Glossary of Investment Terms
* Actively managed funds. A mutual fund in which the fund manager is allowed to use his or her discretion to buy, sell or hold investments in the portfolio.
Most funds are actively managed. Depending on the bylaws of the fund, the manager may have broad leeway in determining how the fund’s assets should be invested.
* Balanced funds. Sometimes called “hybrid” funds, balanced portfolios are a type of mutual fund that invests in a combination of stocks and bonds.
Because they invest in fixed-income securities in addition to stocks, balanced funds are considered safer and more conservative than pure equity funds. That’s one reason why balanced funds are commonly found as an investment option with company-sponsored 401(k) retirement plans.
Traditionally, balanced funds invest approximately 60% of their assets in stocks while keeping the remaining 40% in bonds. However, as investors have become more and more aggressive--and as stocks have skyrocketed in value over the past decade--many balanced funds have upped their exposure to stocks.
* Basket securities. An umbrella term used to describe securities that give investors exposure to an entire portfolio of stocks through a single purchase--much like a mutual fund. As a result, many view basket securities as competitors to funds.
Unlike traditional open-end funds, though, basket securities are exchange-traded. That means investors can buy or sell shares throughout the day--not just once a day at the market closing price.
To invest in a basket security, you must have access to a brokerage account. And this means each time you make a transaction with a basket security, you will likely be charged a commission.
The best-known and oldest forms of basket securities include Standard & Poor’s Depositary Receipts, a type of exchange-traded unit investment trust that are referred to as “spiders,” and World Equity Benchmark shares, commonly known as WEBs.
* Blue chips. A nickname for big, established companies such as those found in the Standard & Poor’s 500 index of large stocks.
* Concentrated funds. Also referred to as “focused” funds. Concentrated funds tend to invest in relatively few stocks in hopes of generating outsized gains.
While the average domestic stock fund invests in 143 stocks, a concentrated fund may invest in only 20-40 of the fund manager’s “best ideas.”
Historically, investing in concentrated funds was considered dangerous. * Diamonds. A nickname for a type of investment trust, or basket security, whose holdings represent all 30 blue chip stocks in the famed Dow Jones industrial average.
Diamonds let investors buy or sell shares of all 30 companies in the Dow as if they were a single stock. While there are mutual funds that give you similar exposure, those funds cannot be traded intraday.
Diamonds (ticker: DIA) are listed on the American Stock Exchange. At any moment in time, shares of Diamonds will be priced at approximately 1/100th of the value of the Dow industrials.
* Diversified funds. A mutual fund that invests in a wide array of different types of stocks. Unlike concentrated funds, diversified funds tend to invest in a large number of holdings--often more than 100 securities--to reduce risk.
* Dividends. Payments that corporations distribute to shareholders.
While companies have historically used dividends to entice shareholders to buy their stock, fewer and fewer firms today are paying out dividends, choosing instead to use the capital to money to back shares or to reinvest in the company.
Within the mutual fund industry, several funds have been designed to invest only in dividend-paying companies--or in companies whose dividends have consistently grown over time. Because it takes cash to pay out dividends, rising dividends has always been seen as a sign of a healthy balance sheet.
* Enhanced funds. These funds try to deliver 125%, 150%, or sometimes even 200% of the movements of a particular market index.
These funds typically achieve this “enhancement” by investing in the stocks found in a particular index--and by investing some of the fund’s assets in futures contracts and options on futures contracts.
* Equity-income funds. A conservative type of stock fund that seeks out dividend income as well as capital appreciation. These funds are often associated with “value” investing.
The terms “equity-income,” “growth and income,” “growth” and “aggressive growth” are part of an old mutual fund classification system that Lipper Inc. popularized decades ago. In recent years, though, many mutual fund shareholders began using a competing system created by Morningstar Inc. that categorizes funds based on the size of the stocks a fund holds as well as the fund manager’s investment style.
* Exchange-traded funds. A new breed of basket security.
ETFs are open-end stock index funds whose shares are listed on an exchange--and thus can be bought and sold intraday like a stock.
ETFs are not to be confused with older “closed-end” mutual funds. Because they have a fixed-number of shares outstanding, closed-end funds have two share prices: one that represents the true value of the underlying portfolio, and the market price of the security, which can be far above or below the true portfolio value depending on investors’ interest, or lack thereof.
* Growth funds. Stock mutual funds that seek out shares of high-flying companies with rapidly expanding earnings and/or revenues.
* Growth and income funds. Diversified funds that seek out both growth and dividend income.
Because these funds invest some of their assets in dividend-paying companies, they have historically been viewed as more conservative than pure growth funds. However, because of the demise of dividend-payouts, many growth and income funds are becoming de facto growth funds.
* HOLDRs. A type of basket security created by Merrill Lynch to reflect a specific basket of stocks.
In addition to the two original HOLDRs--one representing a basket of 20 Internet stocks (ticker: HHH) and another reprenting 20 biotechnology stocks (BBH)--several others have been created.
Unlike other basket securities, in which the shareholder owns units of a security that reflect and track a basket of stocks, HOLDRs give you actual beneficial ownership of the underlying stocks in the basket.
The advantage: It takes only one trade (and commission) to buy all those stocks. And when it comes time to sell the HOLDR, you can sell the security outright for cash or receive ownership of the underlying stocks.
There’s an inherent tax advantage with this structure, analysts say. For instance, merely redeeming the HOLDRs--and accepting the underlying stocks--is not a taxable event. You’ll only be hit with taxes when you sell any of the underlying securities at a profit.
* Index fund. Passively managed portfolios that simply track an existing stock market benchmark, such as the Standard & Poor’s 500 index of blue chip stocks.
For instance, the Vanguard 500 fund, which popularized index investing over the past 25 years, simply buys all 500 stocks found in the S&P 500 and holds them in exact proportions. Only when adjustments are made to the underlying index will Vanguard 500 sell or replace any of its holdings.
The advantage: Because it takes relatively little work to manage an index fund, these portfolios are often extremely inexpensive when it comes to their annual expense ratio. The disadvantage: If the market tumbles, the fund manager is not allowed to try to cushion the fall by making discretionary investments.
* Managed accounts. Also referred to as “separate accounts.”
These accounts are designed for high-net-worth individuals--those with at least $500,000 to $1 million in investable assets. In a managed account, individual investors buy the services of a professional money manager, who invests money for them.
Unlike a mutual fund, in a managed account, you are the sole shareholder. Therefore, the buying and selling activities of fellow shareholders will not affect the way your portfolio manager invests. For instance, if fellow shareholders redeem shares in a regular mutual fund, the fund manager may be forced to sell some of his or her holdings, triggering capital gains taxes.
Managed accounts are considered attractive because they are tax efficient. Also, within a managed account, you can often dictate your manager’s investment strategy.
* Market-neutral funds. A type of stock fund designed to make money whether the stock market advances or declines. These funds do this by placing equal and simultaneous bets on and against the market. For instance, if a market-neutral manager invests $5,000 in Intel, he or she might short Advanced Micro Devices by the same amount to hedge his or her exposure to semiconductors.
* Momentum investing. An investment strategy in which investors pile into stocks that have already gone up, on the bet that they’ll keep going up. The idea being, money that flows into stocks that have already done well will keep them doing well for some time. The danger is, it’s impossible to predict when momentum shifts.
* New economy funds. A term that refers to funds that invest in a cross section of technology, telecommunications and other stocks that stand to benefit from the developing technology- and information-driven economy.
* QQQ shares. A nickname--and ticker symbol--for shares of the investment trust, or basket security, that represents all the stocks in the Nasdaq 100 index (representing the largest non-financial stocks in the Nasdaq composite index).
Like Diamonds and SPDRs, QQQ shares can be bought and sold intraday. Each share is priced at approximately 1/40th the value of the Nasdaq 100.
* Sector funds. Mutual funds that invest in a single sector of the economy--such as financial services, health-care, technology or utilities.
* Self-directed brokerage window. An investment option within a company-sponsored 401(k) retirement plan or similar account that gives the investor access not just to a single mutual fund, but to a discount broker.
Through this investment option, a plan participant can use his or her retirement savings to invest in thousands of stocks and hundreds of mutual funds or hybrid investment products.
* Short funds. Mutual funds that make bets that the stock market (or at least certain stocks) will fall in value--and then try to profit from those losses.
Some funds do this by actually “shorting” a stock. Short selling is the reverse of the more typical buy-low, sell-higher approach to investing. Here, you borrow a security from a brokerage and then sell it on the open market. When the price of the stock tumbles, you can then “repurchase” the security, hopefully at much lower prices. You then return the security to the brokerage, pocketing the difference the higher price at which you borrowed the shares and the lower price at which you repurchased it.
Other short funds achieve similar results by investing in futures contracts or other securities.
* SPDRs. Short for “Standard & Poor’s Depositary Receipts.”
Commonly referred to as “spiders,” these exchange-traded securities represent all 500 stocks in the Standard & Poor’s 500 index of blue chip stocks.
SPDRs can be bought or sold throughout the day, unlike S&P 500 index mutual funds.
Like other basket securities, SPDRs (ticker: SPY) are listed on the American Stock Exchange. At any moment in time, shares of SPDRs will be priced at approximately 1/TKh of the value of the S&P 500.
* Tax-managed funds. A growing breed of stock fund that seeks capital appreciation--but tries to do so in a tax-efficient or tax-managed way.
For instance, if a tax-managed fund decides to sell a stock it has owned for, say, 360 days, it might hang on for a week longer to ensure that profits on the investment are taxed as less expensive long-term capital gains rather than as short-term gains. Or if the fund wants to sell a winning stock, it might simultaneously sell a losing stock in the portfolio to match up--and therefore offset--gains with losses.
* Twice-daily pricing. The vast majority of funds price once a day--at the market close. That means if investors want to buy or sell shares of a fund, they can only do so once a day, at the day’s closing price.
* WEBs. Stands for “World Equity Benchmark shares.”
Think of them as exchange-traded index funds that reflect the stock market of a single country. Currently, there are 17 WEBs representing the markets of developed countries ranging from the Australia to the United Kingdom. Currently, there are plans to create several new WEBs that will track various emerging markets indexes.
* Wrap accounts. See managed accounts.
