The Investor's Dictionary

Summary

• Investment Basics

  • Stocks

  • Dividends

  • ETFs

  • Compound Interest

  • Diversification

  • Inflation

  • ROI

Welcome, fellow rookie investors!

I'm really glad you're here because today, we're diving into a topic that's absolutely crucial for anyone interested in investing. Before we fully immerse ourselves in the world of investments, it's important to understand some key concepts. When we're looking at companies to potentially invest in, there are certain factors we need to understand. These factors help us determine if a company is profitable and if it's a smart investment. The following terms are the ones that you will hear about the most so be sure to remember what each one means because understanding them can play a big role towards your financial success!

Investment Basics

Stocks

A stock represents ownership in a company. When you buy a stock, you're essentially purchasing a small piece of that company. Shareholders, or stockholders, own shares of the company's stock, and they may receive dividends. Stocks are traded on stock exchanges, such as the New York Stock Exchange (NYSE) or the NASDAQ, where investors buy and sell shares to each other. The value of a stock can fluctuate based on factors like company performance, market conditions, and investor sentiment.

Dividends

Dividends are payments made by a company to its shareholders as a reward for owning its stock. When a company earns profits, it may choose to distribute a portion of those profits to its shareholders in the form of dividends. These payments are typically made on a quarterly basis but some companies like Realty Income (NYSE:O) distribute dividends on a monthly basis. Dividends provide shareholders with a source of income and are often seen as a sign of financial health and stability for a company. However, not all companies pay dividends, and the decision to do so depends on various factors, including the company's financial performance, growth prospects, and capital allocation strategy. It’s also important to mention that dividends will be paid to the shareholder as long as he holds the position.

ETFs

An ETF (Exchange-Traded Fund) is like a mixed bag of investments that you can buy and sell on the stock market, just like a stock. Inside the ETF, there are different things like stocks, bonds, or even commodities like gold or silver. When you buy shares of an ETF, you're basically owning a tiny piece of everything inside it. ETFs are designed to track the performance of certain groups of investments, like stocks in a particular industry or bonds from a specific region. They're a handy way to invest because they offer diversification and can be easily traded throughout the day.

One of the most well-known ETFs is the S&P 500 ETF, which follows the 500 biggest companies in the US. By owning a share of the S&P 500 ETF, you own a tiny part of all the companies inside. This means you're investing in big names like Apple, Microsoft, and Amazon, all in one go. It's like having a little piece of the entire US stock market in your pocket!

Below is a table displaying the ten largest companies in the S&P 500 as of September 21, 2023, along with their respective weights in the S&P 500 ETF:

Compound Interest

Compound interest is the interest you earn not only on the initial amount you save or invest but also on the interest that accumulates over time. In simpler terms, it's like snowballing your money.

Here's how it works: Let's say you save $100 in a bank account that earns compound interest. Over time, the bank pays you interest not just on the initial $100, but also on the interest you've already earned. So, your savings grow faster and faster as time goes on, kind of like a snowball rolling down a hill, picking up more snow along the way.

The best part? The longer you leave your money to grow, the more powerful compound interest becomes. It's a fantastic way to make your money work harder for you and reach your financial goals faster!

Albert Einstein once said, "Compound interest is the eighth wonder of the world. He who understands it earns it... and he who doesn't, pays it." This statement underscores the importance of understanding the concept of compound interest, as it can either work in your favor, allowing your savings to grow exponentially, or work against you, resulting in accumulating debt over time.

Diversification

Diversification involves spreading your investments across various market sectors such as technology, healthcare, financials, industrials, and communication services. Rather than concentrating all your investments in one sector, diversifying across different sectors helps mitigate the risk associated with any single sector's performance. For instance, while technology stocks may experience fluctuations, healthcare or financial stocks may perform differently during the same period, potentially balancing out overall portfolio returns. This strategy is widely recommended to safeguard against market volatility and optimize long-term investment outcomes.

Inflation

Inflation is like the silent thief of your money's value. It's the rate at which the general level of prices for goods and services in an economy rises over time, and as a result, the purchasing power of money decreases. In simpler terms, it means that over time, the same amount of money will buy you fewer goods and services than it did before.

Here's how it works: let's say you have $100 today. With inflation, the cost of goods and services gradually increases over time. So, a year from now, those same goods and services might cost $105. That means your $100 can't buy as much as it used to.

Understanding how inflation affects your money is crucial, especially if you want to be financially successful. By knowing how to manage your money in a way that keeps pace with or exceeds inflation, you can ensure that your hard-earned money maintains its purchasing power over time, setting you up for long-term financial security.

ROI

Return on Investment (ROI) is like the scorecard for your investments. It's a measure used to evaluate the profitability of an investment relative to its cost. In simpler terms, ROI tells you how much money you've made (or lost) on an investment compared to how much you initially invested.

Here's how it works: Let's say you invest $1,000 in a stock, and a year later, your investment is worth $1,200. To calculate your ROI, you'd subtract the initial investment from the final value ($1,200 - $1,000 = $200), then divide that by the initial investment ($200 / $1,000 = 0.20), and finally multiply by 100 to get the percentage (0.20 x 100 = 20%). So, in this example, your ROI would be 20%.

This was just the first of many episodes to come related to understanding the terminology of investing. Understanding these words lays the groundwork for better stock analysis in the future so be sure to study the meaning carefully.

I haven’t bought any position this last week so there is no news on that front. I'll be back next week and, we’ll dive into the world of Dividends. So, keep smiling, keep learning, and I'll catch you next time!

Trevor

Disclaimer: This post is NOT financial advice. It is intended for educational purposes only. Investing involves risks, and there is a possibility of losing capital. Always conduct thorough research and consider consulting with a financial advisor before making any investment decisions. Your financial well-being is important, so please invest responsibly.

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