- Glossary of Financial Terms
Asset Allocation Funds attempt to manage your returns by using different asset allocation strategies, depending on current economic conditions. Their investment policies allow wide variances in the percentages of stocks, bonds and cash that they can hold as they try to take advantage of the up and down movements in the markets.
The dollar-weighted average interest rate, expressed as a percentage of face value, paid on the securities held by a bond portfolio.
These funds are combinations of stocks, bonds and money market securities. The characteristics of the fund depend on the allocation of the fund's securities among the various investments. These allocations are typically held fairly constant over time.
Barclays Capital U.S. Aggregate Bond Index This is a composite index of the Barclays Government/Corporate, Mortgage-Backed and Asset-Backed indexes. It includes fixed-rate debt issues rated investment grade or higher by Moody's, S&P, or Fitch. All issues have at least one year to maturity and an outstanding par value of at least $100 million for U.S. government issues and $50 million for all others. All returns are market-value weighted inclusive of accrued interest. The modified duration of this index is currently about 4.6 years.
Measures a fund's sensitivity to market movements. Specifically, beta measures how much a fund's excess returns (returns over Treasury bills) have been tied to the market's excess returns. By definition, the beta of the market is 1.00. A fund with a beta of .85, for example, would have provided excess returns of about 85% of the market's excess return. In a down year, this fund has typically not fallen as much and, in good years, it has typically not advanced as strongly as the market. However, beta is a measure of historical volatility and cannot predict a fund's future performance.
An investment strategy with attributes of both the growth style and the value style of investing.
A debt security (IOU) issued by a corporation, government, or government agency. In most instances, the issuer agrees to pay back the loan at a specific date and make regular interest payments until that date.
Bond funds come in a variety of types from short-maturity, high-quality types to long-maturity, "junk bond" types. These are not insured funds, nor do they have stable principal values even if they invest solely in U.S. Treasury or government-guaranteed bonds. They may be subject to many sources of investment risk. When interest rates rise, the value of the bonds decreases (more with longer maturities), and vice versa. If a company has credit problems or its rating is downgraded, the value of its bonds can be affected. While bonds are fixed-income investments, they are riskier than CDs, treasury bills and money market funds, in some cases much more so. As a result, investors expect higher returns over time which can offset some of the inflation risk inherent in using "fixed income" investments like bond funds for longer term objectives.
Also known as CDs Savings Accounts and Treasury Bills. These investments provide safety of principal and scheduled returns (if held to maturity) and are ideal for short-term objectives and liquidity needs. Because of their relatively low after-tax returns, they are susceptible to inflation risk for longer term investment needs.
Unlike open-end mutual funds, which are always issuing and redeeming shares at net asset value (sometimes with a commission), closed-end funds trade like an individual security in a secondary market. Because of this, the securities can trade at a discount (or premium) to their actual net asset value.
These funds invest in commodities and commodity futures and options. They are extremely volatile and should be considered speculative investments, although some investors use these funds for inflation hedges.
Market valuations of companies that have publicly traded securities are based upon expectations of the company's and its industry's future performance. As these expectations change over time, market values will adjust accordingly.
This risk usually relates to bond investments and refers to the financial soundness of the firm which issued the bonds. The higher the credit rating, the lower the expected return from interest payments because of the very high likelihood of receiving interest and principal back. The lower the credit rating, the higher the bond return needs to be to attract investors, and the more uncertainty involved in collecting both interest and principal. For firms with high credit risk, and especially for bond issues in default, the principal value of the bonds can fluctuate greatly based on perceived changes in the firm's ability to repay the bondholders.
Investments traded in foreign markets or which pay interest or dividends in foreign currencies entail the risk of declines in the currency's value relative to the U.S. dollar. Some investment managers attempt to manage this risk with various hedging techniques. These are not consistently effective, but diversification into many major currencies can help limit this risk.
This is a measure of the dollar-weighted average time until receipt of all cash payments from a fixed-income security expressed in years. "Macauley duration" is simply the average time to receipt of all the scheduled interest and principal payments on a bond. "Modified duration" adjusts the Macauley duration to accurately measure how much a bond's price can be expected to fall if interest rates rise by a certain percentage, or vice versa.
This is a measure of the earnings growth record of a stock or of the average stock in a portfolio. This average number is usually weighted so that larger positions in the portfolio count proportionately more than lesser positions ("dollar-weighted"). Stocks with losses and those that lack a five-year track record are usually excluded from this calculation.
Equity funds carry substantial opportunity for higher returns along with substantial risks of widely varying returns. There are no guarantees of future values or earnings. The scope of the funds includes Conservative (high-quality, blue-chip stocks paying dividends), Index (match market returns), Aggressive (growth companies not paying dividends and/or turn-around companies), Sector (focusing on specific industries, which reduces diversification), International (good quality foreign companies, but subject to currency risk in addition to the other sources of risk), International Sectors (focusing on specific countries or blocks of countries, for example, European Equity Fund), and Emerging Market (stocks of companies in developing non-established countries, such as the Pacific-Rim Emerging Growth Fund, subject to substantial risks including currency and liquidity of the markets). Equity funds historically have been the best long-term inflation hedge available among mutual funds, but they typically suffer along with other financial assets at times when inflation rates are increasing rapidly.
These funds combine both U.S. and foreign securities. A Global Bond Fund includes both U.S. and foreign company and government bonds. A Global Government Bond Fund has only U.S. and foreign government securities. Global Equity Funds contain both U.S. and foreign equity securities and are subject to many sources of investment risk and currency risk. Both international and global funds have a unique characteristic which can enhance long-term portfolio returns most international equity and bond markets are not fully correlated with the U.S. markets, and in some cases, very little correlation is exhibited. Because of this, modest percentages of international exposure can actually reduce the total risk of your entire portfolio, and can at times provide increased returns. When investing in international and global funds, it is important to understand how much of the historical returns have been due to the securities' performance versus how much was due to currency changes.
Investment orientation that focuses on stocks of companies with proven records of earnings growth, and is typically willing to "pay up" for stocks of companies with the best records and prospects.
Hedge funds are speculative funds which make large bets on market movements. They utilize borrowed money to substantially leverage their returns (and losses), often at a factor of ten to one, or more. They purchase exotic securities and also take substantial short positions when they think the market or a particular sector of the market will go down. Such funds are extremely risky and are suitable for high-wealth investors only.
When putting your portfolio together and when making adjustments and revisions, there is an overriding risk that you must consider in order to maintain or increase your standard of living. Inflation does not touch your principal value, but it does steal your future purchasing power. A portfolio that is intended for longer range needs, but is entirely invested in low risk/low reward investments, can actually provide you with less purchasing power (especially after taxes) at the end of the period than at the beginning, even though you minimized all of the other sources of risk along the way. Always review your results in terms of after-inflation (and after-tax) returns, especially for your long-term objectives (like retirement) which are at the most risk from inflation.
Investors in bonds and bond funds must be acutely aware of the risk associated with interest rate changes. When interest rates rise, the values of outstanding bonds fall, and vice versa. In a rising rate environment, while you are receiving monthly bond interest payments as scheduled, your total returns may be eroding because of declining principal values. This is especially true with longer term holdings. Longer term bond issues (for example, 30-year Treasury Bonds) are much more sensitive to interest rate changes than short- or intermediate-term issues.
The values of marketable securities fluctuate every day. Sometimes these changes in value have nothing to do with the real "value" of the investment but instead are influenced by a variety of unrelated events such as political changes, congressional actions, U.S. and foreign activities, or a psychological swing in the market "mood".
Average Maturity The dollar-weighted average length of time until bonds held by the portfolio reach maturity and are repaid. In general, the longer the average maturity, the more a portfolio's share price will fluctuate in response to changes in market interest rates.
Short Maturity of 4 years or less.
Intermediate Maturity of 4 to 10 years.
Long Maturity more than 10 years.
MMFs pool investors' money to purchase short-term investments such as jumbo CDs, commercial paper (short-term IOUs) of corporations, and treasury bills. Because of their size, they allow investors to get slightly better returns than if the investor purchased CDs or savings accounts individually. These accounts are not insured and reflect changes in interest rates daily. They have, however, been extremely safe in preserving principal over their history, but should not be expected to offset inflation risk for long-term objectives.
For a stock, this is the ratio of the current price relative to the current year's earnings per share. For a fund it is the dollar-weighted average of the price/earnings ratios of the stocks in the fund's portfolio.
Average quality An indicator of credit risk, this is the dollar-weighted average of the credit ratings assigned to a portfolio's holdings by credit-rating agencies. Agencies assign credit ratings after appraising an issuer's ability to meet its obligations.
High quality Ratings of AAA and AA.
Medium quality Ratings less than AA but greater than or equal to BBB.
Low quality Ratings below BBB.
Companies with market capitalizations in the $250 million to $1.5 billion range are considered "small cap". Earnings for these companies often are expected to grow faster than earnings of the overall market which, in turn, could increase the stocks' share prices.
This market value-weighted index of 500 widely held stocks is often used as a proxy for the stock market. It is heavily influenced by the largest issues, making it a "large cap" index. The capitalization size is normally at least $1.5 billion. Included are the stocks of 400 industrial companies, 40 public utility companies, 40 financial companies, and 20 transportation companies. This composition is flexible and the number of issues in each sector has varied as relatively unsuccessful companies have been frequently replaced with more successful companies.
This market value-weighted index consists of 400 widely held stocks. These are primarily stocks in the middle capitalization range ($1.5 billion to $7.5 billion market value). Any midcap stocks already included in the S&P 500 are excluded from this index, which was started on December 31, 1990.
This statistical measure represents the degree of fluctuations in historical returns. The higher the standard deviation, the greater the volatility of returns. It is calculated using historical period returns to determine a range of returns around a mean. For example, a fund with an average annual return of 10% and a standard deviation of 5 would have provided a return between 5 and 15% about 68% of the time. Standard deviation, a historical measure, should not be used to predict fund performance.
This is simply the number of individual securities included in a portfolio. It is an indicator of diversification. The more separate issues and sectors a portfolio holds, the less susceptible it is to a price decline stemming from the problems of a particular issue or sector.
This return measure represents the percentage change, over a specified time period, in a fund's value, with the ending value adjusted to account for the reinvestment of all distributions of dividends and capital gains as received.
This investment style focuses on stocks that are believed to be undervalued in price relative to the underlying companies' intrinsic values and will eventually be recognized by the market.
This is the average market value of all outstanding common stock of companies included in a portfolio, weighted in proportion to their percentage of net assets in the fund.