This page is designed to provide individuals with some basic terms that they can use when planning their finances. We'll provide an important investment term, definition, and how the term applies to the typical individual's financial situation.

Liquidity - Liquidity is access. Can you get at your money?  Think of your money in buckets -
in this case "short term" and "long term". Each bucket can be invested with different goals in mind. It's important to always have access to a certain percentage of your money.

Risk - There are a number of risks faced by investors. Risk of loss of principal is the most common. Risk of loss of purchasing power (inflation) is another important risk but not thought of as commonly. Risk is a balancing act. All aspects of money management involve some aspect of risk.

Stock - Stocks represent an "equity stake" in a corporation. Stocks are risky investments (speculative). During the 90's investors saw stocks as a "sure thing" and few considered the risks or consequences of what actually could happen if things went the other way. Stockholders are low on the totem pole with regard to claims on a corporation's assets. Witness shareholders of Northwest Airlines, GM, Enron, Kmart - who lost all their equity after these corporations filed for bankruptcy. An equity stake can of course make you rich if you get lucky! 

Bonds - Bonds represent a contractual obligation by the corporation or entity - a loan with a promise to pay. Bond prices are a function of many factors including the current interest rate paid on new debt issued. If interest rates rise, bond values (especially long term bonds) may drop.


Ladder - A series of certificates of deposit or government bonds with staggered maturity dates. As an example, if an investor has $100,000 allocated to secure fixed income sector of portfolio, a ladder

could be created buying a 1 year, 2 year, 3 year security etc with $10,000 allocated to each security.

Junk Bonds - Also known as "high yield bonds" are of lower credit quality and can be very risky when credit conditions deteriorate or interest rates rise. 

Zero Coupon Bonds (or Strips) - These bonds have their interest payments and the principal payment separated into separate securities. These can be very useful for those planning for retirement. They are not promoted much since no commission is paid to the broker who sells one. These are worth learning about and adding to your self-directed IRA. (Be very cautious in today's zero interest world).

Mutual Funds - also know as registered investment companies pool investor money and professionally manage it. Did you know that there are 25,000+ mutual funds out there?

Certificates of Deposit - CD's as they are commonly known are insured by the FDIC if purchased through a member bank or NCUA if purchased through a member credit union.
CD's of course are boring but having "sleeping power" since your principal is safe and you can count on interest payments. As of late, those interest payments seem to shrink every day, but that could change if rates increase again. 

Market Linked CDs - Overlooked by most investors, these are an option for investors wanting something in between an equity fund and a CD and are good for anyone looking for potentially higher returns (compared to traditional CDs) while retaining FDIC protection. Ask your broker to explain these to you. Most brokers will not volunteer them as an option because the commission generated is too low to be profitable in the eyes of some brokers. Stick to issues that are FDIC insured. Market Linked Notes are not FDIC insured.

IRA - Individual Retirement Account. There is the traditional and Roth. Proceeds from your
employer's retirement plan may be rolled over into an IRA when you change jobs or retire.
An IRA can be started with as little as $100 and added to as you can afford to do so.

Self Directed IRA - A brokerage account, set up as an IRA, is "self-directed" in the sense that you can direct the broker to buy anything from CD's to growth funds inside the account.

Annuity - An annuity is purchased through an insurance agent representing an insurance company. An annuity may be used as an IRA or just as a supplementary investment vehicle.
Earnings inside an annuity are always tax deferred, resulting in a "time bomb" effect without proper tax planning. Annuities come in 2 basic types - fixed and variable. A fixed annuity works much like a CD. Annuities are not insured - you can lose money when purchasing an annuity if the insurance company runs into financial trouble and/or if the investments inside the annuity lose money.
AIG, among the largest and strongest insurance companies in the world, experienced severe financial trouble in 2008 during the heat of the financial crisis. The federal government stepped in and bailed out AIG to prevent huge defaults. Many insurance companies weathered the storm and continue to have high ratings.                  Link to Barron's segment (video) on Annuities

Insurance Company Rating - Independent companies rate each insurers financial strength and
give it a "grade" or rating. Ask prospective agents to provide you with the companies current
ratings in writing. Stick with companies with top ratings for the lowest risk.

ETF - Exchange Traded Funds have some similar features to mutual funds. However, they trade throughout the trading day, rather than simply at the days closing price. There are many ETFs available investing in everything from U.S. Government debt to Gold.

Structured Products or Market Linked Certificates of Deposit -These come in all shapes and sizes and should be considered only in consultation with a trusted advisor. Ask your
broker about MLCDs that include FDIC protection of your principal when held to maturity.

Municipal Bonds - These are bonds issued by municipalities. Usually considered relatively safe investments, there is still default risk and interest rate risk.

Interest Rate Risk - The risk that you will buy a bond paying let's say 4% only to see rates 
rise after you buy your bond, causing the value of your bond in the open market to fall.

Default Risk - The risk that the issuer of the bond will default on it's obligation to pay you back when the bond matures. Governments have defaulted on their obligations at various times in history and this includes U.S. municipalities. Defaults, however, are rare in the municipal arena.

Diversification - Simply defined..."not putting all your eggs in one basket".

Target Date Retirement Fund - These are relatively new types of funds - sometimes called "fund of funds". The investor chooses a fund with roughly the anticipated date of
their retirement, e.g. 2040. The fund managers choose a portfolio of various funds which
typically include mutual funds that invest in stocks, bonds, and other types of investments.
Fidelity, Vanguard, and American Funds among other fund companies offer target date
retirement funds. One could look at the selection of a "Target Date Fund" for the bulk of their retirement funds as a way to put their investment decisions on "automatic pilot". Vanguard's funds have among the lowest cost ratios in the industry, for investors looking  to keep investment costs at rock bottom levels.

REIT - Real Estate Investment Trust. Underlying these investments are real estate holdings which of course come with all kinds of potential rewards and risks. REITS have been "hot" over the past 10-15 years - buyer beware as valuations are rich as of the date of this writing (2016).

Inflation - An increase in the general level of prices, as measured by the CPI, Consumer
Price Index.  Inflation reduces purchasing power of a dollar as prices rise.

Deflation - A decrease in the general level of prices. This is a phenomena that has not 
occurred as frequently in the U.S. Economy. Deflation has been part of Japan's economy as
the stock market bubble of the 80's deflated and consumers lost confidence in the economy. Deflation is looking more and more like a reality in an  era of zero and negative interest rates.

Options - Options, like puts and calls, are contracts that allow investors to hedge their bets.
If you own individual stocks, especially large positions in a single company, you should 
discuss options with your broker to see if they can be used to protect your positions. This
is an area where an experienced broker can be invaluable.

Suitability - Brokers are required to recommend only suitable investments to thier clients. For example, a broker wouldn't recommend a risky investment to a non-profit organization that relies on it's cash reserves to fund operations.

Churning -  This term is usually used to refer to the inappropriate turnover or switching of investments in order to generate new commissions and fees for the broker. For example, the broker sells you shares in Mutual Fund XYZ.  A year later he calls you into his office and suggests that you sell those shares and buy something entirely different, like a variable annuity. Only a few unethical advisors engage in this practice.
As a tax advisor, we see the transactions and can help identify potentially inappropriate trades on your accounts. Recourse may be available in these situations if you can establish that your account was
churned for the benefit of your broker.

Index Fund -  Index funds are passively managed investment funds. Instead of trying  to pick winners and losers, an index fund manager simply buys and holds certain investments tied to its underlying index. Turnover is lower with index funds and fees  tend to be considerably lower as well. An indexing approach does not guarantee profits or better returns than might be available in an actively managed fund.

Managed Account - This is a brokerage account that usually assesses a quarterly fee expressed as a % of
the portfolio's value. Inside the account might be a variety of no-load mutual funds, ETFs,and other
securities. The fee is deductible for tax purposes if it is a non-IRA account.

Privately Held - In contrast to publically held companies whose stock trades on the open market through an exchange, these private companies (sometimes called "closely held) are owned by a short list of often
wealthy individuals. Cargill is one of Minnesota's largest privately held companies. The public cannot buy shares in Cargill Corporation.

Rule of 72 - The "rule of 72" tells you how long it will take to double your money based upon a fixed (guaranteed) rate of return. For example, at 6% interest your money will double in 12 years. At 3% interest, your money will double in 24 years. At today's low interest rates, "the rule of 72" may need to be relegated to the history books.
Because stock markets are so volatile, the rule of 72 will tell you little about how long it will take to double money in the equity markets. 

Monte Carlo Simulation - A technique used to estimate the probability of achieving certain investment returns (targets) based upon a computerized analysis of expected stock market returns. Hint: Monte Carlo is a gambler's paradise.

Slot Machine Effect -  Fund Managers know that if you randomly get outsized returns once in awhile, you are more likely to stay in the game even if overall returns are below average. 

Above Average Investor - Did you know that an overwhelming number of automobile drivers declare themselves as "above average" on the road?  Investors are no different. No one likes to talk about their losses.




NCUA - National Credit Union Administration
            Link to NCUA

FDIC - Federal Deposit Insurance Corporation. 
           Link to FDIC

Todd's Tax Service LLC

Investing explained in plain English

Copyright © Todd's Tax Service LLC. All rights reserved.