Thursday, February 23, 2012
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An investment technique that diversifies a portfolio among different types of assets such as stocks, bonds, cash equivalents, precious metals, real estate and collectibles. When it comes to risk and reward, different asset classes behave quite differently. Stocks, for instance, offer the highest return, but they also carry the highest risk of losses. Bonds aren't so lucrative, but they offer a lot more stability than stocks. Money-market returns are puny, but it's highly unlikely you'll lose your initial investment. An asset allocation strategy allows you to achieve the optimal blend of risk and reward.
A mutual fund that invests in a mixture of stocks, bonds and cash. A balanced fund attempts to blend asset classes to produce a conservative growth and income portfolio. It is also known as a „hybrid“ or asset allocation fund.
A debt instrument that pays a set amount of interest on a regular basis. The amount of debt is known as the principal, and the compensation given to lenders for making such funds available is typically in the form of interest payments. There are three major types of bonds: corporate, government and municipal. A corporate bond with a low credit rating is called a high-yield or junk bond.
A debt instrument that pays a set amount of interest on a regular basis. The amount of debt is known as the principal, and the compensation given to lenders for making such funds available is typically in the form of interest payments. There are three major types of bonds: corporate, government and municipal. A corporate bond with a low credit rating is called a high-yield or junk bond.
A type of mutual fund that issues a set number of shares and typically trades on a stock exchange. Unlike more traditional open-end funds, transactions in shares of closed-end funds are based on their market price as determined by the forces of supply and demand in the marketplace. Interestingly, the market price of a closed-end may be above (at a premium) or below (at a discount) the value of its underlying portfolio (or NAV). Investors in closed-ends will often try to capitalize on large discounts, hoping that eventually they will narrow.
A measure of financial leverage, the debt-to-equity ratio is calculated by dividing long-term debt by shareholders' equity. (Shareholders' equity is the same as book value.) The higher the ratio, the greater the chance a company won't be able to pay its debts in the future.
A derivative is a security whose value is „derived“ from the performance or movement of another financial security, index or other investment. For example, derivatives may be futures, options or mortgage-backed securities. Derivatives may be used to short sell a security or to hedge against downside risk.
When you diversify, you spread your money among a slew of different securities, thereby avoiding the risk that your portfolio will be badly bloodied because a single security or a particular market sector turns sour. If you've got the time and energy, you can create your own diversified portfolio. But it'll mean keeping track of at least 20 different stocks or bonds at once closed-end funds a daunting task, to say the least. A much easier solution is to buy a range of mutual funds and leave the diversification worries up to professional management.
A company's annual dividend expressed as a percentage of its current stock price. As a stock's price declines, its dividend yield goes up. So a stock selling for $20 a share with an annual dividend of $1 a share yields an investor 5%. But if the same stock falls to $10 a share, its $1 annual dividend yields 10%. Value investors often see high dividend yields as a sign that a stock is cheaply priced. A high yield also acts as a cushion in a declining market, which is attractive to risk averse investors. The downside is that dividends are taxed as ordinary income. The greater the yield, the more taxes you will have to pay.
A portion of a company's net income paid to stockholders as a return on their investment. A stock's dividend yield is determined by dividing a company's annual dividend by its current share price. So a stock selling for $20 a share with an annual dividend of $1 a share yields the investor 5%. Dividends are declared or suspended at the discretion of the company's board of directors. A prime benefit of dividends is that once paid, they are money in the bank and provide your only return when stocks are weak. One disadvantage is that dividends are taxed as ordinary income, which, if you're in a high tax bracket, can ramp up your tax bill.
Fund companies are business entities that manage, sell and market mutual funds to the public. They typically offer a wide variety of funds, investing in both the equity and fixed-income markets. Companies also perform administrative tasks, such as fund accounting and customer service, although these responsibilities are sometimes contracted out. Some of the larger fund companies are Fidelity, Vanguard, Franklin-Templeton and T. Rowe Price. In many cases, investors may move their assets from one fund to another within a fund company at little or no cost. Also called fund family.
An agreement to buy or sell a set amount of a commodity or security in a designated future month at a price agreed upon today by the buyer and seller. A futures contract differs from an option because an option is the right to buy or sell, whereas a futures contract is the promise to actually make a transaction. A future is part of a class of securities called derivatives, so named because such securities derive their value from the worth of an underlying investment.
A private investment partnership, owned by wealthy individuals and institutions, which is allowed to use aggressive strategies that are unavailable to mutual funds, including short selling, leverage, program trading, swaps, arbitrage and derivatives. Since they are restricted by law to less than 100 investors, the minimum hedge-fund investment is typically $1 million.
A strategy designed to reduce investment risk using call options, put options, short selling or futures contracts. A hedge can help lock in existing profits. Examples include a position in a futures market to offset the position held in a cash market, holding a security and selling that security short and a call option against a shorted stock. A perfect hedge eliminates the possibility for a future gain or loss. An imperfect hedge insures against a portion of the loss.
The rate at which the general level of prices for goods and services is rising. Inflation has an uncanny ability to erode the value of securities that don't grow fast enough. That's why investing only in a money market fund can be more risky than it appears on the surface. If inflation is rising at 3% a year and your money market is growing at 5% or 6%, you won't have much money left over for your retirement. Measures of inflation include the consumer price index (CPI) and the producer price index (PPI).
The first time a company issues stock to the public. This process often is called „going public.“ Securities offered in an IPO are often, but not always, those of young, small companies seeking outside equity capital and a public market for their stock. Investors purchasing stock in IPOs generally must be prepared to accept very large risks for the possibility of large gains.
The rate of interest charged for the use of money, usually expressed as an annual rate. The rate is derived by dividing the amount of interest by the amount of principal borrowed. For example, if a bank charged $50 a year to borrow $1,000, the interest rate would be 5%. Interest rates are quoted on bills, notes, bonds, credit cards and many kinds of consumer and business loans. Rates in general tend to rise with inflation and in response to the Federal Reserve raising key short-term rates. A rise in interest rates has a negative effect on the stock market because investors can get more competitive returns from buying newly issued bonds instead of stocks. It also hurts the secondary market for bonds because rates look less attractive compared to newer issues.
The investment horizon represents the client’s preferred investment period. The period is calculated by the client prior to purchasing the investment and represents the period during which he/she will have his/her money bound to the investment. It does not mean, however, that the client cannot, in case of need, withdraw his/her current investment value.
It is important to know one’s investment horizon prior to purchasing the actual investment. It is necessary to set this horizon in a really efficient way, as too much caution may lead to an unnecessarily conservative yield, and, on the other hand, too great expectations for a short period may result in losses.
An investment portfolio is a set of investments in which the client, or the mutual fund, invests.. The fund manager, or possibly the investor, tries to compile its investments from various investment instruments so as to decrease the risk and to prevent being dependent on the development of a single investment instrument, and so as to achieve a more stable yield at the lowest possible investment risk.
The investment risk can be decreased in several ways:
by a suitable investment instrument – combination of funds
by a sufficient investment horizon – investment period
by combination of several asset managers, or by a suitable combination of investment strategies
by combination of investment in several currencies – currency diversification
The degree to which an investor or business is utilizing borrowed money. For companies, leverage is measured by the debt-to-equity ratio, which is calculated by dividing long-term debt by shareholders equity. The more long-term debt there is, the greater the financial leverage and the greater the risk of the company falling on its face. For investors, leverage means buying on margin or using derivatives such as options, to enhance return on value without increasing investment. Leveraged investing can be extremely risky because you can lose not only your money but the money you borrowed as well.
A sales charge for buying or selling a mutual fund. For initial, or front-end, loads, this figure is expressed as a percentage of the initial investment and is incurred upon purchase of fund shares. For back-end loads, the amount charged is based on the lesser of the initial or final value of the shares sold.
To buy on margin means to borrow money from a broker to buy securities. The margin is the amount you must deposit with the broker in order to borrow. The minimum is 50% of the purchase, or short sale price, in cash. So if you want to buy $10,000 in stock on margin, you have to put up at least $5,000 to make the purchase. Buying on margin poses the threat of not only losing your own money but the money you borrowed as well.
A type of mutual fund that invests in stable, short-term securities. Money-market funds are easily convertible into cash and usually maintain an unchanged value of $1 a share, but aren't insured by the federal government. There are various types of money-market funds based on the type of securities they buy, but the most important distinction is whether your dividends are taxable or tax-free.
Debt issues backed by a pool of mortgage loans. Investors receive payments from the interest and principal payments made on the underlying mortgages. These bonds are extremely interest-rate sensitive because homeowners have a tendency to prepay and refinance their mortgages when interest rates decline.
An investment company that pools the money of many individual investors to purchase stocks, bonds or other financial instruments. Professional management and diversification are the two primary benefits of mutual fund investing. A management fee is charged for these services, typically 1% or 2% a year (or more!). Funds also levy other fees and charge a sales commission (or load/initial charge) if purchased from a financial adviser. Funds are either open-end or closed-end. An open-end fund will issue new shares when investors put in money and redeem shares when investors withdraw money. The price of a share is determined by dividing the total net assets of the fund by the number of shares outstanding. Closed-end funds issue a fixed number of shares in an initial public offering, trading thereafter in the open market. Open-end funds are the most common type of mutual fund.
Net asset value, also known as price per share. The value of a fund's assets divided by the number of its outstanding shares. The NAV is calculated daily at the close of the markets. Open-end funds always trade at NAV, but closed-end funds often trade at a premium or discount to their asset values.
A type of fund that issues as many shares as investors demand. This contrasts with a closed-end fund, which has a fixed number of shares that trade over-the-counter or on a stock exchange. The share price of an open-end fund is determined by dividing the total net assets of the fund by the number of shares outstanding. This figure is called the fund's net asset value (NAV). The net asset value of an open-end fund is calculated at the end of each trading day. Most mutual funds are open-end funds.
An agreement that gives an investor the right, but not the obligation, to buy or sell a stock, bond or commodity at a specified price within a specific time period. A call option is an option to buy the security; a put option is an option to sell. If the option is not exercised before the expiration date, all monies paid for the option are forfeited. Options are traded on several exchanges, including the Chicago Board of Options Exchange, the American Stock Exchange, the Philadelphia Stock Exchange, the Pacific Stock Exchange and the New York Stock Exchange.
A collection of securities held by an investor. Portfolios tend to consist of a variety of securities in order to minimize investment risk.
A ratio to evaluate a stock's worth. It is calculated by dividing the stock's price by an earnings-per-share figure. If calculated with the past year's earnings, it is called the trailing P/E. If calculated with an analyst's forecast for next year's earnings, it is called a forward P/E. The biggest weakness with either type of P/E is that companies sometimes „manage“ their earnings with accounting wizardry to make them look better than they really are. That s why some analysts prefer to focus on the price-to-cash flow measure instead.
An agreement that gives an investor the right, but not the obligation, to sell a stock, bond, commodity or other instrument at a specified price within a specific time period.
Generally, a stock or a bond. Specifically, a piece of paper that indicates the holder owns a share or shares of a company (stock) or has loaned money to a company or government organization (bond).
A share represents the ownership interest in a particular company, or business. It is connected with the shareholder’s rights to participate as a partner in the management of the joint-stock company, its profit and its wind-up balance upon dissolution of the company. The shareholder is entitled to participation in profit of the company (dividend) as determined by the general meeting according to the economic result achieved. It does not guarantee any income to its holder, and in case of bankruptcy of the particular company, the holder can loose his/her whole investment. From the long-term perspective, however, the average historical performance of shares is higher than that of bonds or financial market instruments.
A trading strategy that anticipates a drop in a share's price. Stock or another financial instrument is borrowed from a broker and then sold, creating a short position. That position is reversed, or covered, when the stock is repurchased to repay the loan. If the stock price falls, the short seller will profit by replacing the borrowed shares at a lower cost.
An investment that represents part ownership of a companies assets and earnings. There are two different types of stock: common and preferred. Common stocks provide voting rights but no guarantee of dividend payments. Preferred stocks provide no voting rights but have a set, guaranteed dividend payment. Preferred stock also enjoys prior claim to company assets over common stock in the case of a bankruptcy. In contrast with bonds.
The characteristic of a security or market to fall or rise sharply in price in a short-term period. A measure of the relative volatility of a security or mutual fund to the overall market is beta. A stock may be volatile because the outlook for the company is particularly uncertain, because there are only a few shares outstanding (i.e., it's illiquid) or because of various other reasons while beta can apply to both stocks and funds, standard deviation is more widely used to measure the volatility of mutual funds. Standard deviation examines a fund's range of historical returns, thus determining a portfolio's potential to swing between high and low returns.
