A guide to planning and investment jargon
I'll admit it -- I'm prone to using jargon. When there's a word that perfectly describes a concept, a word that gets tossed around a lot in conversations amongst colleagues, it's easy to forget that sometimes, it's not a word that normal non-finance-nerds are familiar with!
So with that in mind, I'd like to throw some words at you that you may hear in conversation with a financial planner and/or investment manager, along with some (extremely informal and un-official!) definitions, as well as links to more in-depth Seaborn articles where available. Feel free to bookmark this page and come back to it -- and if you come across some jargon that you think would be useful to add, let me know and I'll add it!
1040: The primary US tax return form. I may be the only person who does this, but I'll say "1040 calculation" to mean "running the high-level numbers on your expected taxes".
Adaptive financial planning: This is a Seaborn-specific piece of jargon that refers to blending a solid financial plan with appropriate flexibility, revisiting and updating the plan periodically in order to course-correct as necessary.
Alternatives/alternative investments: Investments that aren't cash, stocks, or bonds. This includes real estate, options, commodities, futures, etc.
Ancillary estate document: An estate document that isn't your will.
Arbitrage: I like this word a lot. It's a fancy way of saying "buying low and selling high", but instantaneously, or nearly so. (Also, it's French, so it sounds cool.) I often talk about leverage (see below) as a form of arbitrage.
Arithmetic returns: A way of calculating the annualized returns of a security. Arithmetic returns are calculated by simply taking the average of the annual returns.
Asset allocation: The allocation of asset classes within your portfolio, i.e. how much is in stocks v. bonds at the high level, and how much is e.g. in emerging markets v. real estate at the low level.
Asset class: The broad type of an asset in your portfolio, e.g. whether it's a US large-cap stock, an intermediate-term bond, investment real estate, etc.
Basis point: One hundredth of one percentage point. So if your annualized returns go up from 5% to 6%, you've increased them by 20 percent ((6%-5%)/5%), and by 100 basis points (600-500).
Beta: An investment factor that refers to a security's tendency to move in proportion to the movements of its market. High-beta securities move more when the market moves; low-beta securities move less when the market moves.
Bond: For most intents and purposes, a loan. More volatile than cash, less volatile than stocks, with generally lower/higher expected returns accordingly.
Cash (equivalent): Not physical dollar bills, but assets that are extremely stable. Money in checking, savings, or money market accounts, CD's, and money market funds are all often referred to as "cash".
Cash flow management: Managing the daily/weekly/monthly movement of money in and out of your account.
Cash flow projections: Long-term projections of money flowing into and out of your household.
CFP® Professional: A financial planner who has been certified by the CFP Board.
Commodities: Raw materials that can be bought or sold, such as gold or timber.
Correlation: The amount two securities or asset classes move in sync. A correlation of 1.0 means they are perfectly in sync; a correlation of -1.0 means that they are perfectly out of sync (opposite phase, if you like); a correlation of 0.0 means the two move completely independently. Multiple uncorrelated asset classes are the holy grail of investing.
Cost basis: Effectively, the price at which you bought something, for purposes of determining tax on the gains. I say "effectively" because there are events that can affect cost basis after you've purchased something, like deduction recapture or death.
Defined Benefit Plan: A form of retirement plan or account where the amount the employee gets is clearly defined, but the amount contributed may vary. For example, a traditional pension is a form of defined benefit plan: the annual income is clearly defined in terms of a percentage of your salary, years of service, etc., irrespective of what the market does -- and if the market underperforms, the employer has to make up the difference! Contrast with Defined Contribution Plan.
Defined Contribution Plan: A form of retirement plan or account where the amount contributed is clearly defined, but the amount the employee gets may vary based on e.g. market fluctuations. For example, a 401(k) is a form of defined contribution plan: while the amount contributed is clear, the amount you get out can vary widely based on your asset allocation, market performance, etc. Contrast with Defined Benefit Plan.
Death tax: What people call the estate tax when they're trying to annoy me.
Durable power of attorney: Someone who has control of your finances in the event of your disability (hence "durable"). Note that DPOA authority can be made "springing", in which case it only "kicks in" in the event of disability, or it can be made effective immediately upon signing the document.
Efficiency: I refer to the "efficiency" of an investment as the returns you get for a given amount of volatility.
Equity: Ownership of something. For example, the worth of a house minus the mortgage is your equity.
Equities: Stocks. Technically, stocks are just equity that's traded, but when someone says "equities", they are almost always referring to stocks.
Employee Stock Purchase Plan: A plan under which employees set aside funds with which to purchase their employer's stock, at a discount to the fair market value. The tax law tries to treat them like incentive stock options, theoretically encouraging employees to hold ESPP shares long enough for the sale to be treated as a "qualifying disposition", but because ESPP's aren't exactly like ISO's, the results can be...a little strange.
Fee-based: an advisor paid partly by commission. Commonly confused with "fee-only", which clearly was the intent when the phrase was created. (And the financial services industry wonders why people don't trust them.)
Fee-only: an advisor with zero income from commissions.
Fiduciary: the highest standard of care, in which the fiduciary is legally bound to put their client's best interests ahead of their own.
FSA: Flex Spending Account. Contributions to an FSA are pre-tax, but they do not carry forward from year-to-year (they're "use it or lose it"). Employers can offer FSA's for healthcare and dependent care, and thus the subtypes are sometimes referred to as HFSA's or DFSA's.
Geometric Returns: A way of calculating the annualized returns of a security. Geometric returns are calculated by determining what the annualized return would have to be to get from the beginning value to the end value.
HSA: Health Savings Account. Contributions to an HSA are pre-tax, and HSA's carry forward from year to year, and can be invested. Not to be confused with an FSA.
Incentive Stock Options: A form of compensation whereby your employer gives you the "option" to purchase their stock at a certain price which is below the current fair market value. ISO's receive special tax treatment if you hold them long enough to treat the sale as a "qualifying disposition".
Investment factors: Aspects of securities that have been identified through peer-reviewed research as having a material effect on returns and volatility. Examples include beta, size, value, profitability, momentum, term, and carry.
Leverage: Using debt to buy more of an investment than you would otherwise, allowing you to potentially reap higher returns, but potentially at the cost of more volatility.
Living Will: Also known as "advance medical directives", though Texas also refers to all ancillary estate documents as "advance directives", which can be confusing. This document determines what you want to have happen to you medically in the wake of certain events, should you be disabled (e.g. you're in a coma or have a terminal illness).
Medical power of attorney: effectively, the person whom the doctors go to for medical decisions on your behalf if you're incapacitated.
Monte Carlo simulation: In general, running many simulations over a randomized variable. In financial planning, the randomized variable is the sequence of returns of a portfolio, given its expected return and standard deviation.
Non-qualified Stock Options: A form of compensation whereby your employer gives you the "option" to purchase their stock at a certain price which is below the current fair market value. Not available for the special tax treatment ISO's get.
Opportunistic rebalancing: Monitoring your portfolio on a regular basis and rebalancing when the asset allocation falls outside a certain threshold.
Premium: in the insurance world, the amount you pay for coverage. In the investment world, the benefit you get from investing a certain way (e.g. a "factor premium").
Qualified Retirement Plan: An employee-offered retirement plan that follows ERISA guidelines, e.g. a 401(k), 403(b), TSP, SEP IRA, etc.
Rebalance: Move your portfolio towards your desired asset allocation.
Registered Investment Advisor (RIA): A company that is registered with the SEC or state securities board, and falls under the jurisdiction of the Securities Act.
Restricted Stock Unit (RSU): Employer stock shares given employees as part of their compensation. Effectively for tax purposes, it's a bonus that was then immediately invested in your company's stock.
Reverse mortgage: A Home Equity Conversion Mortgage, which is just another kind of home equity loan with some nifty extra features provided by US law. This loan can be taken in the form of monthly payments for life, which is why it's generally referred to as a "reverse mortgage".
Risk capacity: your numerical, quantitative ability/need to take risk.
Risk tolerance: your emotional, qualitative ability/need to take risk.
Securities: Basically, your tradeable investments. Includes stocks, bonds, futures, mutual funds, ETF's, etc.
Self-insurance: Rather than taking out an insurance policy, setting aside cash in the event that something goes wrong.
Standard deviation: The common measurement of volatility used in investment management.
Stock: Part ownership in a company. More volatile than bonds or cash, but also generally higher expected returns.
Tax-efficient asset location: Allocating securities among your accounts in order to maximize tax efficiency. For example, putting high-return, low-tax-efficiency securities like emerging markets and real estate in tax-advantaged accounts like Roth IRA's.
Tax-loss harvesting: Selling securities at a loss in order to realize capital losses, then immediately purchasing similar-but-not-identical securities, so that your overall asset allocation doesn't change. This has the effect of deferring -- but not eliminating -- taxes.
Testamentary trust: a trust created by your will in the event of your death, often used to hold inherited assets that would otherwise go to children not yet old enough to handle them.
...I feel like I've just hit the tip of the iceberg, so seriously -- want something added? Let me know!
Britton is an engineer-turned-financial-planner in Austin, Texas. As such, he shies away from suits and commissions, and instead tends towards blue jeans, data-driven analysis, and a fee-only approach to financial planning.