Five financial industry terms explained in plain English
By Trisha Qualy
I traveled to Nicaragua when I was 19. While I had spent 4 years learning Spanish, it was hard for me to understand questions as basic as “¿De dónde eres?” or “¿Qué hora es?”.
Let's fast forward several years later to my first time at a craft brewery. Hops, barrels, growlers, fermentation, oxidation, IPAs, IBUs, ABV....whaat? There was more jargon at the bar than in a computer science textbook.
Most things that are foreign (read: out of your ordinary) are, at first, hard to understand. But familiarity and confidence can come with practice. Here are five terms that often come up in the financial industry explained in plain English:
- Time horizon - How long an investment will be held before cash is needed. If you are saving for retirement, your time horizon might be 20+ years. If you are saving for a down payment, perhaps your horizon is 2-5 years. Objectives determine time horizon, so horizons are unique to each investor and to each reason for investing.
- Risk tolerance - The level of variability of investment returns (in particular the ups and downs) an investor can tolerate. If you had $1,000, would you be comfortable losing $300 to potentially gain $400? Or would you rather only lose $100, but only gain $120? Risk tolerance is particularly important when the market is going down. If you have invested outside of your tolerance, you might panic and sell at an inopportune time.
- Asset allocation – An investment strategy that tries to balance risk and reward. The portfolio is set up according to goals, time horizon (see above), and risk tolerance (also see above). Since different investments (assets) have different levels of risk, portfolios can be split up (allocated) appropriately to the individual investor.
- Diversification - Be careful of putting all of your eggs in one basket! If you use all of your money to buy one stock, your portfolio is not diversified. If you split your money up and buy smaller portions of different investments, you diversify your portfolio.
- Expense ratio - The amount the investment company deducts from the annual return for operating a fund. For example, if fund ABCDE has a 5% market return and the expense ratio is 1.3%, the investors of the fund will get a 3.7% return. If fund ABCDE had an expense ratio of 0.5%, the investors would get a 4.5% return.
Your homework? Use each term in a sentence with context that is unique to your own financial situation. Then, share the sentences with a friend, a family member, or even your financial advisor. Explain each term and pass on your new knowledge. Cheers to you for adding to your financial vocabulary!