Decoding financial jargon
INT: CROSSFIT GYM LOCKER ROOM – DAY
Chad: Yeah Tad?
Tad: You know, I was talking to Brad about his portfolio, and I just don’t get it. I mean, his asset allocation (1) is terrible. He’s like, gone all in on small-cap (2) stocks in emerging markets (3).
Chad: Bruh, I knew he had a long time horizon (4) and a high risk tolerance (5), but that’s just irresponsible.
Tad: Right? He’s gotta diversify (6). We’re crushing some sushi burritos later, so I think I’ll tell him to move some assets into bonds. Or if he’s sticking to stocks, at least invest in a few blue-chip companies (7).
Chad: Totally. You know, you’re a real friend, man.
Tad: I love you, Chad.
Chad: I love you too, Tad.
- Asset Allocation: “Assets” are your money, and “allocation” is where you’re putting it. Yeah, I don’t know why everything gets a needlessly convoluted term either. Assets might be made up cash, stocks, or bonds. Your personal asset allocation (basically, how you divide your portfolio) depends entirely on your unique financial goals. So think critically about any advice or “hot tips” people throw at you.
- Small-cap: “Cap” refers to market capitalization, or the value of a company’s outstanding stock in the market. In Canada, a “small-cap” company has between $100-million and $2.5-billion in market value. Investing in smaller companies like this can be good strategy for some, but it’s also a lot riskier than sticking with the ol’ Fortune 500.
- Emerging markets: Countries that have financial infrastructure (like banks, a stock exchange, and a currency), but don’t have the same kinds of market regulation as countries like the US or Germany. Not everybody agrees on which countries classify as “emerging markets,” but India, China, Brazil, South Africa, and Russia are always on the shortlist. Investors like emerging markets because they’ve experienced huge gains in economic growth in recent years. But they can be really volatile. If rebels launch a coup, or workers go on strike, your investment could be in for a ride.
- Time Horizon: How long you plan on holding onto your investment. If you’ve got 50 years until retirement, you can afford to make some riskier investment moves. Hey, there’s plenty of room to ride through the tough times and come out ahead, right? But if your time horizon is shorter, like you’re saving to have a kid in four years, you might want to play it safer.
- Risk tolerance: It’s how tolerant you are to, uh, risk – when it comes to your money. Sorry, there was really no better way of doing that one. Understand that there will always be a trade-off with risk tolerance: stick to low-risk investments, and you’ll earn lower returns. Opt for high-risk investments, and you’ve got a greater chance of earning (or losing) a windfall. Again, it all depends on your specific goals and your level of comfort .
- Diversification: Diversity is truly your strength. Let’s put it this way, imagine that you invested all of your money in Blockbuster Video back in 2007. Come 2017, you’d be broke, stuck on your buddy’s couch without a Netflix account to your name. Hypothetically, you could have easily avoided bankruptcy (and protected your social life) by splitting your investment across a variety of industries and investment products/sectors. That way, the good performers would cushion you from the bad.
- Blue chip company: Any poker players in the house? Blue chips are the safest bets on the market, based on their company’s quality of products, reputation for excellence, and consistent market performance. This term is generally interchangeable with “large-cap stocks” (see #2). They may not deliver the highest returns, but you’ll definitely want a few of these in your hand.
Read more articles presented by BMO here