With obvious exceptions like brain surgery and rocket science, concepts we might think are extremely complicated from a distance are actually quite straightforward once you understand the basic vocabulary. While investing can in fact get extraordinarily complicated, the principles that underpin modern investing are much simpler than you realize once a few common terms are explained in layman’s terms.
Most people are familiar with stocks and bonds and generally what they involve but when even slightly more complex instruments are used, the average person might quickly lose interest. Unfortunately, mutual funds often fall into that category even though they are, by far, the most popular form of investing for the typical American.
Simply put, when you purchase a mutual fund, the money you invest – along with the money from all the other investors within that particular fund – are placed into a reservoir of sorts where the fund manager scoops up all the money and invests it in a number of different positions. Those positions can be stocks, bonds, commodities, or virtually anything else the fund manager is allowed to invest in according to that fund’s prospectus.
In short, mutual funds are a convenient way for an investor to achieve significantly more diversification without having to individually purchase all those positions on their own.
Typically associated with stocks, beta is simply a measurement of volatility. The greater a stock’s beta, the wider its prices will swing. Since, generally speaking, volatility and long-term growth work in conjunction with each other, stocks with higher betas will exhibit wider price swings but also superior long-term growth. Furthermore, the stocks of smaller companies tend to have higher betas than those of large companies.
Short for market capitalization, market cap is the total amount of equity owned by a company’s stockholders. If the amount of outstanding stock stays fixed, a company’s market cap will rise when their stock price rises because each share is now worth more. Likewise, when a stock price falls, a company’s market cap will fall along with it.
Most commonly associated with taxes, capital gains are often thought to be far more complex than they actually are. In a nutshell, capital gains are the proceeds from the sale of an investment less the purchase price.
Let’s say for instance you buy 10 shares of stock at $10 per share and sell that stock six months later at $15 per share. Your capital gain would be $5 per share or $50 for the entire transaction. If you sold that stock at $5 per share rather than $15 per share, you would have a total capital loss of $50.
To add one slight wrinkle to the equation, capital gains and losses are often divided by short-term and long-term positions. Short-term positions are those that you’ve owned for less than one year whereas long-term positions are held for greater than one year.
Of course, the vocabulary behind investing is vast and we’ve hardly scratched the surface with these examples. We will help define more terminology in the future but, for now, this is a good first step in demystifying the investment vernacular.
Jeremy Wallace is founder and chief investment officer at Wallace Hart Capital Management, an independent financial services firm committed to offering comprehensive advice and customized services. Jeremy has 20 years of experience in the financial industry and is passionate about helping clients preserve and enhance their wealth so they can pursue their passions. Jeremy graduated from Emory University with a degree in international economics and a certificate in financial planning. Outside of the office, Jeremy spends most of his free time with his wife, Julie, and their three children, Isabel, Lincoln, and Reid. He is an avid Chicago Cubs baseball fan, and he enjoys golfing with his wife and traveling with his family. Learn more about Jeremy by connecting with him on LinkedIn.