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Basic Investment Terms for the Beginning Investor

written by: Tim Plaehn•edited by: Rebecca Scudder•updated: 10/31/2011

Stocks, bonds, mutual funds and ETFs. The basic investment terms for these investment types are the building blocks to start investing.

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    Investment Terminology

    For someone getting started in investing, learning the basic investment terms are the first items to understand. The options and possibillities in the investment world span a range of markets and investment types. The following paragraphs give a basic overview of the investment markets and some of the terms to understand. Read the linked articles for further, in-depth information.

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    Stock Investing

    New York Stock Exchange The stock market provides an investor the opportunity to earn profits through stock price gains and income from dividends. A share of stock is a piece of ownership in the company. The stocks of most companies trade on the New York Stock Exchange or the NASDAQ stock exchange.

    Stocks are purchased through a stock brokerage account. In an online brokerage account, an investor will select the stock to buy and enter the stock symbol and number of shares to buy. The broker will charge a commission of $5 to 10 to buy or sell shares over the Internet.

    There is a lot of financial news about the stock market. The overall changes in the market are indicated by stock market indexes such as the Dow Jones Industrial Average, S&P 500 and NASDAQ Composite. Stock indexes track the value changes of a select group of stocks chosen to give a picture of how the broad market or specific market sectors are performing.

    When most of the stocks in the market are going up for a period of time that stretches into years, it is called a bull market. A bear market is when the stock market and most stocks decline significantly in value. A bear market typically lasts 6 to 9 months.

    Market sectors are groups of stock in related industries. The universe of stocks is usually divided into 10 to 12 major sectors including energy, financial, technology, consumer goods, industrial companies and materials.

    Investors evaluate stocks based on criteria for the profits or earnings per share of companies, how fast the companies are growing and the dividends paid by stocks. Dividends are a payout of profits to shareholders. Some stocks pay dividends and other companies choose to reinvest profits into the growth of the company.

    Some different stock picking strategies are: Blue Chip stocks are the large stable corporations like Coco Cola and Johnson & Johnson. Growth stocks are companies that have profits and sales growing faster than others in their sectors. Value stocks are companies that have intrinsic value greater than indicated by the stock price. Large cap stocks are companies whose total stock market value exceed $10 billion. Small cap stocks have market caps of $1 billion and less. Mid cap stocks fill the middle.

    An investor can combine different strategies in his investing style and stock portfolio.

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    Bond Investing

    Bonds are debt securites issued by governments and corporations. The three major types of bonds are government bonds, municipal bonds and corporate bonds. For investors, bonds are easier to understand and more difficult to understand the risks.

    A bond will have a face amount which is the value an investor will receive when it matures, a maturity date up to 30 years in the future, a coupon rate, which is the annual interest an investor will earn and a current yield or yield to maturity, which is what an investor will earn if the bond is purchased at the current market price.

    Since the amount of interest a bond pays is fixed, the market adjusts for changing rates by changing the market price of the bond. Bonds can sell for more than the face amount or at a premium or at a discount or less than the face amount. The yield to maturity -- YTM -- calculation show the rate an investor will earn, taking into effect the premium or discount. A basic rule of bonds is that when interest rates rise bond prices fall and when rates decline bond values go up.

    Bonds have credit ratings that indicate the issuer's financial strength and future ability to make interest and principal payments on the issuer's bonds. Investment grade bonds have credit ratings of BBB to AAA. Non-investment grade bonds are from issuers with credit ratings below BBB and are referred to as high yield bonds or junk bonds.

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    Funds

    For professional management and owning a diversified portfolio, using funds is one way to invest in stocks and/or bonds. The two major classes of funds are mutual funds and exchange traded funds -- ETFs.

    Mutual funds shares are bought and sold from the mutual fund company. Mutual funds can have sales charges or loads or be no-load. Most mutual funds are actively managed with portfolio managers that select investments to meet the fund objectives and provide the best possible return to investors. Index funds hold the stocks or bonds of a specific market index and provide a low cost way to match market returns. There are stock funds and bond funds. Hybrid funds own both stocks and bonds and are called balanced or asset allocation funds.

    ETFs are funds with shares that trade on the stock market. Shares are bought and sold through a brokerage account. Exchange traded funds are all index type funds, without active management. ETFs are available to focus invest in a wide range of stock market sectors, international stock exchanges, bonds and commodities.

    Closed end funds are a smaller group of funds whose shares trade on the exchanges. Closed end funds are actively managed to meet fund objectives. These funds give investors access to specialized investment strategies or less liquid asset classes.

References