Fund pages, brokerage order screens, and 401(k) menus all assume you already know the vocabulary. Learn about 20 core investing terms, from expense ratio to limit order, before you open an account or pick funds, so you know what you’re buying and what it will cost you.
Two funds can hold the same 500 stocks and still charge you different fees. On a $10,000 balance, a fund with a 0.05% expense ratio costs $5 a year, while one at 0.75% costs $75.
Neither fund will ever send you a bill. The fee comes out of the fund’s own assets, so the only sign of it is a balance that grows a little more slowly.
Many of the terms below name a choice that costs or saves you money, like picking between those two funds. The order type you choose sets the price you pay, and how long you hold an investment before selling can change the tax rate on your gain.
What you’re buying
- A stock is a share of ownership in a company, so its gains and losses are yours, and if it goes bankrupt, stockholders are paid last and may get nothing.
- A bond is a loan you make to a government or company in return for interest and your money back on a set date, and bonds usually swing less in price than stocks but earn less.
- A mutual fund pools many investors’ money to buy a basket of stocks, bonds, or other investments, and every order placed during the day fills at the same price, set when the day’s trading ends.
- An exchange-traded fund, or ETF, holds a basket of investments like a mutual fund but trades on a stock exchange all day like a stock, so you buy it at whatever price it’s trading for when your order fills.
- An index fund, whether a mutual fund or an ETF, copies a market index, such as the S&P 500, instead of paying managers to pick investments, so it usually charges less and earns about the index’s return.
Fees, payouts & taxes
- The expense ratio is a fund’s yearly fee as a percentage of your balance, and since it’s charged every year on everything you hold, a small difference in the rate costs more as your balance grows.
- A dividend is part of a company’s profits paid out to its stockholders, and funds pass along nearly all the dividends they collect, which you can choose to reinvest in more shares automatically.
- A capital gain is your profit when you sell an investment for more than you paid, and outside a 401(k) or IRA, holding it more than a year first can lower the tax rate on that gain.
- Your cost basis is what you paid for an investment, commissions and reinvested dividends included, and it’s what you subtract from the sale price to find your taxable gain, so a basis recorded too low means extra tax.
Building a portfolio
- Asset allocation is how you split your portfolio, everything you have invested, among stocks, bonds, and cash, and the right split depends on when you’ll need the money and how big a drop you can handle.
- Diversification means spreading your money across many investments, so if one company fails or one industry slumps, it costs you only a small piece of your balance.
- Rebalancing means bringing your split back to its target, by selling some of what has grown or putting new money into what has lagged, so years of rising stock prices can’t leave you with more risk than you chose.
- Dollar-cost averaging means investing the same amount on a regular schedule, the way 401(k) contributions come out of each paycheck, so you automatically buy more shares when prices are low and fewer when they’re high.
Placing an order
- The bid is the most any buyer is offering right now and the ask is the least any seller will take, and the gap between them, called the spread, is a hidden cost you pay when you trade.
- A market order, the type your broker enters unless you specify otherwise, buys or sells at the current market price, so it almost always goes through, but the price you get may differ from the last one you saw.
- A limit order sets the most you’ll pay or the least you’ll accept, so you never get a worse price, but the trade may never happen if the price doesn’t reach your limit.
Reading the market
- A company’s market capitalization, or market cap, equals its share price times its number of shares, and an S&P 500 index fund puts the most money into the companies with the biggest market caps.
- The price-to-earnings ratio, or P/E, is a stock’s price divided by its profit per share over the past year, so a P/E of 25 means you’re paying $25 for every $1 of the company’s yearly profit.
- Volatility is how sharply an investment’s price swings up and down, and it matters most for money you’ll need soon, since a big drop could hit right before you have to sell.
- A bull market is a stretch of rising stock prices, and a bear market usually means a broad market index has fallen 20% or more, which is when selling turns a loss on paper into a real one.
Between two funds that track the same index, the one with the lower expense ratio leaves you more of the same return, so check that number first. For any word on a fund page or order screen that isn’t on this list, the SEC’s free glossary at Investor.gov has a plain-English definition.
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