Understanding the stock market can be tricky. Not only is financial advice on investments littered with jargon, the explanations are often equally baffling. For first-timers looking to invest, it can be difficult to know what’s going on – which is why it’s a good idea to speak to an independent financial adviser near you.
However, even with the help of an experienced adviser, it’s helpful to understand some basic investment terminology so that you can make better-informed decisions.
- Market concepts
- Investment types
- Investment metrics
- Investment strategies
- Help and advice with investments
Financial markets are platforms where people can trade financial products, for example, stocks and shares.
Different financial markets trade in different products. Probably the most well-known is the stock market, but there are a number of other markets, too, including ones that trade in bonds or foreign currencies.
Common terms within financial markets include:
Bank or base interest rate
This is the interest rate that central banks charge commercial banks for loans. In the UK, the Bank of England is the central bank.
A bear market describes a financial market that has experienced a decline in prices over several months. Some investors and financial experts go even further and describe a bear market as one where prices have fallen by at least 20% from their most recent high.
In a bull market, stock prices are expected to rise (the opposite of a bear market).
As with bear markets, some investors use a threshold of 20%, so a bull market is one where stock prices have risen by 20%.
When an investor purchases shares (buy stock) in a company or other financial asset.
An index groups together similar financial assets that share similarities in terms of sector or type. Investors can benchmark how well a group of assets performs by tracking its index or indices.
For example, the FTSE 100 Index measures the combined value of the shares of the 100 largest companies on the London Stock Exchange.
This describes how easy it is to turn an asset (like stock) into cash without losing too much money.
For example, savings accounts are liquid assets because they’re already in the form of cash and can be withdrawn. Foreign currency has slightly less liquidity because it can be trickier to change into a local currency without losing money. Land and property are illiquid assets as they can be hard to sell depending on the market.
Sometimes shortened to ‘market cap’, this refers to what the market thinks a company’s value is. The value is calculated using the company’s current share price and multiplying this by the number of shares held by shareholders.
This is a strategy where investors buy assets that are increasing in value or sell those whose value is decreasing, with the aim of making a profit.
For instance, investors buying assets that are rising in price will hope that prices continue to increase. When those assets peak, they’ll be sold at a profit. Investors may also decide to sell assets that are declining in value and keep any profit made from the sale. The main assumption momentum investors make is that once a trend is well-established, they expect it to continue.
Resistance and support levels
These terms represent opposite ends of a market:
- Support is the lowest level that a certain stock price will typically fall to
- Resistance is the highest level that a certain stock price will typically rise to
Assets can fall or rise to their support or resistance levels in line with market predictions.
However, assets can also break their usual patterns, rising or falling beyond their support or resistance levels. If this were the case, new support or resistance levels would be created.
Selling shares you’ve bought. Investors might decide to sell shares because they’ve made the money they wanted or because they’ve decided to cut their losses.
This describes how much and how quickly a share price changes in value.
You can invest in different types of assets, including:
A bond is when an investor loans money to a company or government organisation for a fixed period in return for interest payments. At the end of the loan period, the investor’s money is repaid. Bonds are also known as fixed-income investments.
ETF (exchange-traded fund)
An ETF is a collection of assets, for example, stocks, bonds, and currencies. Some ETFs are single security, meaning they only contain one asset (for example, stock from just one company). ETFs can also focus on a specific sector, for instance, green energy.
Exchange-traded funds can be bought and sold on the stock market in the same way shares are.
Funds (unit trust/mutual fund)
A fund is where money from different investors is pooled together to buy a range of assets. Funds are often managed to spread risk and generate the greatest returns for investors.
Unit trusts and open-ended investment companies (OEICs) are two of the UK’s most common types of funds.
A share represents a unit of ownership of a company. Shares are also known as equities.
Investment metrics let investors analyse how well an asset is performing. Examples include:
A benchmark is a standard that lets investors compare the performance of a particular asset against an index.
Benchmarks can be broad, for example, using an index such as the MSCI World Index, which covers firms across developed markets. Benchmarks can also be narrow, measuring specific stocks, for example, technology or precious metals.
This is your profit if you sell shares or investments for a higher price than you paid. You may need to pay capital gains tax on the profit you make for certain assets.
Dividends are payments made to shareholders; they’re usually paid in cash but can also be paid in shares. Companies sometimes make one-off dividends if there is surplus cash.
This shows how much you’ll pay to own a fund, and it’s usually shown as a percentage. The lower the expense ratio, the greater the return for the investor.
Expense ratios are calculated by taking the cost of management fees (which covers operating expenses and other admin charges) and dividing this by the amount of money in the fund. In most cases, investors won’t need to work this out as managed funds will typically say what the expense ratio is.
This refers to the possibility that your investment may not yield the expected returns, which could result in a financial loss.
Price-to-earnings (P/E) ratio
The P/E ratio calculates a company’s share price in relation to its earnings and helps investors asses a company’s value.
The ratio is calculated by dividing the share price by its earnings per share (or EPS). EPS is calculated by taking the company’s net profit and dividing it by the number of shares it has sold.
For example, if a company has a share price of 200p and an EPS of 40p, its P/E ratio is 5 (200 divided by 40). This means that shares in the company are selling for five times what they earn.
As a general rule, a high P/E ratio suggests there is potential for high growth, which investors may be willing to pay a higher share price for. However, a high P/E ratio could also suggest that shares are overpriced.
P/E ratios can be historic or forward. A historic P/E ratio is based on actual earnings per share over the last year. Forward price-to-earnings ratios are forecasts that predict the EPS for the year ahead.
Return on investment (ROI)
This measures how profitable an investment is compared to how much it costs; it’s often shown as a percentage.
It’s calculated by deducting the profit from the purchase price and dividing that figure by the cost.
For example, if you bought shares for £1,000 and sold them for £1,500, your ROI was 50%.
Yield measures investment earnings. It’s usually shown as a percentage; the higher the percentage yield, the greater the income received.
An investment strategy is a plan that helps you achieve your goals. A plan could focus on investing in a particular sector, asset, or principle. Terms that you’ll often hear in relation to investment strategies include:
Anything that has financial value.
For example, assets can include property, shares, bonds, and anything else with financial value, such as your car.
This is the different proportion of assets in a fund.
For example, a fund may have an asset allocation of 25% shares, 25% property, and 50% bonds.
An asset class is a grouping of investments that share similarities and are subject to the same rules and regulations. For instance, cash and cash equivalents would be a different asset class to shares or bonds.
This is a strategy that aims to spread the risk by investing in a range of different asset classes, industry sectors, or geographic locations. The aim is to spread risk, reduce volatility and increase potential return on investment.
Environmental, social and governance (ESG)
ESG is an approach which prioritises investing in sectors and companies with socially responsible values and a robust governance structure that enforces those principles.
It’s also sometimes known as socially responsible investing or sustainable investing. For some investors, it can be a key part of their strategy.
A portfolio describes the collection of assets held by an investor. A portfolio can be made up of different asset classes. Investors can have multiple portfolios and may split them according to risk or need.
Investments can generate income to boost what you earn from your job or as a way to supplement funds in retirement. It’s worth speaking to an independent financial adviser in the first instance as they should be able to explain all your options and devise an investment strategy that supports your financial goals, incorporating your wider financial situation.
When you choose a financial adviser, it’s important to check they’re listed on the Financial Services Register. This register shows all the firms and individuals regulated by the Financial Conduct Authority (FCA).
Financial advisers will be happy to discuss any concerns and readily show you their qualifications. Most will also offer a free initial meeting to discuss what you want out of your investments. Plus, bear in mind that advisers will rarely pressure you into making quick decisions.
The Alan Boswell Group difference
Whether you’re just starting out in investing, need advice about funding your retirement, or setting up a pension for your children, we can help.
As qualified and independent advisers, our focus is on delivering tailored advice that supports your financial goals.
To find out more, you can speak directly to our team on 01603 967967.
Please note, the value of an investment and any income from it can go down as well as up and you might not get back the original amount invested. The past is not a guide to the future.