Glossary of Foundational Investing Terms
Financial terminology creates barriers for new investors. This glossary defines 25 foundational terms you'll encounter when building portfolios, reading financial news, and opening brokerage accounts (Source: SEC and FINRA investor education standards, 2025). Each definition is one sentence focused on practical understanding (not academic precision). The practical antidote: bookmark this page and reference it when you encounter unfamiliar terms in articles or account documents.
Essential Terms (A-Z)
Asset Allocation: Mix of stocks, bonds, and cash in a portfolio, based on goals, timeline, and risk tolerance.
Bear Market: Market decline of 20%+ from recent peak; typically coincides with economic pessimism and occurs every 3-5 years on average.
Bull Market: Market increase of 20%+ from recent low; typically coincides with economic optimism and lasts 3-10 years historically.
Compound Interest: Earning interest on principal AND previously earned interest; accelerates wealth growth over time through exponential rather than linear gains.
Correlation: Statistical measure of how two assets move together, ranging from -1.0 (perfect inverse) to +1.0 (perfect positive); negative correlation provides diversification benefits.
Diversification: Spreading investments across multiple assets to reduce risk from any single holding; reduces unsystematic risk but cannot eliminate systematic market risk.
Dividend: Portion of company profits paid to shareholders, typically quarterly; can be reinvested automatically or taken as cash.
Dollar-Cost Averaging (DCA): Investing equal dollar amounts at regular intervals regardless of price; reduces timing risk but historically underperforms lump sum investing.
Equity: Ownership stake in a company; "equities" and "stocks" are synonymous terms.
Equity Risk Premium: Expected return of stocks over risk-free rate (Treasury bonds); historically 3-6% in US markets as compensation for volatility risk.
Expense Ratio: Annual fee charged by mutual fund or ETF, expressed as percentage of assets (e.g., 0.05% = $5 per $10,000 invested annually).
Index Fund: Mutual fund or ETF that tracks a market index (e.g., S&P 500); low-cost and passively managed.
Inflation: Rising prices over time; erodes purchasing power of cash; measured by Consumer Price Index (CPI), currently 2.7% annually.
Liquidity: Ease of converting an asset to cash without significant price impact; stocks are highly liquid, real estate is illiquid.
Market Capitalization: Total value of company's shares calculated as share price × shares outstanding; determines large-cap (>$10B), mid-cap ($2-10B), or small-cap (<$2B) classification.
Nominal Return: Stated return before adjusting for inflation (e.g., 10% gain on stock investment).
Portfolio: Collection of all investments (stocks, bonds, funds, cash) held by an investor across all accounts.
Real Return: Return after adjusting for inflation; measures actual purchasing power gain (Real ≈ Nominal - Inflation).
Rebalancing: Adjusting portfolio back to target allocation (e.g., 60/40 stocks/bonds) by selling winners and buying laggards; typically done annually or when allocation drifts 5%+ from target.
Risk Tolerance: Investor's ability and willingness to endure portfolio volatility without panic selling; determines appropriate asset allocation.
Standard Deviation: Statistical measure of return volatility; higher standard deviation indicates more risk and wider range of potential outcomes (S&P 500 averages 15-20% annually).
Tax-Advantaged Account: IRA, 401(k), or similar account with tax benefits including deferred taxation (traditional) or tax-free growth (Roth).
Time Horizon: How long until you need invested money; determines risk capacity where short (<5 years) suggests conservative allocation and long (>10 years) allows aggressive allocation.
Total Return: Investment return including both price appreciation AND dividends or interest reinvested; the only complete measure of performance.
Volatility: Degree of price fluctuation measured by standard deviation; high volatility means large price swings and higher risk.
Yield: Income return on investment expressed as percentage; includes dividend yield (dividends ÷ stock price) and bond yield (interest ÷ bond price).
How to Use This Glossary
Reference these terms when reading financial articles or account documents. If you encounter "the fund's expense ratio is 0.75%," you now know that means $75 annually per $10,000 invested. If you see "rebalance your portfolio annually," you understand that means adjusting back to your target stock/bond mix.
These terms form the vocabulary for communicating with financial professionals. When a financial advisor asks about your "risk tolerance" and "time horizon," they're determining appropriate asset allocation. When they mention "tax-advantaged accounts," they're referring to IRAs and 401(k)s with special tax treatment.
The practical point: you don't need to memorize these definitions, but you should recognize them when encountered and know where to look up precise meanings. Bookmark this page for quick reference.
Next Step
Read one full article from the Foundations of Investing series and note every term from this glossary that appears. This active practice reinforces definitions better than passive reading. After encountering each term in context 3-5 times, you'll internalize the meaning without needing to reference the glossary.
Sources:
- SEC Office of Investor Education. Glossary of Investing Terms. https://www.investor.gov/introduction-investing/investing-basics/glossary
- FINRA Investor Education. Investment Terms. https://www.finra.org/investors/learn-to-invest/types-investments