Q&A with a CPA: Investment Terms
Now that we know there’s no such thing as a “safe” investment, let’s take some time to define some of the terms you’ll need to understand to get started on saving for long-term goals like retirement or just plain old financial security. This week’s Q&A is on investment terms. Read on for an explanation of some of the more common terms you may encounter as you take charge of your investments.
Public Company: A corporation whose stock is traded on a stock exchange (such as the New York Stock Exchange (NYSE) or NASDAQ), allowing investors to buy shares of ownership in the company. When a company “goes public,” its original owners sell all or part of their stake in the company on the open market in the form of stock. Investors then buy and sell the shares of stock, which are traded daily.
For example, when Martha Stewart’s company (MSO) went public in 1999, ownership of Martha’s various enterprises shifted from Martha and other private investors to any investor that was willing to pay the approximately $35 per share at that time. For context, MSO is currently trading at about $2.30 per share.
Market Capitalization: A common way for the investing community to measure the size of a company. Sometimes called “market cap” for short, it is calculated by multiplying the number of shares of stock trading on the stock market by the current price of the stock.
Large Cap: An abbreviation for “large market capitalization,” which describes companies with a market capitalization greater than $10 billion. An example of a large cap company is Procter & Gamble.
Mid Cap: An abbreviation for “middle market capitalization,” which describes companies with a market capitalization between $2 billion and $10 billion. Examples of mid cap companies are Aeropostale and Dick’s Sporting Goods.
Small Cap: Companies with a market capitalization between $200 million and $2 billion. MSO is considered a small cap company.
Risk tolerance: The degree of uncertainty that an investor can handle if her portfolio decreases in value. The lower an investor’s risk tolerance, the less she should invest in stocks, though she also is giving up the opportunity for greater reward.
Time horizon: How much time an investor has until she will need to use the assets in her investment portfolio. The longer an investor’s time horizon, the more risk she should be able to tolerate. A 35-year-old investor may have a long time horizon for her retirement portfolio but a short time horizon for her savings toward a down payment on a home. (I would never put my down payment savings in the stock market, by the way)
Asset allocation: An investment strategy that aims to balance risk and reward by distributing a portfolio’s investments according to the investor’s risk tolerance and time horizon. The three main investment classes are equities (stocks), fixed income (bonds) and cash. The stock portion of a portfolio is then divided among different asset classes, like large cap, mid cap and small cap, to diversify the exposure to all sizes of companies.
I have found Investopedia to be very helpful with basic explanations. Information on specific companies is simple to find at Yahoo! Finance as well. And of course, keep an eye on this column for further information. I’m always interested to hear from readers on what they want to learn, so please leave your ideas in the comments.