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Annuity An annuity is a contract between an insurance company and a buyer. The buyer pays a premium, in one or several payments, and the insurance company agrees to pay the buyer a regular return for a specified period of time, usually the remainder of the buyer’s lifetime. The insurance company invests the money to earn interest, receive dividend income, or collect capital gains distributions. The insurance company then pays the buyer an income based on the terms of the contract. Annuities can be variable or fixed, deferred or immediate. A fixed annuity ensures that the insurance company will pay a set principal plus a set interest rate. Returns on a variable annuity, however, fluctuate based on the performance of the investments. With a deferred annuity, the premium gathers interest for a certain set period of time, tax-free, before payments to the buyer begin. Immediate annuities, on the other hand, establish a return for the buyer based on the buyer’s age, part of which is considered principal and part of which is considered taxable interest. Thus, age, wealth, and risk tolerance will heavily influence the type of annuity an individual buyer selects.
Asset Assets include any of an individual’s possessions that have exchange value. Examples of assets include stocks, bonds, cash, real estate, and other properties.
Asset Allocation Asset allocation refers to the specific distribution of funds among a number of different asset classes within an investment portfolio. Asset classes such as stocks, bonds, and real estate have unique types of expected risk and return. Within each asset class are several variations of the asset, meaning that there are levels of risk within each asset class. Asset allocation involves determining what percentage of funds will be invested in each asset. The investor's goals, time frame, and risk tolerance will all affect how an investor wishes to allocate funds.
Back-end Load A back-end load is a fee or redemption charge an investor pays when withdrawing money from an investment. In many cases, the fee is reduced over the years of investment, or holding period, and eventually is reduced to zero. A back-end sales charge is also called a contingent deferred sales charge.
Bear Someone who believes or speculates that a particular security or the securities in a market will decline in value is referred to as a bear.
Bear Market A bear market is a market in which a group of securities falls in price or loses value over a period of time. A prolonged bear market may result in a decrease in market prices by 20% or more. A bear market in stocks may be due to investor’s expectations of weak economic trends.
Blue Chip Blue Chip refers to companies that have become well established and reliable over time, demonstrating sound management and quality products and services. Such companies have shown an ability to function throughout both good and bad economic times, usually paying dividends to investors even during lean years.
Bond A bond is essentially a loan made by an investor to a division of the federal or state government, a government agency, or a corporation. The bond is a promissory note to repay the loan in full at the end of a fixed time period. The date on which the principal must be repaid is the called the maturity date, or maturity. In addition, the issuer of the bond, that is, the agency or corporation receiving the loan and issuing the promissory note, agrees to make regular payments of interest at a rate initially stated on the bond. Interest from bonds is taxable based on the type of bond. Corporate bonds are fully taxable, municipal bonds issued by state or local government agencies are free from federal income tax and usually free from taxes of the issuing jurisdiction, and Treasury bonds are subject to federal taxes but not state and local taxes. Bonds are rated according to many factors including cost, degree of risk, and rate of income.
Bull Someone who believes that a particular security or the securities in a market will increase in value is known as a bull.
Bull Market A bull market is a long period of rising prices of securities, usually by 20% or more. Bull markets generally involve heavy trading volume and are marked by a general upward trend in the market, independent of daily fluctuations.
Capital Gain or Loss The difference between the sales price and the purchase price of a capital asset. When that difference is positive, the difference is referred to as a capital gain. When the difference is negative, it is a capital loss. The tax rate on a capital gain depends on how long the security was held.
Certificate of Deposit (CD) A Certificate of Deposit (CD) is a note issued by a bank for a savings deposit that the individual agrees to leave invested in the bank for a certain term. At the end of this term, on the maturity date, the principal may either be repaid to the individual or rolled over into another CD. The bank pays interest to the individual, and interest rates between banks are competitive. Monies deposited into a Certificate of Deposit are insured by the FDIC, thus they are a low-risk investment and a good way of maintaining principal. Maturities may be as short as a few weeks or as long as several years. Most banks set penalties for premature withdrawal of monies from a Certificate of Deposit.
Commission A commission is a fee charged by an agent making transactions of buying or selling securities for another individual. This fee is generally a percentage based on either the number of stocks bought or sold or the value of the stocks bought or sold.
Credit Risk Credit risk refers primarily to the risk involved with debt investments, such as bonds. Credit risk is essentially the risk that the principal will not be repaid by the issuer. If the issuer fails to repay the principal, the issuer is said to default.
Default To default is to fail to make timely payments of interest and principal as they come due or to meet some other provisionof a bond indenture. In the event of default, bondholders may make claims against the assets of the issuer in order to recoup their principal.
Defined Benefit Plan A defined benefit plan is a qualified retirement plan under which a retiring employee will receive a guaranteed retirement fund, usually payable in installments. Annual contributions may be made to the plan by the employer at the level needed to fund the benefit. The annual contributions are limited to a specified amount, indexed for inflation.
Defined Contribution Plan A defined contribution plan is a retirement plan under which the annual contributions made by the employer or employee are generally stated as a fixed percentage of the employee's compensation or company profits. The amount of retirement benefits is not guaranteed; rather, it depends upon the investment performance of the employee's account.
Diversification Diversification is the process of optimizing an investment portfolio by allocating funds to a number of different assets. Diversification minimizes risks while maximizing returns by spreading out risk across a number of investments. Different types of assets, such as stocks, bonds, and cash funds, carry different types of risk. It is important to diversify among assets with dissimilar risk levels for an optimal portfolio. Investing in a number of assets allows for unexpected negative performances to balance out with or be superceded by positive performances.
Dividend A dividend is a payment made by a company to its shareholders that is a portion of the profits of the company. The amount to be paid is determined by the board of directors and dividends may be paid even during a time when the company is not performing profitably. Dividends, when paid, are normally paid out to shareholders on a quarterly basis. Dividends may be paid directly to the investor or reinvested into additional shares of the company’s stock. Dividends must be declared as income in the year they are received.
Dow Jones Industrial Average The Dow Jones Industrial Average is a price weighted average to which the performance of individual stocks can be compared; it is a means of measuring the change in stock prices. This index is a composite of 30 Blue Chip companies currently including such companies as IBM, Johnson and Johnson, and Kraft Foods. These 30 companies represent not just the United States; rather, they are companies involved with commerce on a global scale. The index is computed by adding the closing prices of these 30 stocks and dividing by an adjusted number which takes into account stock splits and stock dividends equal to 10% or more of the market value of an issue as well as for substitutions and mergers. The average is quoted in points, not dollars.
Early Withdrawal Early withdrawal is the removal of funds from a fixed-term investment before its maturity date, or the removal of funds from a tax-deferred investment account or retirement savings account before a prescribed time, such as the account owner's attainment of a minimum age requirement. An early withdrawal fee is usually imposed, which acts as a deterrent to frequent withdrawals before the end of the early withdrawal period.
Equity Equity is the total or partial ownership an individual possesses minus any debts that are owed. Equity is the amount of interest shareholders hold in a company as a part of their rights of partial ownership. Equity is considered synonymous with ownership, a share of ownership, or the rights ownership.
401(k) Plan A 401(k) plan is a retirement plan sponsored by employers. Employees may choose to have a portion of their salary deferred to any of the 401(k) investment choices selected by the employer. The employer may also contribute to the employee’s 401(k) by matching a portion of the investment (for example, $.50 for every $1.00 the employee invests). The investments to which the tax deferred contribution is made may include stocks, bonds, money market funds, and company stock. Employee contributions to the 401(k) are subtracted from the employee’s gross income. The maximum amount allowed to be contributed to a 401(k) changes annually. If money is withdrawn from the 401(k) before the employee turns 59 1/2, the individual may have to pay penalties. If the individual changes jobs, the monies in the 401(k) may be rolled over to a 401(k) of the new employer or to an Individual Retirement Account (IRA).
403(b) Plan A 403(b) plan is a tax deferred retirement plan much like a 401(k) plan described above but for public schools, colleges, and universities as well as charitable entities tax-exempt under 501(c)(3) of the IRS Code.
Fiduciary A fiduciary may is an individual, corporation or association holding assets for another party, often with the legal authority and duty to make decisions regarding financial matters on behalf of the other party. A financial advisor held to a fiduciary standard occupies a position of special trust and confidence when working with a client.
Front-end Load A front-end load is a sales charge applied to an investment at the time of is initial purchased. Investments that may require a front-end load include mutual funds, annuities, and life insurance policies.
Going Public A company that has previously been privately owned is said to be "going public" the first time the company’s stock is offered for public sale.
Hedging Hedging is a strategy of reducing risk by offsetting investments with investments of opposite risk. Risks must be negatively correlated in order to hedge each other; for example, an investment with high inflation risk and low immediate returns with investments with low inflation risk and high immediate returns. Hedging is not the same as diversification, as it aims to protect against risk by counterbalancing a specific area of risk.
Individual Retirement Account (IRA) An Individual Retirement Account allows individuals who are earning income to contribute to a tax-deferred investment. An individual can contribute up to $2,000 per year or $4,000 if married to an unemployed spouse. Contributions to an IRA are tax-deductible based on the individual’s marriage status and income level. Monies contributed to an IRA may be invested in stocks, bonds, mutual funds, annuities, bank savings accounts, Certificates of Deposit, government bonds, and investment trusts but not more personal and immediate investments such as a home or collectibles. The individual may contribute to the IRA account until age 70 1/2, but if money is withdrawn before age 59 1/2, penalties may be incurred.
Inflation Risk Inflation risk is the possibility that the value of assets or income will decrease as inflation reduces the purchasing power of money. Inflation causes money to decrease in value at some rate, and does so whether the money is invested or not.
Junk Bonds Junk bonds are high yield bonds that have a below investment grade rating and are considered to have a greater risk of default. Junk bonds normally pay higher interest than better quality bonds to make them more attractive to investors.
Keogh Plan The Keogh Plan is a type of tax-deductible retirement plan, similar to Individual Retirement Accounts, for self-employed individuals. It is also known as a self-employed pension plan. The tax deductible contributions and any interest or gains are not taxed until withdrawn.
Liquidity Liquidity refers to the ease with which investments can be converted to cash at their present market value. Additionally, liquidity is a condition of an investment that shows how greatly the investment price is affected by trading. An investment that is highly liquid is composed of enough units (such as shares) that many transactions can take place without greatly affecting the market price. High liquidity is associated with a high number of buyers and sellers trading investments at a high volume.
Lump-Sum Distribution A lump-sum distribution is the disbursement of the entire value of a profit-sharing plan, pension plan, annuity, or similar lump-sum account to the account owner or beneficiary. Lump-sum distributions may be rolled over into another tax-deferred account.
Market Risk Market risk is that part of a security's risk that is common to all securities in the same general class (stocks and bonds) and, therefore, cannot be eliminated through diversification.
Market Value Market value is the value of an investment if it were to be resold, or the current price of a security being sold on the market.
Modern Portfolio Theory (MPT) Modern portfolio theory proposes how investors seek to construct an optimal portfolio by considering the relationship between risk and return, especially as measured by alpha, beta, and R-squared. This theory recommends that the risk of a particular stock should not be looked at on a stand-alone basis, but rather in relation to how that particular stock's price varies in relation to the variation in price of the market portfolio. The theory goes on to state that given an investor's preferred level of risk, a particular portfolio can be constructed that maximizes expected return for that level of risk.
Mutual Funds Mutual funds are investment vehicles that are made up of a pool of funds from many investors for the purpose of investing in securities such as stocks, bonds, money markets or similar types of assets. Investors in a mutual fund typically have the same investment objective and a portfolio manager invests the pooled assets to match the investment objective of the fund as stated in the fund's prospectus. Mutual funds are divided into shares and can be bought much like stocks, allowing mutual funds to have a high liquidity. Mutual funds are convenient, particularly for small investors, because they diversify an individual’s monies among a number of investments. Investors share in the profits of a mutual fund, and mutual fund shares can be sold back to the company on any business day at the net asset value price. Mutual funds may or may not have a load or fee.
National Association of Securities Dealers Automated Quotations The National Association of Securities Dealers Automated Quotations is the largest electronic screen-based equity securities trading market in the U.S. It provides up-to-the-minute information on over-the-counter stocks. Whereas on the New York Stock Exchange (NYSE) where securities may be traded on a trading floor, all securities on the NASDAQ are traded via computer.
Net Asset Value (NAV) Net Asset Value is the price per share of a mutual fund or the per share value of an exchange traded fund (ETF). The NAV is calculated by dividing the total market value of all the securities in the portfolio, minus any liabilities, by the number of fund shares outstanding that day.
New York Stock Exchange (NYSE) Established in 1792, the New York Stock Exchange in the largest equities-based exchange in the world. It is home to the majority of the world's largest and best-known companies.
Option An option is a contract between a buyer and seller that gives the buyer the right, but not the obligation, to buy or sell a particular asset at an agreed price (called the "strike price") at a later date. In return for providing the right, the seller of the option collects a premium from the buyer of the option. A call option gives the buyer of the option the right to buy the underlying asset. A put option gives the buyer of the option the right to sell the underlying asset. The holder of the option can then choose to buy or sell the underlying security at the strike price during this time period. However, the holder is under no obligation to buy the asset and may choose to let the option expire.
Price Earnings Ratio (PE Ratio) The price-earnings ratio is a measure of how much buyers are willing to pay for shares in a company, based on that company’s earnings. Price earnings ratio is calculated by dividing the current price of a share in a company by the most recent year’s earnings per share of the company. This ratio is a useful way of comparing the value of stocks and may help to indicate expectations for the company’s growth in earnings. It is important, however, to compare the P/E ratios of companies in similar industries. Price-earnings ratio is sometimes also called the "multiple".
Real Rate of Return The Real Rate of Return refers to the return on an investment after being adjusted for inflation.
Reinvestment Reinvestment is the use of dividends, interest, or profits from an investment to buy more of that investment , rather than receiving the payout in cash. Normally, taxes must still be paid on a distribution even though it was reinvested.
Revocable Trust A revocable trust is a type of trust in which provisions can be altered or canceled by the grantor. During the life of the trust, income earned is distributed to the grantor, and only after death does property transfer to the beneficiaries. This is the opposite of an Irrevocable Trust, which cannot be modified or terminated without the permission of the beneficiary.
Risk Risk is the possibility that an investment's actual return will be different than expected; includes the possibility of losing some or all of the original investment. Measured by variability of historical returns or dispersion of historical returns around their average return.
Rollover A rollover is a method by which an individual can transfer the assets from one retirement program to another without the recognition of income for tax purposes. The requirements for a rollover depend on the type of program from which the distribution is made and the type of program receiving the distribution.
Roth IRA Individual retirement plan. Contributions are not deductible and qualified distributions are tax free.
Securities and Exchange Commission (SEC) The Securities and Exchange Commission is a federal government agency established to protect the individual investor from fraud and manipulative practices in the securities marketplace. The commission oversees and regulates the activities of registered investment advisors, stock and bond markets, broker/dealers, and mutual funds.
Security A security is an investment instrument, other than an insurance policy or fixed annuity, issued by a corporation, government, or other organization which offers evidence of debt or equity. Securities include total or partial ownership of an asset, rights to ownership of an asset, and certificates of debt from an institution. Examples of securities include stocks, bonds, certificates of deposit, and options.
Simplified Employee Pension Plan (SEP) A type of plan under which the employer contributes to an employee's IRA. Contributions may be made up to a certain limit and are immediately vested.
SIMPLE A retirement plan sponsored by companies with fewer than 100 employees which is attractive for employers because it avoids some of the administrative fees and paperwork of plans such as 401(k)s.
Standard and Poor's 500 The Standard and Poor’s 500 Index is a market index of 500 of the top-performing United States corporations. This index is a broader measure of the domestic market than the Dow Jones Industrial Average, indicating broad market changes. The S&P 500 index includes 400 industrial firms, 20 transportation firms, 40 utilities, and 40 financial firms.
Stock Split A stock split is when a company’s board of directors and the shareholders agree to increase the number of shares outstanding. The shareholders equity does not change; instead, the number of shares increases while the value of each share decreases proportionally. For example, in a 2-for-1 stock split, a shareholder with 100 shares prior to the split would now own 200 shares. The price of the shares, however, would be cut in half; shares that cost $40 before the split would be worth $20 after the split.
Tax-Exempt Bonds Under certain conditions, the interest from bonds issued by states, cities, and certain other government agencies is exempt from federal income taxes. In many states, the interest from tax-exempt bonds will also be exempt from state and local income taxes.
Volatility Volatility is an indicator of expected risk. It demonstrates the degree to which the market price of an asset, rate, or index fluctuates from average. Volatility is calculated by finding the standard deviation from the mean, or average, return.
Warrant A warrant is similar to an option, giving the holder the right to purchase securities at a set price for a specific period of time. Warrant certificates last longer than options, typically holding value for a few years or indefinitely. Warrants are often traded as securities at a price that reflects the underlying security.
Yield Yield is the annual income earned from an investment, usually expressed as a percentage. For stocks, it is the annual dividend received divided by the purchase price. For bonds, it is the coupon interest rate divided by the price of the bond. Yield does not include capital gains on the investment.
Zero-Coupon Bond A zero-coupon bond makes no periodic interest payments. Instead, the bond is sold at some price below (discounted) its face value and returns full face value at maturity. The difference is taxed as ordinary interest. This type of bond is a popular fixed income investment in tax deferred accounts such as IRAs.