50 Basic Financial Terms You Should Know
If you’re trying to immerse yourself in the world of finance and investing, chances are you have run into some complex lingo and technical terms that may seem a little daunting.
It is totally normal to get a little discouraged by all of these. In fact, a survey conducted by Harris Poll found that 69% of adults younger than 35 years consider investing, and the accompanying jargon, complex and confusing.
Despite all this complexity, investing still offers several benefits. It will always be a perfect way to put your money to work toward a brighter financial future. Take a look through this list of basic terms so you can get rid of the fuzziness and get on your way to a successful investing journey.
What is a stock? A stock is a share of ownership in a public company. When you buy a stock (or a fraction of a stock), you become a shareholder of the issuing company.
What are fractional shares? Fractional shares are small portions of a whole stock. They represent ownership of a company just like a whole share and provide the same benefits proportionally. They were created to help small investors access top stocks at a lower price.
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What are penny stocks? Penny stocks are stocks that can be traded for a price lower than $5. In some cases, their price could go even lower than $1.
What is a dividend? A dividend is a compensation paid to shareholders in exchange for their investments. When a company earns profits, it distributes a portion back to shareholders as a reward for trusting their money in their business.
What are bonds? A bond is a financial instrument that represents a loan made by an investor to a borrower. When you buy a bond, you are basically lending money to the company (or government) in exchange for periodic interest payments.
What is a portfolio? An investment portfolio is the collection of financial assets an investor owns, such as stocks, bonds, ETFs, cash equivalents, etc.
What is an investment fund? An investment fund is a pool of money from various investors that is used to purchase different financial instruments. There are different types of investment funds including:
- ETFs: An Exchange-Traded Fund is a bundle of stocks from different companies or industries. It is a type of investment fund that can be traded just like a stock and offers benefits such as diversification and liquidity.
- Index fund: An index fund is a type of ETF built to replicate the performance of a specific index and its market.
- Mutual fund: A mutual fund is a basket of shareholders’ assets used to invest in stocks, bonds, and other instruments.
What is margin? In the world of investments, margin is the money an investor borrows from a broker to purchase more stock than they would normally be able to afford.
What is ROI? The Return On Investment (ROI) is a measure to evaluate the efficiency of an investment or to compare it to other options. It is calculated as a percentage by dividing the net profit of an investment by the initial amount invested.
What is the stock market? A stock market is a venue where stocks of public companies and other financial securities are bought and sold. The stock market has different trends:
- Bull market: A bull market is a financial market in which prices rise continuously by 20%. It gets its name from the upward movement a bull makes when thrusting its horns up into the air.
- Bear market: A bear market is a financial market in which prices drop continuously by 20%. It gets its name from the downward movement a bear makes when attacking prey with its claw.
What is an IPO? An IPO, or Initial Public Offering, is the offering of shares from a private company to the public for the first time. A company has its IPO when it becomes a public-traded company when its shares are offered through a stock exchange.
What is an index? When talking about financial markets, an index is a small sample of a market that is used to represent the whole stock market or one of its segments. There are several indices for the markets including:
- Dow Jones Industrial Average: The Dow Jones Industrial Average is a market index that tracks the 30 most important companies in the US economy.
- Nasdaq: The Nasdaq Composite, or simply Nasdaq, is a market index that tracks more than 3,700 stocks listed on the Nasdaq stock exchange.
- S&P 500: The Standard & Purse 500, or S&P 500, is a market index that tracks the 500 largest publicly traded companies in the US.
What is volatility? Volatility is a measure of price movements of the assets in a market. For example, when the price of a stock rises and falls frequently, it is called a ‘volatile’ asset. Volatility is commonly related to risk. In most cases, the greater the volatility is, the greater the risk of the investment.
What is a stock split? A stock split is the division of a company’s shares. A company may increase the number of outstanding stocks to make their price lower for the average investor. Even if the number of stocks and the price per share change, the value of a certain amount of stocks won’t change.
What is a reverse stock split? A reverse stock split is a process in which the number of shares a company has in the market is reduced, elevating the price of each stock. It usually happens when the price of a stock has dropped drastically.
What are EPS? Earnings Per Share (EPS) is a ratio that shows how much money a company makes for each share of its stock. It is calculated as a company’s net income divided by the number of outstanding shares.
What is dividend yield? The dividend yield is a ratio of a company’s annual dividend compared to the price of its stock, represented as a percentage. It is an estimate of the dividend-only return of a stock investment.
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What is P/E ratio? The price-to-earnings ratio is an indicator that compares a company’s stock price with its earnings per share. The P/E ratio is calculated by dividing the market value price per share by the company’s earnings per share.
What is market cap? The market cap of a company is the total market value of such a company. It can help understand how much the company is worth. It is calculated by multiplying the total number of shares of the company by the market price of one share.
What is EBITDA? EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, and it refers to the gross earnings of a company. It is a metric of corporate profitability used in most earnings announcements and financial statements.
Investing in action
What is diversification? Diversification is the strategy of investing in a variety of assets. Having a diversified portfolio lets you reduce the risk of losing the value of your investments. It is basically ‘not placing all your eggs in the same basket.
What is technical analysis? Technical analysis is a trading discipline that looks into past stock market data to predict future price moves.
What is value investing? Value investing is an investment strategy that picks stocks that appear to be trading for less than their intrinsic value. Its long-term orientation usually results in gains because these investments tend to yield greater returns despite short-term volatility.
What is a limit order? A limit order is a direction given to buy or sell a stock at a specific price or lower. A purchase limit order can only be executed at the limit price or lower, while a sell limit order can only be executed at the limit price or higher.
What is a stop loss order? A stop loss order is a direction to buy or sell a stock when it reaches a specific price. It is designed to limit the potential loss of a specific investment.
What is cryptocurrency? A cryptocurrency is a digital asset that is based on a blockchain instead of being backed by a government or central bank. Nowadays, cryptocurrency is used for investments and payments.
What is a blockchain? A blockchain is a digital shared ledger that provides an easy way of recording transactions and tracking assets in a specific network.
What is Bitcoin? Bitcoin is the first digital payment system based on a blockchain. It is not run by an entity, but it is a decentralized peer-to-peer currency.
What is an altcoin? Altcoins are any cryptocurrency other than Bitcoin. Some of the most popular altcoins are Ethereum, Dogecoin, and Litecoin.
What is a stablecoin? A stablecoin is a cryptocurrency whose value is linked to another currency, like the US dollar, or the price of a commodity, such as gold. Stablecoins provide a steadier alternative to the high volatility of most cryptocurrencies.
What is financial literacy? Financial literacy refers to the set of skills and knowledge that allows a person to carry out proper stewardship of their financial resources.
What is a budget? A budget is an estimated plan of income and expenses over a specific future period of time. Budgets can be used by individuals and companies to keep better control of their finances.
What is income? When talking about personal finance, income is the amount of money received by a person during a certain period of time because of their work or investments.
What is an expense? Regarding personal finance, an expense is the amount of money used by a person when making a purchase.
What is an asset? An asset is a resource that provides an economic benefit for a person or a company. The assets a person can own are stock investments, bonds, real estate, cash, certificates of deposit, etc.
What is a liability? Referring to personal finance, a liability is a pending debt a person must pay off. Examples of liabilities are student loans, mortgages, credit card debt, personal loans, etc.
What is cash flow? Cash flow is the net amount of cash a person possesses over a certain period of time. In other words, cash flow refers to the total income minus expenses.
What is net worth? The net worth of an individual or a company is the value of their assets minus the sum of liabilities owed.
What is an interest rate? The interest rate is a percentage of the total principal amount of a loan that the lender charges the borrower in exchange for such a loan. An interest rate can also be the amount earned for the money in a savings account, for example.
What is compound interest? Compound interest is the addition of interest returns you’ve already earned over time to the original principal every period. In simple words, it is the result of reinvesting interest instead of cashing it out.
What is opportunity cost? When talking about investments, the opportunity cost is the benefit an investor misses out on when choosing one alternative over another. For example, if you buy a stock of company A and company B increases its share price by 10%, your opportunity cost would be the money that would have come from that increase.
What is inflation? Inflation is a measure of how prices in an economy increase over time. Inversely, it is the rate at which the purchasing power of a given currency gradually decreases.
Implementing your knowledge
By getting to know these basic terms you will notice you will start to feel a lot more confident as you dive deeper into the investing world. Remember that knowledge is power, so the more you learn, the more tools and strategies you will have to apply on your journey.
If you are interested in keeping on learning, make sure to take a look at the rest of our articles. Besides the most relevant financial news, our blog is filled with valuable tips and tricks to improve your financial health and increase your investing skills.