The world of finance is awash with terms that can be intimidating for the lay investor. Personal Finance has always aimed at cutting through industry jargon to explain finance in language you can understand. However, if you’re interested in investing and want to take your interest to the next level, here are some terms and concepts you need to know.

Asset

In the context of investing, an asset is something you own that has economic value and will potentially grow in value. The four mainstream asset classes are: listed equity (shares in public companies), listed property (shares in property companies or Reits – see below), bonds and cash. Alternative asset classes include private equity (shares in private companies), precious metals, cryptocurrency and art.

Asset allocation

The proportions in which capital is allocated to different assets or asset classes in a portfolio. A fund manager will blend assets with similar or differing performance characteristics in line with the fund’s mandate in order to optimise returns.

Benchmark

The performance target a portfolio manager aims to beat. It is typically an appropriate market index (see below) or a certain number of percentage points above Consumer Price Index inflation, such as CPI+4%.

Bond

A debt instrument (essentially an “IOU”) issued by a government or a company. It has a fixed maturity date (short- or long-term) and a fixed or floating interest rate, known as the coupon. Bonds are traded on a secondary market similar to a stock market. When interest rates rise, bond prices fall and the resulting yields (see below) rise.

Derivative

This is an investment contract whose value is dependent on the performance of an underlying asset, group of assets, or index. It confers rights but not ownership. Standardised contracts are bought and sold on a secondary market. They may be used to protect (hedge) against the fall in price of an asset or simply as an alternative to direct investing. Popular among traders are CFDs (contracts for difference), which rely on the difference between the price of an underlying asset when the contract is opened and its price when the contract is closed.

Dividend

The portion of a company’s profits that goes to shareholders, expressed as an amount per share. Because dividend payouts may be fairly consistent, the amount as a percentage of the share price (yield – see below) may rise or fall in the opposite direction to the movement of the price.

Exchange traded fund (ETF)

A collective investment scheme registered on a stock exchange whose units are traded like shares according to the prices of the underlying investments. In the past, ETFs were restricted to funds that tracked a market index by holding the shares in the index in the same proportions. Recently, the JSE amended its rules to allow for ETFs in which the fund manager has the discretion to choose the underlying shares or bonds.

Index

A representation of the value of a market or market sector, taking into account the prices of all assets in that market, giving investors a view of how the market is performing overall. Since the rise of ETFs and index-tracker funds, indices have taken on a new significance and now represent a wide range of parameters and sub-groups in the markets.

Investment risk

The probability of an investment not performing as expected. This could be because of returns not matching inflation (inflation risk), a fall in asset prices (market risk), or the failure of a financial institution such as a bank or life company (systemic risk). Other risks include liquidity risk (not being able to sell your assets when you want to) and currency risk (losing money from offshore investments when the offshore currency declines in value relative to your home currency).

Leverage and gearing

These terms apply to investing with borrowed money and to trading on margin, whereby you put down a “deposit” of a percentage of the asset price, with the balance lent to you by the broker. This amplifies both your gains and losses – you can do very well if the price of the asset rises, but lose more than you invested if it drops.

Liquidity

How easy it is to buy or sell an asset, according to supply and demand. An asset is liquid if there are buyers ready to buy it at a price acceptable to the seller and the transaction can be accomplished without delay.

Long or short position

Taking a long position on a share means you buy it in the hope that the price will rise, increasing the value of your asset. If you take a short position, known as short selling, you do it in the expectation that the share price will drop. This involves borrowing a share and selling it immediately. When the time comes to return the share to its owner, you profit from buying it at the lower price.

P/E ratio

The price-to-earnings (P/E) ratio is a popular way to determine a share’s valuation (see below). It is calculated by dividing the share price by the company's earnings (profits) per share. A high P/E ratio means that a share’s price is high relative to the company’s earnings and is possibly overvalued. A low P/E ratio indicates that the share price is low relative to earnings and is possibly undervalued.

Real estate investment trust (Reit)

This is a type of property investment company, which maintains a portfolio of physical properties, providing rental income and capital growth as the property appreciates in value. Reits are listed on a stock exchange – you can invest in them directly via a stockbroker or indirectly through unit trusts or ETFs specialising in listed property.

Share/stock

A unit of ownership in a company. A public company has its shares listed on a public stock exchange, which means anyone can buy and sell them, through a stock broker. Shareholders have rights, such as having a vote at the company’s AGM, and being eligible for a share of profits, in the form of dividends,

Unit trust fund

Known overseas as a mutual fund, this is a collective, or pooled, investment scheme structured like a trust, with an investment portfolio managed by a fund manager. These funds are categorised according to the assets, markets and countries in which they invest. The unit price is determined once a day, at the end of the trading day, unlike an ETF, whose price fluctuates throughout the trading day.

Valuation

When investment experts talk about share valuations, they do not refer to the price of the share directly, but to its price relative to the estimated fair value of the company. One way to value a share is by looking at its P/E ratio (see above).

Yield

The income provided by an asset expressed as a percentage of its price. Income from bonds is in the form of interest; from shares it is in the form of dividends; and from property it is in the form of rental. For example, if a share costing R100 delivers a dividend of R5, its dividend yield is 5%.

* Hesse is the former Personal Finance editor.

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