Financial Terms Every Beginner Investor Needs to Know
Do you know your ETFs from your NFTs? Here is how to make sense of all that finance-related jargon.
Talking finances can sometimes feel like a jumble of letters and numbers—from 403(b)s and 401(k)s to IRAs and ETFs—which can be a little off-putting for the beginning investor. You don’t need a degree in finance to take the first steps toward investing, so this is a great place to start! This is a list of some of the most common financial terms so you can get started on the road toward building your wealth.
Stocks
Stocks are small portions of ownership in companies that you can purchase on the publicly traded stock markets, such as the New York Stock Exchange. For most people, stocks are the primary asset they invest in as they can generally be relied on to provide strong returns over time. As the value of the company increases, so will the value of your portion of ownership in that company – your stocks. You are free to buy and sell stocks as you please, but holding them as long-term investments is usually the safest option to help guarantee positive returns.
Bonds
Bonds allow you to loan your money to a company or government that will pay you a set amount of interest. The rate of return you receive on your investment depends on the economy at the time of investing, how risky the investment is, and how creditworthy the entity you are loaning money to is. Bonds will generally be low-risk investments, and as a result, they currently pay around 2-2.5% interest in Canada and the US, with interest generally paid out every six months. You can also buy into bond funds, which are like mutual funds. They allow you to buy into a pool of different bonds.
401(k)s, 403(b)s, and RRSPs
All these numbers and letters are different forms of retirement accounts that allow you to defer your taxes – 401(k) and 403(b) are US retirement accounts, and an RRSP is the Canadian equivalent. The money in these accounts grows with taxes deferred until you take it out for retirement or if you really need to withdraw some before then. However, if you do withdraw before retirement, you may face:
- Penalties you have to pay depending on the reason for the withdrawal (US)
- Loss of contribution room equal to the withdrawal amount (RRSP)
The most notable difference between 401(k)s and 403(b)s:
- Most private employers use 401(k)s. Often companies offer a 401(k) matching program where your employer pitches in some money to match a portion of what you’re contributing.
- 403(b)s are for nonprofits, schools, and government organizations and come with benefits such as reduced fees.
RRSPs are quite different from the US versions, so check out the RRSP-specific blog and the Investing 101 course for more information.
Roth IRAs and TFSAs
IRA means Individual Retirement Account—so it is money you can put aside for your retirement. Conversely, a TFSA is a Tax-Free Savings Account, so it is not intended for retirement, although you can use it for that purpose if you want to.
Neither of these accounts offers tax benefits now, but you can withdraw the money you make on your investments inside them tax-free when you retire. You won’t pay taxes on any capital gains, interest earned, or dividends from assets within these accounts. TFSAs are more flexible regarding withdrawals because you can withdraw from them at any time, whereas you usually have to wait until you retire with Roth IRAs if you don’t want to pay any penalties.
Mutual Funds and ETFs
Mutual funds are a way to invest in many different companies at once, helping you diversify your investment portfolio regardless of how much you have to invest. When investing in mutual funds, you get a fraction of each of the investments in the mutual fund. However, you will have to pay high fees for investing in mutual funds because they have people managing them.
ETFs are similar to mutual funds because they too allow you to buy shares of a large pool of companies in a single, lower-priced share. You often pay considerably less in management fees for ETFs than for mutual funds, and you can invest in them through the stock market.
Dividends
A dividend is a portion of a company’s profits paid out to shareholders. The amount paid out varies depending on the company’s performance. There are many different classifications of dividends, but it is important to know that no company is legally required to pay any dividends. The type of stock you own in that company determines who gets paid dividends first if they are declared.
Cryptocurrencies
There is a lot of buzz about this new type of investment. Cryptocurrencies are digital money systems that aren’t connected to or controlled by any government, making them easy to move. They also have the same value worldwide, so using them to make purchases avoids having to do foreign currency exchanges.
Bitcoin and Ethereum are the two most popular cryptocurrencies currently, but there are plenty of others. These currencies are one of the most volatile forms of investment, so you should know that before entering into the market if you choose to do so.
Major Takeaways:
- Stocks are the most popular choice of security to invest in due to their generally reliable strong returns. Bonds are less risky because they guarantee a return, but as a result, the returns are lower than what you can make from stocks.
- 401(k)s, 403(b)s, and RRSPs are accounts meant to help you save for your retirement. They allow you to defer paying taxes until you withdraw from them.
- Roth IRAs and the TFSA are accounts you can invest in that allow you to withdraw money from them tax-free.
- Mutual funds and ETFs allow you to invest in many different companies at once – mutual funds are managed by people, and you pay higher fees. ETFs are usually passively managed and thus charge much lower fees.
