You are thinking to start investing, but you don’t have a financial background. You may try to read some informatory articles, but there’s so many unknown terms that are making the subject harder to understand. Learning how to invest successfully is not easy, but there are ways to predict safe returns without so much previous knowledge.
If you really don’t want to learn anything and you have cash at your disposal, hiring an investment manager might be an option. However, knowing the basics is valuable even in this case, in order to choose the right advisor.
If you never invested, I recommend you understand certain terms, to understand why and which of the numbers presented are valuable to you based on your investment goals.
Starting with the basics, investments represent the allocation of an asset with the expectation of a future benefit, such as profit. Assets can range from money to physical items such as luxury goods. Trading represents the action of buying or selling the asset with the intention of personal gain.
Financial markets are acting as a bridge between the lender and the borrowers. Investors, who have money, wish for better yields and returns, at a higher risk. On the other hand, borrowers need access to capital. The trade between the two is the main driver of the financial markets.
These are the financial instrument categories you’ll be trading. They can vary a lot, but below are described the primary categories.
- Fixed income - This brings most business to traditional banks. It involves getting interest from lended money. People need to borrow, while others want to profit from borrowing.
- Equity - represented by stocks and their derivative products. Stocks are an investment in a company and that company's profits.
- Investment Banking (IBD) - they deal mainly with corporate finance. This involves raising capital, initial public offerings (IPO), mergers and acquisitions of other companies. If you’re starting out, you shouldn’t worry about this category!
- Alternative investments - financial assets that don’t fall into one of the conventional cash, income or equity categories. They can range from property, commodities to luxury items or cryptocurrencies.
Forces in the financial world
Of course, you could trade on your own, but if you want to protect yourself and perform the action through a regulated market, you’ll probably deal with one or more of the following players.
- Commercial banks offer a large range of services such as deposits, loans and safeguarding assets, for both individuals and businesses.
- Investment banks provide services to large corporations and institutional investors.
- Asset managers help individuals and businesses perfect their financial strategies.
Below are a few basic terms you should get familiar with when investing. Each of these have theories and KPI’s built around them. Based on how you’d like to invest - short term or long term, safely or risky - you can research further to see which metrics are most important for your strategy.
- Securities refer to financial instruments that hold some type of monetary value, which one owns. It can represent ownership over anything that is being traded, from stocks to gold or luxury goods.
- Issuers are legal entities that register and sell securities to finance their operation.
- Volatility is a rate at which the price of a security increases or decreases for a given set of returns.
- Appreciation is the amount or percentage an asset’s value has grown in a certain time frame.
- Yield is the income returned on an investment, such as interest or dividends.
- Market capitalization refers to the total dollar market value of a company's stocks, calculated by the amount of stocks on the market multiplied by the stock value.
- Dividend is a distribution of profits by a corporation to its shareholders, paid at a certain payout ratio (e.g every quarter). Company boards choose before each payout if and how much of the profit is allocated to dividends.
- Holding period is the time between the purchase and the sale of an asset.
- A bear market is when a market experiences prolonged price declines, generally of more than 20%.
- Due diligence is the act of examining the current state of a fact (e.g. a financial record) or hypothesis (financial models/estimations) in order to confirm the correctness of the information provided.
The financial world is complicated. If we wanted to, we could probably write full books of terms and formulas. I believe humans have evolved to make calculated decisions with limited information on hand, even if the decision is as small as knowing an expert is needed. At the same time, it should also be enough to understand what to look for when reading investment specifications. I do hope this small glossary is a good first step in your path to becoming a successful investor.