Become a savvy investor.
From the news to your 401(k) statements, financial jargon is everywhere. Growth versus value stocks — what’s the difference, and why do you need to know? Similarly, why should you learn the nuances of various classes of bonds? It’s important to understand the investments available to help you make the right decisions for your portfolio. Here’s a guide that decodes the financial terms you need to know.
Growth stocks
Growth stocks are shares of companies investors believe are poised to grow faster than the industry norm. These stocks present a chance for higher gains but come with higher risks. They also tend to rise quickly when the market is on an upswing and fall fast when the market falters. In addition, because these companies are looking to grow, they often don’t hand out dividends.
Value stocks
These are shares of companies investors believe the market has undervalued based on negative publicity, a bad quarterly report or some other factor. The idea is that the stock’s price will eventually rise to reach its “true” value. Value stocks are generally perceived as less volatile than their growth counterparts, as they tend to be investments in established companies.
Small-, mid- and large-cap stocks
Stocks are further separated into small-cap, mid-cap and large-cap categories. These terms refer to market capitalization, or the size of a company calculated by multiplying its stock price by the total number of shares outstanding. Large caps are usually considered companies with market caps that exceed $10 billion. Mid caps include companies between $2 billion and $10 billion, and small caps are generally less than $2 billion.
Treasury securities
These U.S. government-issued debt securities are divided into three categories by maturity dates: Treasury bonds mature in 10 or more years, Treasury notes mature between one and 10 years and Treasury bills mature in one year or less. These debt obligations are considered the safest option for bond investors since they are backed by the full faith and credit of the U.S. government. But that safety comes at a price: The interest rates on Treasurys are lower than other bonds with the same duration.
Municipal bonds
Municipal bonds are issued by a government, such as a state, county, district or municipality. Issuers often use the money to pay for public projects, like roads or construction projects, that would otherwise come directly out of taxpayers’ pockets. In most cases, the interest holders of municipal bonds receive is exempt from federal taxes, which is a huge appeal for investors. Maturities can range from the short term, usually one to three years, to a decade or longer.
Corporate bonds
These bonds are riskier because the issuer is a business. Consequently, the interest rates on corporate bonds tend to be higher, so investors are rewarded for the extra risk. But keep in mind that the corporation could default or the bond could be called, meaning the issuer could redeem the bond before it reaches maturity. Corporate bonds are rated by agencies, including Standard & Poor’s, Moody’s and Fitch, based on the company’s financial health and ability to pay bondholders.
Investment-grade bonds
Municipal or corporate bonds that have high and medium credit quality are considered “investment grade,” meaning the risk of the bond issuer defaulting is low. These bonds are rated between AAA (the highest credit quality) and BBB.
Junk bonds
Junk bonds are rated BB or lower, which means they carry a higher risk of defaulting. Sometimes called “high yield” bonds, these issues tend to pay investors more in exchange for the additional risk. Junk bonds can be lucrative for investors if the issuing corporation has recently changed management or strategy and shown potential to substantially improve its credit.
Interest rates
Interest rates affect the return you receive on bonds (and much more, including what you pay for loans). Keep in mind that interest rates have an inverse relationship to bond prices, and the bond market fluctuates just like the stock market. When interest rates rise, bond prices fall, and vice versa.
Actively managed mutual funds
These mutual funds are run by a professional money manager or a team or money managers who choose investments based on their own research and knowledge of companies or industries. Actively managed mutual funds generally aim to beat the performance of a benchmark index, which is a big appeal for investors.
Index funds
Index funds are passively managed, meaning they track an established market index, such as the Standard & Poor 500 index, which invests in 500 of the largest companies in a range of industries. The appeal to many investors is broad market exposure at a low cost, since index funds carry lower expenses compared with actively manged funds. And when it comes to performance, index funds often beat actively managed mutual funds over long periods of time.
Exchange-traded funds
ETFs are also low-cost funds that generally track an index, which can be broad, like the S&P 500, or more narrow, like the S&P Global Nuclear Energy Index. A big difference between ETFs and mutual funds, however, is that ETFs trade on exchanges like stocks and fluctuate in price during the day. They are becoming a popular way to invest because of their low cost and ease of trading.
More from U.S. News
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12 Financial Terms Every Investor Should Know originally appeared on usnews.com
