If you’re new to investing your money, you may hear a wide variety of terms and financial jargon that can be confusing, misleading and downright off-putting. But fear not, many of the terms are easy to understand, once you’re in the know.
The Dow, S&P 500, NASDAQ and the TSX Let’s start with the most common thing you’ll hear during the nightly news when they talk about the markets, the big four stock indexes. They are the Dow, S&P 500, NASDAQ and TSX in North America.
Dow Jones Industrial Average – This is probably the best known index, and is more commonly known as the Dow or DJIA. It’s made up of the 30 largest companies that trade on the New York Stock Exchange and NASDAQ. They include powerhouses like Apple, Walmart, Exxon Mobil, and Coca-Cola. It is a price-weighted average and was intended to serve as a proxy of the U.S. economy. When a newscaster says the U.S. markets are up, they are usually referring to the Dow.
S&P 500 – The S&P 500 is a much larger index comprised of 500 companies with a current market cap (or the total value of the companies shares) of at least $6.1 billion. This includes all the companies on the Dow, plus a broader number of companies from every sector of the economy. Many market watchers consider the S&P as a more accurate gauge of the broader market. The index is designed to give a higher weighting to larger companies.
S&P/TSX Composite Index – The TSX is a composite index for Canada’s largest stock exchange and is essentially the Canadian equivalent of the S&P 500. It’s made up of 250 companies which represents about 70 percent of the Toronto Stock Exchange. Companies in the index include Air Canada, Blackberry and the big banks like Toronto-Dominion and Royal Bank of Canada.
NASDAQ Composite index – The NASDAQ composite index is made up of around 3,000 companies listed on this exchange. The NASDAQ does not limit itself to just companies with U.S. headquarters, so it includes many international companies in its index.
Now, let’s move onto some of the terms used in business and finance.
Annuity – An annuity is an investment vehicle that’s designed to pay out a steady stream of income. There are two phases in this investment, accumulation and annuitization. During the accumulation phase, investors pay into the fund to build up its cash reserves, which will typically grow due to compound interest. After a period (specified in the contract), the annuitization phase begins, where the money is paid out (usually in retirement). The length of payments will depend on the type of annuity, and it could be paid out monthly or yearly.
Read more: What is an annuity?
Bonds – A bond at its most basic level is a loan or an IOU from either a company or government. If you’ve ever bought a U.S. Treasury Bill or a Canadian Savings Bond, you’re loaning money to the federal government. Simply put, the government will promise to pay you back your investment plus interest. Bonds are rated based on their risk, with AAA bonds being safest (and offering the least interest), to junk bonds with ratings of BB or lower. These are not considered investment grade bonds but do provide a high-interest rate, as well as a higher risk the bond issuer will default, and not pay anything.
Compound interest – Compound interest is a powerful savings benefit where interest is calculated not only on your principal but also on interest accumulated from past periods. This allows savings to snowball quickly.
Credit rating – Your credit rating is an important figure used for my purposes, include by financial institutions to calculate how likely you are to repay loans. The higher the rating, the more likely you are to repay on time, so you usually get rewarded with a lower interest rate. If you have a history of late payments or a bankruptcy, your credit rating score will be low, meaning lenders see you as risky, and you’ll likely pay much more for a loan.
Diversification – Diversification can be summed up in one saying, don’t put all your eggs in one basket. The objective is to spread your risk around by putting your money into a range of investments like different equity classes, real estate, fixed income products like bonds and commodities like gold. The idea is that if one sector of the market or economy dips, your other investments will continue to make money.
Exchange-Traded Funds (ETF) – An exchange-traded fund is similar to a mutual fund, but it can be sold throughout the trading day (while a mutual fund’s price is calculated at the end of the day). ETFs can be made up of stocks, bonds, and commodities. Fees for ETFs are usually cheaper than other investment products because they are not actively managed, and they can sometimes also have tax advantages.
Gross Domestic Product (GDP) – The gross domestic product is a way for governments to quantify how the overall economy is doing. GDP adds up the total value of all sales and services in the country (or state/province) for a period (usually by the quarter or year). It’s a good benchmark to see how the economy performed during a period. Two consecutive quarters of negative GDP growth is one definition of a recession.
Inflation – Inflation is the increase in prices and the drop in purchasing power over time. Many things can trigger inflation, from a decline in the dollar (which makes imported products more expensive) to low unemployment (which forces companies to pay more for workers). Controlled inflation isn’t a bad thing; it’s a requirement for economic growth. Central banks like the U.S. Federal Reserve and the Bank of Canada attempt to manage inflation by raising or lowering interest rates.
Interest Rates – Central banks, like the U.S. Federal Reserve and the Bank of Canada set monetary policy by using interest rates (called the federal funds rate in the U.S., and the overnight rate in Canada). These interest rates are what major financial institutions charge each other for very short-term loans that last a day. These rates are also used by banks to price different interest rates for things like mortgages and other consumer loans. They influence how much interest you’ll get for keeping cash in your savings account. Interest rates have traditionally been used by the central banks to control inflation. Think of it like the tap in your kitchen. If economic growth is slow, the bank can turn on the tap and lower interest rates. This will make loans cheaper and should lead companies to invest in expanding their business, or consumers to buy homes. If inflation is soaring, the bank can cool the economy by turning off the tap and raising interest rates.
Mutual fund – A mutual fund is an investment vehicle that pools money from a number of investors to buy a diversified portfolio of stocks, bonds and other types of securities. A fund manager decides where to invest with a goal of producing gains or income for the investors. A mutual fund allows small or individual investors access to this type of professional management, and can provide diversification.
Foresters Financial does not provide investment, tax or legal advice. This material has been prepared for informational purposes only. Please consult with your financial and legal advisors before engaging in any transaction.
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