November is financial literacy month! Exciting right? Okay, maybe it’s just exciting for those of us who blog about money, and for those who are trying to make money.
Managing our money is hard enough so it’s no surprise that many of us glaze over when we hear money terms in the news that makes no sense to us. Asset allocation? equities? fixed-income? What? What? It’s all getting lost in translation so here’s a list of money terms you need to know.
Money terms you should know
Compound Interest – When it comes to investing compound interest is your best friend. Interest is what you get when you deposit money, compound interest is the interest you get on your deposit amount plus the interest you already earned. The earlier you invest your money, the more time it has to compound.
Equities – This represents something you have ownership in; this generally refers to stocks when referring to investments. Equities are considered risky since their value can go up or down at a moment’s notice. With greater risk comes greater returns.
Fixed-Income – Unlike equities, fixed income assets are safe since they pay a set amount at certain intervals. Fixed-Income assets include; bonds, guaranteed investment certificates (GIC’s), treasury bills and cash. Since fixed-incomes are very safe, the returns on your investments are limited.
Risk Tolerance – If you want your investments to grow you need to take on some risk, but how much risk are you willing to take on? Would you still be able to sleep at night if your money dropped in value 20% overnight? Understanding what you’re getting into is basically risk tolerance. Be realistic, the last thing you want to do is freak out and sell at the wrong time.
Asset Allocation – This is the balance between your equities and fixed-income, or risk and return. There’s no set formula here but generally speaking the younger you are, the more risk (equities) you should have since you have plenty of time to recover in case of any market drops. On the other hand, the closer you are to retirement the more fixed-income you should have since you can’t really afford to take a big hit to your portfolio.
Indexing – Stock picking sounds sexy but let’s be honest how many of us would know what to pick. Indexing is an investment strategy where you’re (well a computer is) basically buying the entire market instead of one individual stock. No one ever got rich off indexing but it’s a solid strategy that has been proven to beat active investing (mutual funds).
Time Frame – This refers to when you need your money so you can set your asset allocation accordingly. It’s not just retirement we’re talking about, say you plan on buying a home in 5 years, well investing your money in high risk equities is probably a bad idea.
Diversification – This is where you have different types of investments to reduce risk. This way if one of your investments falls in value you are protected from your other assets. Putting all your money into real estate and having no other savings is an example of not being diversified.
Rebalancing – Rebalancing is when you adjust your portfolio to realign with your intended asset allocation. E.g. say your targeted asset allocation is 70% equities and 30% fixed-income. Well your stocks did well and now your asset allocation is sitting at 80% equities and 20% fixed-income. You would then sell 10% of your equities and buy 10% of fixed-income putting you back at your intended target of 70/30. This strategy keeps you to your plan, and you’ll end up selling high and buying low.
Market Timing – Trying to predict how markets will do and investing based on those predictions is market timing. It’s impossible to time the markets so you should avoid this at all costs.