Many Find the Language of Investing Confusing

By RUSS WILES

Aug. 7, 1994 12 AM PT

RUSS WILES, <i> a financial writer for the Arizona Republic, specializes in mutual funds</i>

One of the main reasons many people find mutual funds confusing probably has to do with the language of investing.

We’re not talking about simple terms and concepts here. Many financial words and phrases are fairly challenging. A few lie somewhere between vague and misleading. Consider the following examples:

* “Securities.” This is one of the most basic financial terms, but it’s a confusing one. Generally speaking, a security is a paper-based investment, typically regulated by the U.S. Securities and Exchange Commission--things like stocks, bonds and mutual funds but not real estate or rare coins.

What makes the word troublesome is that there’s nothing especially “secure” about most securities. Even the prices of U.S. government bonds can gyrate wildly. But some of the safest financial instruments around--namely, government-insured bank accounts--aren’t securities.

* “Value-added.” This seems to be a favorite term among many brokers and financial planners looking for ways to justify the commissions they charge. Example used in a sentence: “We offer a value-added approach that you just can’t get with the discounters and no-load funds.”

However, most securities (see above) are essentially the same, whether purchased through a full-service or discount brokerage or managed by a load or no-load fund family. What “value added” usually boils down to is “advice and hand holding through scary markets,” two legitimate services provided by brokers, even if they don’t like to phrase them as such.

* “No load.” Too bad this term is a double negative, because the concept behind it is great. No-load mutual funds are those that can be purchased directly by do-it-yourself investors who don’t feel they need the value-added help (see above) offered by a broker, and who thus want to avoid paying a sales charge.

In other words, no-load funds are “commission-free” products, a more telling and upbeat description.

* “Net-asset value.” This is merely a fund’s price per share, excluding any load (see above), if applicable. How “price” got transformed into “net-asset value” can only be explained by the fact that the mutual fund industry is run by securities (see above) lawyers. By now, you should be noticing how all of these financial terms fit together.

* “Non-diversified fund.” Studies have shown that with as few as a couple of dozen stocks, you can achieve a decent amount of risk-reducing diversification. So how can it be that some mutual funds might hold two or three dozen stocks yet still be branded as “non-diversified”--a dirty word in the business.

Again, the answer lies with those pesky securities lawyers, who follow an arbitrary definition of mutual fund diversification that is too complex to be cited here.

Suffice to say that “non-diversified” funds aren’t necessarily riskier than diversified funds. Most such portfolios hold at least a couple of dozen stocks; above that level, factors such as the types of stocks held and management’s competency weigh much more heavily than the actual head count.

* “Fixed income.” This phrase describes bond market investments. It’s misleading because not all such investments pay a fixed rate of income--zero-coupon bonds, mortgage-backed securities, bonds denominated in foreign currencies and bond mutual funds spring to mind.

And with the exception of government bonds, any fixed income you receive certainly isn’t guaranteed. Worse, you might assume that the “fixed” part also applies to your principal--a dangerous assumption.

* “Closed-end.” Technically, regular mutual funds are called “open-end” funds because they must stand ready to accept new investors or cash out existing shareholders. Closed-end funds, by contrast, don’t deal with the public in this manner. They issue a fixed number of shares in a single transaction, after which investors essentially do their buying and selling from one another in the stock market. Depending on the confidence in the fund managers, the shares may sell above or below the current value of the underlying shares.

The terminology gets hairy when you consider that closed-end portfolios are always open, in the sense that you can always purchase shares that somebody else has to sell. But open-end funds sometimes “close,” or shut their doors to new buyers. This happens when the portfolio manager fears the fund might get too big to run effectively.

Thus, you may encounter a closed open-end fund, but not a closed closed-end fund.

* “Emerging markets.” This euphemism almost certainly was dreamed up by some mutual fund company’s marketing department.

Emerging markets are Third World stock exchanges that have been noticed within the past few years. These markets tend to be situated in countries where the inhabitants have finally discovered the joys of paved roads and telephones--the communications theme is always big with emerging-markets fund managers.

In fairness, many developing economies are growing rapidly, which makes them good places to invest a portion of your long-term money. But the “emerging-markets” nomenclature glosses over the white-knuckle volatility that swamps these markets from time to time.

Once you master the nuances of investment English in terms such as these, you will be halfway there. Unfortunately, the second half is a bit more troublesome--it involves mutual fund math.

Test Your Vocabulary

Think you could define most key mutual fund words and phrases, or at least well enough to survive a cocktail party discussion? Try out your skill on the following terms.

1. “Dollar cost averaging” is:

(a) a popular method of investing fixed sums on a regular basis

(b) a method global stock funds use to calculate gains and losses

2. “Portfolio turnover” is the rate at which:

(a) investors enter and exit a fund

(b) a fund buys and sells stocks or bonds

3. The “break point” is the point at which:

(a) investors give up and sell their shares

(b) the fund company gives up and closes a fund

4. In investing, “bottoms up” would describe:

(a) the approach of a manager who tries to time the market

(b) the approach of a manager who buys promising stocks without worrying about the market’s direction