Financial glossary
Understanding financial terminology is important
Use the Scarborough glossary to improve your financial vocabulary. We’ve included common terms routinely used in conversations about retirement planning and investing.
Active management: An investment approach in which the portfolio manager uses analytical research, forecasts, and their own judgment and experience to select securities to meet a particular objective.
After-tax return: The return from an investment after all income and capital gains taxes have been deducted. By comparing after-tax returns, an investor can determine which investment makes the most sense based on his or her tax bracket.
Alpha: A measure of risk-adjusted performance. Alpha takes the volatility (beta) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to that of the index is the fund’s alpha.
Asset allocation: The strategy of dividing investment dollars among various asset categories such as stocks, bonds, and cash (stable value). By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can help protect against significant losses.
Back-end load: A charge an investor pays when withdrawing money from an investment. Back-end loads typically decline each year a shareholder remains in a fund. Also known as contingent deferred sales charges (CDSC), withdrawal charges or surrender charges.
Balanced fund: A fund that seeks both growth and income through a portfolio that includes both stocks and bonds.
Basis point: One one-hundredth of one percentage point, or 0.01%.
Bear market: A market is judged to be in a bear phase when an index has fallen 20% off its most recent high.
Benchmark: A standard used for comparative purposes in assessing investment performance.
Beta: The measure of a mutual fund’s sensitivity to market movements. It measures the volatility of a mutual fund in comparison to the market as a whole. A beta of 1.0 indicates that a fund’s price will move with the market. A beta of less than 1.0 means that the fund will be less volatile than the market. A beta of greater than 1.0 indicates that the fund will be more volatile than the market. For example, a fund with a beta of 1.1 is expected to perform 10% better than the market in up markets and 10% worse in down markets.
Bond: A debt security issued by a government or corporation that pays a bondholder a stated rate of interest and repays the principal at the maturity date.
Bond maturity: The lifetime of a bond, concluding when the final payment of that principal is due.
Book value: The net worth, or liquidating value, of a business. Calculated by subtracting all liabilities, including debt and preferred stocks, from total assets, and dividing by the number of shares of common stock outstanding.
Bull market: A prolonged period of rising security prices.
Capital gains: The profits you receive from the sale of assets such stocks and bonds. Gains from investments held less than one year are considered short-term capital gains. Gains from investments held over one year are long-term capital gains.
Capital gain distribution: A payment to shareholders of net gains (after deducting any losses) realized on the sale of a fund’s underlying securities. These are generally annual short-term and long-term distributions, listed in dollars per share. The net asset value of the fund is reduced by the amount of the distribution. For equity funds, these amounts are usually paid out once a year in December.
Certificate of deposit (CD): A receipt for funds that have been deposited in a bank for a specific period of time at a fixed rate of interest. Early withdrawal may result in a penalty.
Commercial paper: Unsecured corporate promissory notes issued to provide short-term financing, sold at a discount and redeemed at face value. This is a principal component of many money market fund portfolios because of its relatively higher yield.
Common stock: Securities that represent ownership and usually voting rights in a corporation. Common stock dividend rights are subordinate to preferred stock, and its dividends, if any, are not fixed.
Compounding: Interest paid on interest, resulting in a geometric rate of increase on the initial principal. For example, a $100 investment that earns 5% generates $5 per year. With compounding, it would generate $5 the first year, making a new basis of $105; then $5.25 the next year, for a basis of $110.25; $5.51 the next year; and so on. In a mutual fund, reinvesting dividends and capital gains takes advantage of the power of compounding.
Cost basis: The cost of an investment, used as the basis for calculating and reporting capital gains or losses. It is adjusted for stock splits, distributions, and returns of capital.
Credit risk: The possibility that an issuing organization could default on an interest payment or repayment of your principal (when the bond matures).
Cumulative return: The actual total return of an investment for a specified period. A cumulative return does not indicate how much the value of the investment may have fluctuated during the period. For example, a fund could have a 10-year positive cumulative return despite experiencing three negative years during that time.
Custodian: The bank or trust that holds an investment portfolio’s assets (stocks, bonds, cash, and other securities) and handles payments and receipts for the fund’s securities transactions.
Deflation: The opposite of inflation; a decline in the prices of goods and services.
Distribution: Withdrawal of assets from a qualified employer sponsored retirement plan or IRA.
Diversification: The act of spreading your money across a range of investments in hopes that positive performance of some investments can help offset negative performance of others.
Dividend: A payment from a company’s profits to its stockholders.
Dollar cost averaging: An investment strategy based on making investments of equal amounts at regular intervals in the same fund or security. Since the shareholder buys more shares at lower prices and fewer shares at higher prices, the average cost of the shares purchased will generally be lower than the average price over the investment period. However, dollar-cost averaging does not ensure a profit, nor does it protect against a loss in a declining market.
Dow Jones Industrial Average (“the Dow”): A commonly used indicator of United States stock market performance based on the prices of 30 major blue chip stocks.
Duration: The average time (expressed in years) it takes investors to receive the present value of the future cash flows on their investment. It is used to measure the sensitivity of bond prices to interest rate changes (the shorter the duration, the less the bond’s price will rise or fall in value when interest rates change). Duration is affected by maturity, the coupon, and the time interval between payments. Other things being equal, a bond with a higher coupon will have a shorter duration, while zero-coupon bonds have the longest.
Early withdrawal tax penalty: A 10% penalty tax is imposed by the IRS on taxable distributions made prior to normal retirement age (usually 59½ unless an exception applies). As a qualified retirement plan, the IBEW Local Unions Savings & Security Plan has an exception to the 59 ½ rule. If you retire at age 55 or older, distributions from your account will not be subject to IRS restrictions or penalties.
Earnings estimate: A forecast for a company’s net income during a given period. An earnings estimate can come from the company’s management as well as from independent analysts.
Earnings growth rate: The rate at which a company’s earnings are expected to increase in the future.
Employer matching contribution: An employer contribution that is allocated on the basis of a participant’s elective contribution (salary deferral). The rate of matching contribution may be specified in the plan document or may be determined at the discretion of the employer. It may be made on an ongoing basis, as salary deferrals are paid into the 401(k) plan, or at the end of the plan year.
Employer-sponsored retirement plan: A retirement plan established by an employer for employees. Most employer-sponsored plans are contributed to by the employer only. One exception is the 401(k) plan that also allows employees to also contribute on a tax-deferred basis.
Expense ratio: This amount, expressed as an annualized percentage of total assets, is what shareholders pay for mutual fund operating expenses and management fees. The expense ratio is disclosed in the prospectus.
Fixed-income security: A security that pays an unchanging rate of interest. Fixed-income securities include bonds and money market instruments.
401(k): An employer-sponsored retirement plan that allows employees to elect to defer a portion of their salary and contribute it to a tax deferred account in the plan. Earnings on these salary deferrals (and any employer contributions) are also tax deferred until the participant makes a withdrawal from the account.
Front-end load: Sales charge applied to an investment at the time of purchase.
Gross domestic product (GDP): The total market value of all goods and services produced in a country in a given year.
Growth stocks: Stocks of companies with strong growth potential, generally reinvesting most of their earnings into their business.
Historical yield: The actual yield of an investment over a given period, measured from the beginning of the period.
Inception date: The date on which the fund commenced operations.
Inflation: A persistent and measurable rise in the general level of prices. Inflation is generally measured in the U.S. economy by the Consumer Price Index, an economic indicator that measures the change in the cost of a basket of goods and services.
Investment objective: An investor’s financial goal, such as long-term capital growth or current income. Investors’ objectives, combined with their risk profiles, help them narrow their search for investment vehicles appropriate for their particular needs.
Investment strategy: A plan to allocate assets among investments, including stocks, bonds, commodities, and real estate, to reach a financial goal. A strategy should be based on an investor’s age, tolerance for risk, amount of capital available to invest, and future needs for capital.
Investor profile: A description of the type of investor who might consider investing in a particular fund.
Large-cap stock: A company that has a total market capitalization of at least $10 billion. Market capitalization is calculated by multiplying the number of a company’s shares outstanding by its stock price per share.
Liquidity: The ability to turn assets into cash. An investor should be able to sell a liquid asset quickly with little effect on the price.
Load: Sales charge (front or back end) paid by an investor who buys shares in a loaded mutual fund. These loads are essentially commissions that pay the professional advisor or broker who sold you the fund.
Long-term investment Strategy: A strategy that looks past the day-to-day fluctuations of the stock and bond markets and responds to fundamental changes in the financial markets or the economy.
Management fee: Fee for portfolio management charged against fund assets. The fee is listed in each fund’s prospectus and is based on a percentage of the fund’s total asset value.
Market timing: A strategy of buying or selling securities in anticipation of short-term changes in market or economic conditions.
Mid-cap stock: Refers to companies that have market capitalizations between $2 billion to $10 billion.
Money market fund: A fund designed to provide stability of principal and current income by investing in securities that mature in one year or less, such as bank certificates of deposit, commercial paper, and U.S. Treasury bills. The price per share is usually fixed at $1.00. An investment in a money market mutual fund is not insured or guaranteed by the FDIC or any other government agency. Although it seeks to maintain a stable share price of $1.00, it is possible to lose money by investing in money market mutual funds.
Morningstar Ratings: System for rating open- and closed-end mutual funds by Chicago-based Morningstar, Inc. The system assigns funds one to five stars, based on a risk-adjusted performance rating including the effects of fees, charges, loads, and redemption fees, with an emphasis on downward variations and consistent performance. The score is plotted on a bell curve and applied to 48 distinct categories.
Mutual fund: A term for a diversified, professionally managed portfolio of securities that pools the assets of individuals and organizations to invest toward a common objective such as current income or long-term growth. A mutual fund is a regulated investment company registered under the Investment Company Act of 1940.
NASDAQ (National Association of Securities Dealers Automated Quotations): An electronic system for up-to-the-minute price quotations and trading on over 5,000 stocks not traded on the New York, American, or other major exchanges.
Net asset value (NAV): The value of a mutual fund share, calculated by deducting a fund’s liabilities from the total assets in its portfolio and dividing this amount by the number of shares outstanding.
No-load: Mutual fund offered by an open-end investment company that imposes no sales charge (load) to purchase shares. Investors can buy shares directly from the fund company, rather than through a broker.
P/E ratio: The price-to-earnings ratio shows the “multiple” of earnings at which a stock is selling. The P/E ratio is calculated by dividing a stock’s current price by its current earnings per share. A high multiple means that investors are optimistic about future growth and have bid up the stock’s price.
Prospectus: Formal written offer to sell securities, enabling an investor to make an informed decision. The prospectus describes the fund’s objectives, investment strategy, fees, and other important information.
Quantitative: A style of portfolio construction that emphasizes a rigorously systematic, mathematical approach to asset allocation and selection. Quantitative management employs complex mathematical models to predict and analyze risk and return, thus generating the optimal selection of assets for a portfolio.
R-Squared: The percentage of a mutual fund’s movement that are explained by movements in its benchmark index. An R-Squared on 100 means that all movements of a fund are completely explained by movements in the index. For example, a S & P 500 Index fund would have an R-Squared of 100.
Real rate of return: The return on an investment after it is adjusted for the effects of inflation.
Recession: A period, generally considered two consecutive quarters, of zero or negative economic growth and increasing unemployment.
Reinvestment: Using dividends, interest, and capital gains earned in an investment to purchase additional shares, rather than receiving the distributions in cash.
Return: The ratio of the value of an investment at the end of a period, plus any reinvested distributions during the period, divided by the initial value.
Required Minimum Distribution (RMD): The minimum amount you must withdraw from your retirement accounts each year. You generally must start taking withdrawals from your traditional IRA and retirement plan accounts when you reach age 73. Participants in a qualified retirement plan can delay taking their RMD until the year they retire.
Risk: Refers to an investment’s vulnerability to fluctuations in value relative to changing economic or market conditions. Risk is used to define all uncertainty relating to the outcome. The level of risk incurred by a fund shareholder varies from fund to fund, depending primarily on the types of securities in which a fund invests.
Risk/Reward: The relationship between the degree of risk associated with an investment and its return potential. Typically, the higher the potential return of an investment, the greater the risk.
Risk Tolerance: The extent to which an investor will accept risk in the pursuit of a financial reward. The greater an investor’s tolerance, the more risk he or she will accept in order to reach his or her investment goal.
Rollover (Direct): A distribution from a qualified employer sponsored retirement plan that is sent directly to the trustee or custodian of another qualified employer sponsored retirement plan or Rollover IRA.
Sales Charge: Also referred to as the load, this is a fee paid by a buyer to acquire shares in an investment fund.
Securities and Exchange Commission (SEC): The federal agency created by the Securities and Exchange Act of 1934 that administers the laws governing U.S. securities markets. The SEC regulates the registration and distribution of investment fund shares in the U.S.
Substantially Equal Periodic Payments (SEPP): Section 72(t)(2) of the Internal Revenue Code provides for an exception to the early withdrawal penalty tax by allowing an individual to take distributions as Substantially Equal Periodic Payments (SEPP). Under SEPP the IRS requires that you take withdrawals whose annual amounts cannot be changed without penalty for 5 years or until you reach age 59 ½, whichever is longer. These payments are usually taken monthly. The IRS sets forth guidelines on the maximum allowable amount a participant can take and Scarborough will calculate that amount for you. A participant can take up to the maximum amount or any amount less than that for their SEPP period. The IRS permits a one-time switch in your SEPP calculation method to the RMD (Required Minimum Distribution), which can change your annual distribution* for the remainder of your SEPP period. *RMD methods will generally decrease your SEPP amount.
Small-Cap Stock: Generally refers to a company with a total market capitalization between $300 million and $2 billion.
Standard & Poor’s 500 Index (S&P 500): A capitalization-weighted index of 500 stocks of companies across major U.S. industry sectors.
Standard Deviation: This indicates the volatility of a portfolio’s total returns as measured against its mean performance. Unlike alpha, beta, and R-squared which are relative to a benchmark index, standard deviation is an absolute measure. In general, the higher the standard deviation, the greater the volatility or risk.
Tax Deferral: Delaying the payment of income taxes due on an account. Assets held in an employer-sponsored plan for the benefit of a participant are tax deferred until withdrawn. If the participant wishes to continue the tax deferral on these assets he can directly roll over the distribution to a Rollover IRA.
Ticker Symbol: Ticker symbols are a system of letters used to represent a stock or mutual fund. These letters allow you to search for more detailed information on a fund.
Total Return: Return on an investment over a specified period, including price appreciation (or depreciation), plus any reinvested income.
Transaction Fee Fund: A fund with a brokerage fee for buying or selling shares.
Trustee: An organization or individual that serves as the fiduciary for one or more individual accounts, usually acting in conjunction with a commercial bank. The trustee is authorized to act on behalf of the accounts.
12 b-1 fee: Fee assessed by a mutual fund to cover advertising and promotion expenses. It is assessed against the net assets of the fund, so all fund shareholders pay it. A 12b-1 fund must be registered with the Securities and Exchange Commission (SEC), and the charge must be disclosed in the fund’s prospectus.
Value Stocks: Stocks of companies that are currently undervalued and tend to pay out earnings as dividends to shareholders.
Volatility: Refers to market price fluctuations.
Year-to-Date Return: Return on an investment including price appreciation (or depreciation), plus any reinvested income from the beginning of the year to the present.