InvestingFinancial Dictionary -> Investing
If you want to succeed in anything you have to put a lot of effort and time into it and investing is no exception. This section of Financial Dictionary defines the most important terms every investor must know.
Many investors invest into different asset classes (asset allocation), with the expectation of appreciation of their assets. Others put their capital to work in expectation that they'll get a positive cash flow from their investment. All these investors have one common goal and that is to make money.
One of the mainstream ways to invest is to put your money in common shares also known as stocks. When an investor buys common shares in a company they become a shareholder in the company. Stocks are traded on stock exchanges like NYSE, Chicago Stock Exchange, Chicago Board of Trade, American Stock Exchange (AMEX), NYMEX, Australian Stock Exchange, Bombay Stock Exchange, Frankfurt Stock Exchange, Hong Kong Stock Exchange, Tokyo Stock Exchange, Shanghai Stock Exchange, London Stock Exchange, NASDAQ, and Toronto Stock Exchange – TSX. Investors worldwide follow several important stock market indices like Dow Jones, S&P 500, FTSE 100, DAX, CAC 40, Nikkei 225, Hang Seng, and Straits Times.
Types of Vehicles and Risk Level
There are many other investment vehicles used by investors including bonds (see junk bonds and convertible bonds), certificates of deposit (CD), options, warrants, futures, index funds, exchange traded funds, derivatives, treasury bills, financing instruments and various other securities. Some investment vehicles are safe but yield low returns while others are high-risk and are designed for seasoned investors. Examples of safe investments include money market and bank savings accounts, government issued savings bonds and other securities, certificates of deposit, and fixed annuities. A fixed annuity is a type of contract with an insurer. Investors are offered guaranteed returns in exchange for money. There are risky investment vehicles such as Forex trading, options and futures, microcap stocks, timeshares, and others. They offer higher returns. Microcap stocks are considered risky because they are sometimes traded as part of fraudulent schemes. They are also risky because microcap stocks are offered by businesses with limited assets. Penny stocks and foreign stocks offered on emerging and developing markets are also considered risky. Small cap, mid cap, and large cap stocks and foreign and corporate bonds are at the middle of the spectrum. While investments vary in returns and risk level, a balanced portfolio includes diverse investment vehicles, including hedge funds, private equity, REITs, commodities, precious metals, and MLPs. Experienced investors use a mix of risky and low-risk assets to build a diverse portfolio. The goal is to spread cash over various asset classes and investment vehicles and avoid exposure to excessive risk. Asset allocation is the key to success as to achieve a balance between earnings and capital growth. It is based on risk tolerance. Aggressive investors, on the other hand, devote less money to fixed-income securities and more money to equities. Conservative portfolios are made of cash and cash equivalents, fixed-income securities, and a small amount of equity (about 15 to 20 percent).
Some portfolios also contain foreign and domestic stocks from different sectors. Investors also use different strategies to build a successful portfolio, for example, bond picking and stock picking. Another option is to allocate money to index funds, mutual funds, or exchange-traded funds. Exchange-traded funds specialize in stocks, grouped together by country or region, capitalization, or sector. Index funds are passively managed and mirror some index while mutual funds are actively managed, and the fees are higher.
To maintain a balanced portfolio, it is a good idea to look at your assets to determine which positions are underweighted or overweighted. One option is to trade overweighted positions and buy underweighted securities to rebalance your portfolio. The downside is that you have to pay capital gains tax. A better strategy may be to experiment and invest in new asset classes and vehicles.
Advanced Investment Techniques
Some investors don't believe in fiat money and invest only in gold, silver, precious metals and commodities (oil for example). More risk inclined investors use leverage (see margin) when investing, and speculate in penny stocks. Others use the Dollar Cost Averaging investment strategy, ordering stocks gradually over time. Technical analysis is indispensible tool for some investors, while others dismiss it and concentrate on the big market trends. Some investors prefer FOREX markets (see currency), and others do day trading for a living. Most investors have long positions in company shares (expecting dividends and/or appreciation), but some use advanced investment techniques like short selling and arbitrage. At the end of the day what counts is the return on investment (ROI) they all made and have their investments increased their net worth. Some investors use tax-loss selling as a part of their investment strategy.
If an investor wants to be successful, they will have to do their due diligence, learn how to do a valuation of an investment, understand the difference between book value and face value, and learn to read company's balance sheets, earnings reports and income statements. There are many other key investment terms that must be understood by investors no matter what their level of experience is. These terms include, but are not limited to market capitalization, capitalization, capital gain, P/E ratio, net income, profit, current assets, fixed assets, liquid assets, dividend, earnings per share (EPS), buyback, preferred stock, quick ratio, revenue, bear market, bull market, goodwill, IPO, and opportunity cost.