Investing terms, defined
“It is either something to buy, or a place to hold the thing you bought. ”
I often talk to people who know they have investments, but don’t know what the investments are. They have statements of account, but have no idea how to decipher the words and symbols on the page.
Jargon and TLAs (three-letter acronyms) are common in most industries, and the investment industry is no different.
Cutting through the jargon can be simple. Just remember this: Everything is either A) something to buy, or B) a place to hold the thing you bought.
Things you buy:
You learn in Accounting 101 that every asset is backed by an equity or a liability. Equity refers to money that is owned and debt refers to money that is owed.
Equity - The most common form of equity is company stock. Each share of company stock represents fractional ownership in the company who issued it.
Debt - If you’ve ever purchased a Certificate of Deposit (CD) from a bank, you have purchased debt. The bank is borrowing your money, and in return they pay you a rate of interest; the bank is in debt to you. Debt can also be issued by the federal government (Treasury Bills, Notes, and Bonds), your state or local government (Municipal bonds), private corporations (Corporate bonds), and many other financial institutions.
Most, if not all, investments in your various accounts are known as securities, which is a catch-all term referring to “an investment…with profits to come solely from the efforts of others”. Securities, notably, does not describe such investments as gold, real estate, and commodities.
All publicly traded stocks and funds will have a ticker symbol, which is a unique identifier of 1-5 letters, often prefixed with a $ sign. Ticker symbols are often random (particularly with mutual funds and ETFs) but often have clever meanings. For example, Harley Davidson uses the ticker symbol $HOG and Papa John’s uses $PZZA.
Because they are less permanent, bonds don’t have a ticker symbol. Instead, they use a CUSIP which is longer and contains numbers and thus is less memorable.
Stock – Many (but not all) stocks pay you a dividend. Even if the stock does not pay a dividend, investors may still buy the stock in anticipation of a future dividend. (Notably, Amazon has never paid a dividend.)
Bond – Most bonds have a maturity date and will pay interest on a fixed schedule, usually twice per year. On the maturity date, the amount that was initially borrowed will be repaid to the lender (the investor). I’ve seen very few people that actually hold single bonds in their account. Most people use mutual funds or ETFs that hold a number of bonds (see below).
The following investments are simply combinations of stocks and/or bonds, and while there exists no exhaustive list of investments, I believe this list includes most everything the average investor has heard or read about.
Mutual fund – Imagine someone went around your town and gathered investible money from everyone who had it. This person then took all this money to the stock exchange and purchased a wide variety of stocks and bonds, much more than any one person could buy on his or her own. She collects the interest and dividends from these investments, and after withholding a small fee for administering the fund, she passes along the income, proportionately, to the shareholders.
This essentially describes a mutual fund, which pools money from thousands of investors and allows investors to diversify their portfolio with just one purchase. Dividends and interest paid from the investments are passed along to the mutual fund shareholders.
ETF – Exchange-traded fund. Conceptually similar to a mutual fund with some technical differences. In practice, though, they are both investment vehicles that allow you to hold many different stocks or bond with just one purchase.
REIT – A real estate investment trust is an entity that invests in real estate and has characteristics of both stocks and bonds. They regularly distribute interest payments (which come from lease payments on the real estate) and they also can increase and decrease in value based on the value of the underlying real estate holdings.
Places to hold the things you bought:
Brokerage account – A term so vanilla you’ve probably never seen it. Basically, this is an account that allows you to buy and hold securities. Think of this as a checking or savings account, where you can add and withdraw money freely, and you must pay taxes on any income received in the account.
TOD, POD – Transfer on Death or Payable on Death. These are contracts on brokerage accounts that designate the beneficiary who will receive your assets when you die. Notably, these designations supersede declarations made in a will.
Custodial – A designation used when an adult maintains custody of an account for a minor, who is unable to own the account outright. These are usually titled “[Adult] Custodial account FBO (for benefit of) [Minor]”.
IRA, 401(k), 403(b), 457 – Accounts that are designed to facilitate retirement saving. Money placed in these accounts will reduce taxable income (subject to limitations), but withdrawals will be taxed, which usually happens after age 59 ½. You may sometimes see the word “Traditional” in front of these accounts, which signifies the tax treatment and to prevent confusion with “Roth”, described below.
SIMPLE IRA, SEP IRA – A type of IRA opened by small businesses to make contributions on behalf of their employees.
Roth (used to modify any of the above) – Roth is tax arrangement where money deposited into the account does not give you a tax deduction in the current year, but the money (and investment growth) can be withdrawn tax-free later in life (typically after age 59 ½).
HSA – Health Savings Account – If you are covered by a High-Deductible Health Plan, you can use this account to save for medical expenses. Contributions are deducted from taxable income, and can be withdrawn tax-free for qualified expenses. HSAs are one of the most effective ways to reduce taxes and offer benefits beyond saving for healthcare.
FSA – Flexible spending account – Functions similar to an HSA, with the added “use it or lose it” restriction. There is also a FSA for qualified child care.
529 – A qualified tuition plan, which gets its nickname from the section of tax code in which it was defined. This account is good for those who want to save for the cost of higher education. Funds in this account grow tax-free and can be withdrawn tax-free for qualified expenses. Nebraska residents can deduct contributions from state income tax, subject to limitations.
About the Author
Joseph Fowler, CFP® is a financial planner and co-owner of 402 Financial in Lincoln, NE.
402 Financial provides financial planning and investment management services to people approaching or in retirement. Joe always acts as a fiduciary and never takes commissions on product sales.
Click this link to schedule a free consultation with Joe.
