Investing 101
If you’re new to investing, you will likely come across terms that are unfamiliar to you. Even if you have experience with investing, you may have a general idea what a word means but aren’t sure of the exact definition. You might find it helpful to bookmark this page so you have easy access to definitions when you need them.
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Glossary
Diversification is a risk management technique that mixes a wide variety of investments within a portfolio. A portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.
ETF1 is an acronym for Exchange Traded Fund. Unlike mutual funds, an ETF is a fund that trades like a common stock on a stock exchange, similar to the way stocks are bought and sold throughout the trading day. ETFs typically have higher daily liquidity and lower fees than mutual fund shares. Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated once at the end of every day like a mutual fund does. Instead, its price varies throughout the day.
A formula designed to create a mix of assets in an individual’s portfolio that will become more conservative as a specific goal, such as retirement, approaches. The objective is to manage assets in a way that captures opportunity (by taking on greater risk) in the early years of the investment time horizon, and then reduces risk as the date of retirement approaches to preserve accumulated wealth.
Transferring specific investments from an account held with one financial institution to an account at a different financial institution without actually selling the investments. For example, if you wish to retain ownership of a particular mutual fund held in an existing account, you can request a “transfer-in-kind” of the fund’s shares to your account from another custodian.
Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted due to the intervention of random variables. One way to employ a Monte Carlo simulation is to model possible movements of two components of asset prices: drift, which is a constant directional movement, and a random input, representing market volatility. Historical price data can be analyzed to determine the drift, standard deviation, variance and average price movement for a security.
Rebalancing is the process of restoring a portfolio to its target allocation. Different asset classes will experience different levels of performance over a specific period of time, sometimes referred to as “drift”. As a result, a portfolio may end up overweight in one asset class and underweight in another asset class. To bring the portfolio back to its target allocation, assets are adjusted and rebalanced by selling a portion of the asset that is overweight and purchasing more of the position that is underweight.
Tax efficient investing refers to the practice of making investment decisions that minimize the impact of short-term (assets held less than one year) and long-term capital gains and losses which are often taxed at different rates (per the IRS tax code). This practice is most frequent in taxable investment accounts, where consideration is given to hold positions with gains at least a year to get favorable tax treatment, and selling positions with a loss to offset positions sold for a gain. Note that the tax implications of buying or selling a position is only one of many considerations for maximizing an investors overall return.
A strategy to sell securities that have lost value to help reduce taxes on realized capital gains. Capital gains are realized when an investment position is sold for a profit – or when a fund or ETF sells securities for a gain – and passes the earnings on to the individual shareholder. Tax loss harvesting offsets those gains by selling positions at a lower price than what was paid for those assets.
A wash sale is a transaction where an investor sells a losing security to claim a capital loss, only to repurchase it again for a bargain. Wash sales are a method investors employ to try and recognize a tax loss without actually changing their position. The effectiveness of this strategy has been greatly reduced with the implementation of the IRS 30-day wash rule, where a taxpayer cannot recognize a loss on an investment if that investment was purchased within 30 days of sale (before or after sale).