Friday, July 4, 2014

Basic Investor Terminology For Beginning Investors

Today I had a friend of mine ask me to explain some investor jargon that is a language of it's own for those new to investing. The most important thing to remember is that you don't need to memorize or even fully understand all these concepts to become a successful investor - you simply need to be aware of them.

What Is Bid/Ask?
When you are buying stocks for the first time you will usually see 2 columns of prices - Bid and Ask.
Bid = Think of this as the 'offer price' to buy a given stock. For example, let's assume a seller has a baseball card on ebay listed for $40.00 or best offer - and you offer him $30.00 dollars. That $30 offer is essentially like making a "Bid" or offer to buy a stock.
Ask = Using the same example above, the ask would be $40.00 because that is what the seller is "asking" for his shares, or in the examples case - a baseball card.

So in summary.
The Bid Price is what buyers have offered to pay for shares of stock.
The Ask Price is how much sellers are asking for the shares they want to sell.

What Is FOREX? = "Foreign Exchange Market"
Also known as FX, FX Market, the "currency market"
Basically you are trading currencies from around the world ie: US Dollar, Euro, Yen ... ect.
Personally I don't trade currencies, not that it's particularly difficult, just not a market I follow very much. There tends to be a large amount of webspam related to FOREX, that's the only reason why I include it on a beginners guide. If you want to learn more about FOREX trading - make sure the source is a reputable one.

What Is A Mutual Fund? = A group of stocks - often in a common industry - that are bundled together to create a fund.
For example: a "Internet Company Mutual Fund" might have a portfolio like this:

AAPL 100,000 Shares
GOOG 79,000 Shares
YHOO 35,000 Shares
YELP 16,000 Shares
....ect

Mutual funds are intended to be a longer-term investment and not meant to be bough/sold within a short time period. In fact, many mutual funds have a ~2% (or more) penalty if you sell within 30 days of purchase. Mutual funds often have a minimum initial investment - for example $100, $1,000 or even $10,000 or more. Subsequent investments are often allowed in lower dollar amounts ranging from $1 - $100 or more. When you buy shares in a mutual fund, there is no bid/ask price - you simply buy the shares at market value. Additionally, when you sell - you sell at the market price. The trades go through after the close of trading for mutual funds. For total beginners, mutual funds are a great starting point for leaning investment basics because buying them is relatively simple.

Mutual Fund Fees:
- Trade Commissions - Typically you can find a broker (or invest directly with the mutual fund company itself) where there is no fee for buying or selling shares.
- Front Load Fees - You will see some mutual funds charge an upfront fee every time you buy shares. For example, a front load fee of 5% means the company charges you 5% for every dollar you invest.
- Back-End Load or Contingent Deferred Sales Load (CDSL) is slightly more complicated than a front load fee. It's better described here.
- The mutual funds the majority of investors should look for are no-load mutual funds. They don't have a front-end or back-end load, however there are management fees associated with the fund usually described as an 'expense ratio."

What Is An ETF? = Exchange Traded Fund
I think of ETF's as a trade-able mutual fund. Essentially a basket of stocks (or similar investments) traded on one of the major stock exchanges - like NASDAQ. The advantages of ETF's over mutual funds is they can be traded, and/or used as a short term investment. Unlike mutual funds, ETF's are traded on the stock market with a bid/ask price.

ETF Fees:
- Trade Commissions - You will typically pay a trade commission fee each time you buy and sell. For example most brokers charge $8.95 - $9.99 per trade. You will find some brokers like Schwab, E-Trade, -Ameritrade...ect who offer some ETF's as a commission free trade.
- Expense Ratio - These are fees that are siphoned off from the fund on a yearly basis. The norm is around 1% but they can get much higher or lower.

What is a Bond?
Think of bonds like debt. On one side you have the borrower, and the other side you have a lender who earns interest as the borrower makes re-payments on the loan. Bonds are very similar. Countries, Cities (municipalities), companies/corporations will issue bonds with a coupon (interest) rate. Buyer purchase the bonds, and earn interest on those bonds until they are paid off. If you forget all that - the most important thing to remember about bonds is as interest rates go up - the price of the bond goes down ... and vise-versa.  For example, today a bond has a price of $50 with an interest rate of 5%. Tomorrow, interest rates go up to 5.25% - the price of the bond would go down to something like $45.

What Are Options?
I strongly recommend only trading options after you have become an experienced investor and trader. Option trading requires you to be correct about the direction a stock is going AND you have to guess the correct time period that move will happen. The average investor will likely not need to worry about options, however a high net worth investor might be wise to hedge portions of your portfolio with options.

In a nutshell, options are contracts to buy or sell stock at a given time.

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