The world of finance and investing can often seem confusing, cluttered and in need of jargon busting. It needn’t be that way. At Nutmeg, we like to keep things as simple as possible. Investing should be interesting, engaging and easily understood. So we’ve put together a list of investment-related words and phrases and unpacked them, removing the jargon and clutter.
If there are any terms or phrases you’d like us to add to the list, tweet us @thenutmegteam.
There are different ways to manage investments. The active management approach (which is also called active investing) means the investment manager will use their knowledge of the financial markets to pick company shares they believe will increase in value. This approach also involves avoiding shares they believe will fall in price. Active managers tend to make lots of changes to their investments on a regular basis.
The opposite of active investing is passive investing, which is more about tracking the value of a wide range of investments, or an index of company shares such as the FTSE 100, over a given period of time.
You can invest your money in several ways. For example, stocks and bonds, commodities like gold and silver, even property – they’re all types of investments, or investment ‘assets’ (see Asset class below). Your asset allocation refers to the different types of investments you hold, and the proportion of each. You might have a portfolio that’s half company shares and half government bonds. That’s your asset allocation.
The mix of assets you should have in your portfolio depends on things like how much risk you’re willing to take and how long you plan to invest for.
An asset class is quite simply a type of investment, or an investment category. With so many different types of investments or ‘assets’ available, it helps to be able to sort them into groups.
The three main asset types are cash, stocks and shares, and bonds, but there are many others.
Bacs Payment Schemes Limited (Bacs), previously known as Bankers’ Automated Clearing Services, is the organisation that oversees the clearing and settlement of UK automated payment methods – commonly known as direct debits.
Founded in 1968, Bacs facilitates payments from wage and benefit payments to household bills and charity donations made by direct debit.
A bear market refers to a general decline in the stock market over time. Investors tend to define it as when the value of the market falls by 20% over the course of at least two months.
A lack of confidence sees people selling shares, pushing stock prices down and creating something of a vicious circle. A bear market followed the Wall Street Crash in the 1920s and, more recently, in 2007 because of the global financial crisis.
The bid-offer spread is the difference between the bid price for an asset and the offer price for that asset. The bid is the price at which you can sell the investment, the offer is the price at which others can buy it. The difference is what’s known as ‘the spread’. Why are they not the same? Because this is how the market maker, the organisation selling those shares to you and buying them from you, makes their money.
It’s like the buy and sell prices you may see at a foreign exchange counter when you get your holiday money. Say you’re buying £1,000 in euros. When you buy it, you’ll pay the offer price, let’s assume it’s €1.30 – giving you 1,300 euros in total. If your holiday was then suddenly cancelled and you had to switch your euros back to pounds, you’d switch it at the bid price. As the bid price is usually lower than the offer price, it’s unlikely you’d get your initial £1,000 in full at the exchange kiosk.
If a share’s bid price stands at 99p, and the offer price is 101p, the bid-offer spread would be 2p. Buying shares with a low bid-offer spread is important when investing as it minuses the value you can potentially lose when you decide to trade your investments.
This is one of the reasons we favour using exchange-traded funds (ETFs) – they generally have a low bid-offer spread, and they can be traded easily and quickly at high volume.
There are two types of bonds: corporate bonds and government bonds. Corporate bonds are issued by companies, government bonds are issued by governments.
Companies often need to raise money to pay for things such as new factories and machinery. One way of doing this is to issue corporate bonds. Investors can buy these bonds and in return for handing over money for an agreed number of years, they’ll receive their money back, plus guaranteed interest when the bond ‘matures’.
Governments do the same thing, to fund a new motorway project for instance. Bonds issued by the UK government are also called gilts.
The guarantees offered with corporate and government bonds are different. For example, if a company goes out of business, its corporate bond holder can only be paid out from the assets that remain, which may not be enough to cover their initial investment.
When investors feel particularly confident about the economy and expect companies to perform well, share prices will often rise. A bull market refers to a period of extended stock market growth and an overall feeling of optimism. Investors commonly refer to a bull market when the value of the stock market has risen by 20% for a period of two months or more.
Capital gains tax (CGT)
In general, people buy shares with the aim of selling them for more than they paid. If you manage this successfully and make a profit, you experience a ‘capital gain’, something you may need to pay tax on.. This tax is known as capital gains tax (CGT).
Whether you’ll need to pay CGT on your investment gains will depend on how much money you make. It also depends on the tax efficiency of your chosen investment. You don’t pay CGT on ISAs, personal equity plans, UK government gilts and premium bonds.
Wheat, livestock, oil, gold and sugar are all types of commodities. They are raw materials that are used to create a range of consumer products. Commodity investors study the markets for these products with the aim of predicting how prices will change in the future. Historically, the price of commodities has been very volatile, responding quickly to changes in the political and economic environment.
Compounding, compound interest, compound returns
Compounding is all about earning interest on your interest (or returns on your returns), rather than just on the original money you invested. The power of compounding can have a huge effect on your investment returns. If you don’t make withdrawals and let your returns mount up over time, the knock-on effect can be substantial.
For example, put £1,000 in a savings account with an interest rate of 5% for one year and you’ll earn £50. Withdraw that interest and the next year you’ll earn the same amount. However, leave the interest where it is and in the second year, you’ll earn £52.50 in interest. Not a huge amount more but that’s £2.50 you haven’t had to work for. Keep adding to your savings, leave the interest untouched and over time the effect increases with every year and can be ultimately very significant.
Corporate bonds are used by businesses to raise money. The investor hands over a lump sum for an agreed period and in return receives a fixed rate of interest. The original investment should then be paid back, but if the company goes out of business, the investor could potentially lose out. (See Bonds)
A derivative is a type of financial contract. The contract is about a particular investment – it could be the price of a company’s shares, for example. You can also have derivatives that are tied to bonds, commodities, interest rates and currencies.
Once a derivative is in place for a particular investment, investors then try to make money by correctly forecasting whether the value of the investment in the contract will go up or down.
Diversification is all about not placing all your eggs in one basket. Owning a variety of investments, whether they’re shares, property or bonds, will ensure you’re not facing too much risk from a particular area. If one investment falls in value, it shouldn’t spell disaster as you’ve got money invested elsewhere.
Maintaining a diverse portfolio of investments helps to manage risk and reduces the impact of prices dropping in any one area of your portfolio. It also means you can benefit from investment gains across many different investments.
Diversification can be across investment types – such as bonds, stocks and commodities – but you can also diversify across different industry sectors, currencies and countries.
Dividend payments are often made by companies to their shareholders once or twice a year. These payments are the shareholder’s ‘share’ of the company’s annual profits. The amount you’ll receive depends on how many shares you hold. People buy shares in companies not just to make a return by selling them at a higher price in the future, but also to receive a regular dividend.
Emerging markets are developing nations, whose economies are deemed by investors to not yet be fully developed, but where strong economic growth is predicted for the future. The most well-known emerging market economies are China, India and Brazil.
Investors monitor emerging markets closely because companies in these nations can increase in share price very quickly – off the back of good economic growth in the region or increased global trade. However, they can also experience large decreases in share price too, which is why emerging markets are often see as quite volatile and best suited to high-risk investment strategies.
‘Equity’ is quite simply another name for company shares. Equities are popular with investors who are looking to make more money than they could through savings accounts or bonds, provided they’re prepared to accept more risk as a result.
Exchange-traded funds (ETFs)
Exchange-traded funds (ETFs) contain many individual investments and can span many different asset classes. They could, for example, contain shares in hundreds of Japanese companies, or be linked to the S&P 500, which is the stock market that tracks the 500 largest businesses in the US.
The aim of an ETF is to reflect the performance of a whole section of the stock market so your money is not dependant on the fortunes of just one company or investment type. They are a good way of spreading your money across a high number of investments, to help spread risk.
ETFs can be bought and sold just like individual shares, making them highly accessible to small investors. At Nutmeg, we favour using ETFs to build our customers’ portfolios because they are cost-effective to trade and we can trade them quickly and easily at high volume. These cost savings can be passed onto you, allowing you to keep more of any returns you receive.
See our ETF guide.
FTSE, FTSE 100
FTSE is an acronym for the Financial Times Stock Exchange. Today, the FTSE manages lists of companies – known as ‘indices’ – trading on the London Stock Exchange to show how they’re performing. There are several lists: The FTSE 100, FTSE 250 and FTSE All-Share index are the most common and are all used to chart the fluctuations in company share prices over time.
Fund, fund manager
A fund pools together money from many people and puts it all into different types of investments. This can be a more cost-effective way to get your money into these investments because to do it all on your own, you may have to pay trading fees, admin fees and set-up fees each time. There are many types of funds: exchange-traded funds, passive funds, which are designed to mirror the ups and downs of an index like the FTSE 100, and actively-managed funds, where the fund manager will tend to make frequent changes to the investments in that fund to make a series of short-term profits.
Every investment fund has a particular objective, which could be steady growth or alternatively, high risks for potentially large rewards. And every fund has a fund manager. The fund manager is there to oversee and make new investments, with the aim of generating profit for the investors, while also sticking to the objectives of that fund.
Gilts is another name for bonds issued by the UK government (see below).
Regarded as one of the safest types of long-term investment, government bonds (gilts) are popular with financial organisations and private investors who want minimum risk, but a good fixed rate of annual interest. In effect, you provide a lump sum of money to help the government to raise cash. The original money invested is returned after an agreed period when the bond is said to have ‘matured’, along with the pre-agreed interest. Generally regarded as low risk, strictly speaking, government bonds are not risk-free investments, despite some people viewing them in that way.
Indices are a way for investors and analysts to collect together a group of different investments for tracking and analysis. An investment fund can be designed to mirror the investments in a particular index, either perfectly or partly. These funds are called tracker funds or index funds.
One of the best-known examples of a stock market index is the FTSE 100 – a collection of the 100 largest companies listed on the London Stock Exchange. There are lots of different indices like this around the world covering particular sections of the market, such as real estate and energy, or different countries, and different company sizes.
Investors use indices to get a bigger picture of economic growth and measure business trends. Investing in an index is popular because it means your money is invested in a number of companies rather than being reliant on the fortunes of just one or two, which can be a high-risk strategy. Other popular indices are the S&P 500 and the Dow Jones in the US, and the Dax in Germany.
The rate of inflation is the level at which prices for goods and services increase over time. It’s particularly important for savers and investors as inflation can impact interest rates on savings, along with the performance of companies and therefore share prices.
ISA, stocks and shares ISA, cash ISA
Individual savings accounts, commonly known by the acronym ISA, have been available in various forms since 1999 and offer a tax-free or tax-efficient way to save money. There are two main types: cash ISAs and stocks and shares ISAs.
Cash ISAs are just like typical savings account at your high street bank, but you’re not required to pay any tax on the interest you earn. With stocks and shares ISAs, money is invested and again there’s no tax to pay on any capital gains you might make. Download our ISA guide to find out more.
Modern portfolio theory
In short, modern portfolio theory is about aiming to build a portfolio that can offer the maximum possible expected return for a given level of risk. By efficiently combining assets, a risk-averse investor aims to maximise their return while reducing their risk. For example, by holding multiple risky assets which perform differently at different times, an investor may be able to reduce their overall risk and increase their reward.
OEIC, open-ended investment company
Open-ended investment companies (OEICs) are a popular way for lots of people to pool their money and invest in the stock market. They are a type of shared investment. By coming together with hundreds or thousands of others in a fund, small investors can get access to a much greater range of investment opportunities.
A passive investment strategy is used to attempt to track the performance of an index or pool of investments. The idea is to spread risk and create a portfolio that will mirror the performance of an overall stock market or index, usually over a long period of time.
Pensions are schemes that enable you to invest money for later in life. The idea is to build up a pot that will help to fund your desired lifestyle once you reach the eligible retirement age.
There are three main types of pensions: workplace pensions, where both you and your employer usually pay in a fixed monthly amount; personal or private pensions, where you pay in lump sums or monthly contributions as you see fit but there is no link to your employment status; and state pensions, which you contribute to in the form of regular national insurance contributions.
A portfolio is a collection of investments and can include anything from cash in the bank to stock market shares. How your portfolio is made up will affect everything from the amount of risk you face to the amount of money you might make, or lose.
Rebalancing is what you do to your portfolio to help keep it in line with your initial investment goals and the level of investment risk you’re comfortable with.
The best way to understand rebalancing is to look at an example. Imagine you start a portfolio with half of your money invested in shares and half in bonds to match your tolerance for risk. Over time, certain investments will perform well and others less so. Let’s say that your shares go up in value by 10% and your bonds fall in value by 5%. Overall, you’re in profit, which is great. But your portfolio has become imbalanced and no longer matches your desired risk level because you’re now overweight in shares – it doesn’t have the same 50/50 value of stocks and bonds as it did at the start. To get it back to its starting position, you need to sell some of your stocks and buy more bonds. This is where many investors struggle to stick to a disciplined approach because it is against their nature to sell the investments that have been doing so well for them and buy more of the ones that haven’t.
The term securities once referred to paper certificates sent out to investors as proof of an investment. Today, it is used more broadly as a way of describing the most common types of investments – from stocks and shares to commodities like oil and gold, and bonds.
An organisation that sells a security is known as the issuer. In the UK, the London Stock Exchange is the main domestic securities market.
These two terms are often used interchangeably. Strictly speaking, a stock is a share in a company. Investors generally aim to buy them at one price and sell once the value has increased. Stockholders or shareholders usually receive dividends once or twice a year, which are paid from the company’s profits.
Tracker fund (index fund)
Tracker funds are designed to track indices. They can be set up to track indices either perfectly – tracking every investment in an index, or partly – to track just part of an index with other investments also included.
Investing in a tracker fund is considered to be a form of passive investing.
A unit trust is a type of investment fund that contains many individual investments. While private investors can buy shares in companies on their own, funds such as unit trusts allow many people to come together to invest in stock markets around the world. Thanks to the number of people involved, they allow investors to spread risk and access an incredibly wide range of investments. The trust is split into ‘units’, hence the name, with different prices, and these are either created or cancelled as investors enter or leave the fund.
One of the most important lessons about investing is that prices can go down as well as up, and over time they generally will. The volatility of a stock relates to how much it rises and falls. Shares regarded as highly volatile are likely to experience major fluctuations in price over a short period of time, whereas the value of an investment said to have low volatility will tend to be far more stable and won’t be so prone to sudden and severe price changes. Investors prepared to risk investing in stocks with high volatility could potentially make a lot of money, whereas a stock with low volatility will usually offer slower growth but less risk.
A wrapper is another word for a financial product for your money. A wrapper is a way of consolidating a number of different investments so that they can receive a particular tax treatment – such as ISAs and pensions – or simply be administered and managed together. Depending on your investment goals, different wrappers could be suitable for you.
When reviewing a current investment or a new opportunity, investors will talk about yield. It’s a way of measuring how well an investment is performing and how it is expected to perform in the future.
In the case of cash in a savings account, it would refer to the annual interest you might get from your bank. In the case of shares, the yield would be calculated by adding up the value of any dividends paid out during the year and expressing that figure as a percentage of the cost of buying the shares in the first place.
For example, if you invested £3,000 in shares and received an annual dividend of £140, the yield would be 4.7% (£140 ÷ £3,000 × 100).
If you have any terms or phrases you’d like us to add to the list, tweet us @thenutmegteam.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance. ISA and pension rules apply. Tax treatment depends on your individual circumstances and may be subject to change in the future.