s contributions.

401(k)

Employers offer 401(k) plans as a way for you to set aside money on your own and have it taken straight from your paycheck before taxes are deducted. Some employers match a portion of your contributions, which is literally free money for you. One great thing about a 401(K) is that It lets you contribute pre-tax money from your paycheck, which reduces your current taxes. The funds keep growing in the account until you retire; if you choose to get your money out, then you’ll pay taxes on all withdrawals.

Roth 401(k)

Roth 401(k)s are just like regular 401(k) plans except that you pay taxes on the money before it goes into your account. This way, when you retire and start to withdraw funds from the account, that money (including any earnings) will be tax-free. Who is a Roth 401(K) for? It suits people who expect a higher tax rate post-retirement best.

IRA

An Individual Retirement Account (IRA) is a type of retirement account that you can set up on your own, without an employer. IRAs have similar advantages to 401(k)s, and they’re a great option if you don’t have access to an employer-sponsored plan. Contributions are not taxed, but withdrawals in retirement are.

Roth IRA

Roth IRAs are retirement accounts you control, not your employer. You pay taxes upfront, but all your withdrawals in retirement are tax-free.

403(b)

A 403(b) is a retirement savings plan for employees of public schools, some non-profits, and certain ministers. Like a 401(k), you contribute pre-tax money to grow for retirement with tax advantages. There may also be a Roth option for after-tax contributions with tax-free withdrawals in retirement.

SIMPLE IRA

Designed for small businesses with 100 or fewer employees, SIMPLE IRAs offer a user-friendly way to save for retirement. Employees contribute pre-tax dollars, while employers must match a portion of those contributions, typically up to 3% of salary or a flat 2%. This employer match is a great benefit, but there’s a downside, too. The disadvantage is that SIMPLE IRAs have lower contribution limits for employees compared to traditional IRAs and 401(k) plans.

SEP IRA

SEP IRAs allow employers to contribute directly to their employees’ retirement savings. The employer has significant control, making contributions on behalf of employees. No employee contributions are allowed. Also, the employer is permitted to adjust the contribution amount year-to-year based on business needs. However, there’s a limit of up to 25% of the salary, but not a penny more than $69,000 (as of 2024)). An employer doesn’t need to match since there’s no employee contribution to match.

Stocks

Stocks are like tiny ownership certificates in a particular company. When you buy a stock (or share in other places), you’re basically buying a piece of that business. That company’s success (or struggles) can affect the stock price, so, the value of your stock can go up or down over time. This makes stocks an investment – they can potentially grow your wealth, but there’s always a chance of losing money. Stocks are traded on markets like the NYSE or online platforms. Some companies even share their profits with stockholders through regular payments called dividends. Overall, stocks offer the potential for high returns, but remember, they also come with risk.

Common Stock

Common stocks are shares of ownership in a company. Once you buy the stock, you own part of the business and get to benefit from any profits it earns. Typically, when a business issues financial statements showing profitability, the value of the stock tends to increase.

Common stock in publicly traded companies allows you to vote on certain corporate matters. Still, voting rights typically only hold significant sway if you own many shares. The key takeaway? Don’t get glued to the stock market during downturns (bear markets). These fluctuations are normal, and prices often rebound in bull markets. However, common stock carries inherent risk, so understand your tolerance before investing your hard-earned money.

Preferred Stock

Preferred stocks are also shares of ownership, but they give you certain privileges. While they don’t allow for voting, they divest larger dividends that may be guaranteed. Dividends for common stockholders, on the other hand, are not guaranteed. A dividend is a portion of a company’s profits paid to shareholders as a reward for investing in the company. The company you invest in determines the amount and frequency of payments.

Voting Rights

Voting rights empower owners or members to influence decision-making, or ta least have a say at the table. Shareholders in corporations vote on matters like leadership and mergers, with voting power often tied to share ownership. Similarly, members of cooperatives or associations cast votes on policies and budgets, shaping the organization’s direction. These voting structures, along with considerations like thresholds and proxies, ensure a voice for those invested in the business’s success.

IPO

IPO stands for Initial Public Offering, the process by which a private company first sells its shares to the public. Many companies start small, often the brainchild of an individual with big dreams. As they grow, they may choose to go public through an IPO, allowing outsiders like individual investors, portfolio managers, and institutions to own a piece of the company. By listing shares on a stock exchange, the company raises capital and increases its public profile. IPOs have indeed minted billionaires in America and worldwide. After an IPO, the company becomes a public entity, though some ambitious entrepreneurs have been known to buy back the entire company later, regaining full control and steering its future course.

Market

A market is a meeting place for investors, whether it’s a bustling physical exchange like the New York Stock Exchange (NYSE) or a convenient online platform like Charles Schwab. Here, investors buying and selling stocks, bonds, and other investments determine their prices through supply and demand. This is where your trades happen too> When you buy or sell shares in your mutual fund, those transactions occur within a market. Think of it as the central hub where everything related to buying and selling investments comes together.

Trading

Trading is buying and selling investments like stocks or bonds within a market, hoping to profit from short-term price movements. Unlike long-term investors, traders aim to capitalize on these quick swings. Think swapping investments: buy low, sell high. Day traders do this frequently, while others hold positions for a bit longer. Trading is risky and requires market knowledge, so stick to investing as a beginner.

Trading Day

Market Capitalization

Financial experts rely on market capitalization (aka market cap) to gauge a company’s size. It’s calculated by multiplying the number of outstanding shares by the current stock price. This market cap fluctuates as the share price changes. You can often find the number of outstanding shares in a company’s annual report. Multiplying shares by share price gives you the company’s market capitalization.

New York Stock Exchange

The New York Stock Exchange (NYSE) is the crown jewel of American finance. Imagine a colossal marketplace, not for antiques or produce, but for slivers of ownership in the world’s leading companies. Here, corporations list their shares, and investors, both individual and institutional, engage in a continuous auction to buy and sell them. Founded in 1792, the NYSE boasts the title of the world’s largest stock exchange by market capitalization. Though trading is now primarily electronic, the NYSE remains a powerful symbol of financial power and a cornerstone of the global market.

Dow Jones Industrial Average

The Dow Jones (DJIA) isn’t a stock exchange where you buy and sell all kinds of stocks. Think of it as a report card for 30 big US companies. The DJIA tracks the prices of these stocks and gives investors a general idea of how a chunk of the US market is doing. A rising Dow means these companies are doing well, which is usually a good sign for the market. A falling Dow? Maybe those companies are struggling, which could reflect a slowdown in the economy. The Dow isn’t the only market indicator, but it’s popular because it tracks influential companies. So, as a beginner, the Dow can give you a quick snapshot of a key part of the US market.

Investment Portfolio

Your investment portfolio is simply the total value of the assets you own or manage. If you own a bunch of stocks across industries, some junk bonds, municipal bonds, REITs, ETFs, and other financial assets, that is your investment portfolio. Some people prefer being their portfolio manager because paying fees to money managers doesn’t sound good. Your job as an investor is to ensure that you get decent returns from your assets without losing them partially or wholly. If you’re new to investing, it’s a good idea to have a portfolio that’s not too aggressive. You just don’t want to blow your funds before you even start, so diversify your investing.

Bear Market

A bear market is like a grumpy bear, bringing down investment prices (usually by 20% or more). Imagine the whole market feeling down—that’s a downtrend. Don’t panic, though, bear markets are normal and are (historically) eventually followed by sunny bull markets (upward trends). While scary, some investors see them as a chance to buy on sale! Bear markets freak some people out, leading to a share-selling spree, often at prices that are way lower than their true worth. Try not to be that person.

Bull Market

Bull markets are like a charging bull—happy times for investors! Prices (stocks, bonds) surge (over 20%! ), everyone’s optimistic, and buying pushes prices even higher. This upswing can last for months or years, but remember, bull markets eventually turn into bear markets (downturns). Enjoy the ride, but stay grounded and avoid overspending!

Dollar Cost Averaging

Dollar-cost averaging (DCA) is an investment strategy designed to reduce the impact of market volatility on your overall investment cost. Imagine you’re buying groceries every week, and sometimes lettuce is expensive, sometimes it’s cheap. DCA is like buying the same amount of lettuce each week, regardless of the price.

Asset Allocation

In investing, asset allocation refers to how you divide up your investment funds among stocks, bonds, and cash. Stocks offer potentially high growth but can be volatile, while bonds provide steady income but lower returns. Cash sits safely but earns little. As a committed investor, it’s critical to learn how to choose the right mix assets for your risk tolerance and goals (growth for young investors, income for retirees). Aim to balance risk and reward.

Investment Portfolio

Diversified Portfolio

A diversified portfolio is an investing strategy where you spread your money around in different types of investments, including stocks, bonds, ETFs, real estate, and more. The idea is that even if one type of investment performs poorly, another goes up. This helps you avoid putting all your eggs in one basket and potentially losing everything. So, diversifying your portfolio is like having a safety net for your investments. It helps you ride out the ups and downs of the market and feel more secure about your financial future.

Passive Income

Passive income is like magic money—you earn it with minimal effort, even while you sleep! It’s different from your paycheck (active income). Think renting out an apartment (passive) vs. working a job (active). Royalties from a book, dividends, online courses you sell, recurrent affiliate commissions, or even interest from your savings account are all great examples of passive income! It takes less work than a job, but often some upfront effort to set up. There’s nothing wrong with active income, but what’s better than the ability to afford your living expenses and even a little luxury without going into debt or working a job you hate? Nothing!

Different Asset Classes

The U.S. financial landscape offers a variety of asset classes for investors. Equities (stocks) provide ownership in companies, while fixed income (bonds) offers stability and reliable income. Cash equivalents ensure liquidity, while real estate provides rental income and potential appreciation. Commodities can hedge against inflation, and alternative investments offer diversification with higher risk profiles. You can’t build a well-rounded investment portfolio if you don’t understand the different asset classes there are.

Fixed Income Securities

Fixed income securities are essentially IOUs (I Owe You) issued by governments, corporations, or other entities. They work by you lending money to the issuer in exchange for a guaranteed interest payment (coupon) at regular intervals and the return of your original investment (principal) at a set maturity date. Corporate bonds, corporate bonds, savings bonds, and certificates of deposit (CDs) are examples of assets that provide fixed incomes to investors

Savings bonds: They’re a type of government bond often used for saving towards long-term goals. They may offer lower interest rates, but they also come with government backing.

Government bonds: Government bonds are considered very safe investments because they are backed by the full faith and credit of the issuing government. Examples include U.S. Treasury bonds and municipal bonds.

Corporate bonds: are issued by companies to raise capital. They generally offer higher interest rates than government bonds but carry more risk because a company could default on its debt (e.g., bonds issued by Apple, Ford)

Certificates of Deposit (CDs): Issued by banks, offering a fixed interest rate in exchange for your money being locked up for a specific period (e.g., 1-year CD, 5-year CD).

By the way, what are bonds? Bonds are debt securities (a kind of investment) that represent loans, usually to a government or company. You’ll get paid back the amount you originally invested plus an agreed-upon rate of interest and maturity date.

The interest rates for bonds are usually pretty low because they’re a safer investment. Government-issued bonds are almost always paid back. Less risk, less reward. As a new investor, bonds are worth considering as a low-risk investment vehicle. Corporate bonds issued by private companies typically pay a higher interest rate than government bonds, but that’s because corporate bonds are a riskier investment. The interest payments a company or government makes to holders of its bonds are known as interest coupons.

looking at her stocks that she invested investing terms for beginners

Real Estate

The basic idea behind investing in real estate is that you buy a property and sell it sooner or later at a higher price than what you paid. The profits you earn after selling houses or stocks are capital gains. While you can include your home in your net worth calculations, it’s best not to view your place of residence as an investment. Your home is where you live, and you might not make money when you sell it, but you’ll benefit from having a residence.

Real estate investments are properties that you purchase and then rent or lease out for money. Investing in real estate can be risky if the purchase is made with a mortgage. In that case, you have to ensure the rent charged is sufficient to cover the mortgage, taxes, insurance, and maintenance.

When real estate is purchased with cash, there is more room for error; the rent received doesn’t have to cover the mortgage each month.

Ways to Buy Investments

You can work with a financial advisor or buy from financial institutions, but you can buy individual stocks by yourself. There are many different ways to spread the risk across a grouping of stocks, but you can’t eliminate investment risk.

talking about ways on how to invest for beginners

Exchange-Traded Funds

Exchange-traded funds are baskets of stocks that trade like individual securities. Broadly speaking, ETFs offer exposure to a group or index of assets rather than just one company or sector. This is diversification, a smart way of minimizing the odds of making losses on your investments. Below are ways you can put your money to work and make it grow over time.

Index Funds

Index funds are a type of mutual fund that aims to match the performance of an index, like the S&P 500. This means you’re investing in stocks like Exxon Mobile and Apple without having to pick them out yourself–you just invest your money with one company that’s doing all the work for you.

This spreads the risk out over many stocks but also dilutes potential rewards. Investing in an index fund means that you can own a tiny bit of many different companies. When one company’s stock value increases, the index fund value will also increase, but by a smaller amount.

Likewise, when the value of an individual stock drops, the index fund value will decrease by a smaller amount. An index fund is a way to reduce the risk of market fluctuations, but it also reduces the payoff of crazy upswings.

If you want to invest money outside of a retirement account, an index fund is the way to go for beginners.

Mutual Funds

Mutual funds pool your money with others to buy a variety of investments, like stocks or bonds. This diversification spreads your risk. Actively managed funds have professional money managers and investors pick investments for you, but they charge higher fees, while index funds track a market index, and you’ll potentially pay lower fees. They’re good for beginners who want diversification without picking individual stocks or bonds.

Trust Funds

Trust funds are a legal entity that holds assets that will eventually be given to a beneficiary. They’re usually set up as a way to transfer wealth to the following generations. It’s how some wealthy individuals transfer property and financial assets to their children or grandchildren.

Trust funds are flexible legal tools, customized to the wishes of the creator (grantor) and the beneficiaries who will receive the assets. These assets can be actively invested in the stock market for growth or simply held until distribution. While you wouldn’t directly invest in a trust fund itself, it acts as a framework for managing and eventually transferring your assets to others.

Hedge Funds

Hedge funds are exclusive investment clubs for the wealthy. Unlike mutual funds, they target rich investors and institutions with high minimum investments. These funds chase aggressive returns using complex strategies (short selling, leverage) that regular investors can’t access. Think fast lane investing: high potential rewards, but a higher risk of crashing. Think twice before jumping in; hedge funds are for professionals, not beginner investors.

Real Estate Investment Trusts

A real estate investment trust (REIT) is a type of security similar to an ETF, except you’re investing in a bunch of properties instead of stocks.

They’re a way to invest in real estate without buying individual properties. Instead, you purchase a portion of many properties, which spreads out both the risks and rewards.

Even more basic investment terms…

This is just the tip of the iceberg when it comes to investing! But it’s a great starting point. Don’t worry if you’re new or can’t invest a lot – start small and learn as you go. Focus on educating yourself in areas that interest you. Remember, investing is a marathon, not a sprint. With patience and smart decisions, it can pave the way for financial security and even passive income.