The investment industry is fond of jargon. Deciphering this alphabet soup of acronyms can give the impression that investing is complex and impenetrable. It may even deter people from making the best long-term decisions for their wealth. Much like flat-pack furniture, the clearer the instructions, the better the outcome.
That said, while it is our job to understand and interpret the detail, it is worth getting to grips with some key concepts. This can help unlock some of the complexities of investment markets. With this in mind, we give five pieces of jargon it is worth understanding, as well as five you can comfortably ignore.
Five to understand:
- Volatility – Volatility is the extent to which the price of an asset moves around. It is used as a proxy for risk – so higher volatility would be higher risk. However, this isn’t exactly true because a stock that moves up very rapidly has the same volatility as a stock that moves down very rapidly, but they may not mean the same thing to an investor.
- Diversification/asset allocation – This is how different assets – bonds, shares, property, cash – are blended in a portfolio. The ideal is to build a portfolio that suits the investor’s overall goals and is robust in different market conditions. A more risk-averse investor, for example, would have more in bonds and less in stock market investments. Asset allocation may also change over time and with income needs.
A diversified portfolio will hold a range of different assets, including cash, bonds and shares. This means it remains resilient at each point in the business cycle. If stock markets are performing poorly, then high quality government bonds should do well. As well as ensuring that their overall portfolio is diversified, it is worth ensuring that the sources of income are diversified, generated by bond, equity and/or property holdings.
- Total return approach versus income only – Under a total return approach income and capital gains generated by the portfolio are treated identically in terms of performance. With an income approach the income yield and capital gains are treated separately and increasing yield becomes the focus.
- Target return and time horizon – It is important to know what you want your investment to achieve (target return) and how long you have to achieve those goals (time horizon). This influences this amount of investment risk you can take and how much you can allocate to higher growth, but more volatile areas such as emerging market equities.
- Benchmarks – The idea of a benchmark is to provide a comparative measure against which someone can judge the portfolio’s positioning and performance. The benchmark should match the investor’s long-term goals – be that long term capital growth or income.
Five you can comfortably ignore. But just in case you’d like to know…
- EBITDA – Earnings before interest, tax depreciation and amortization OR, in layman’s terms, a measure of profitability before taking away the nasty bits.
- Negative capital growth – The value of the investments has gone down! Many investment managers find it more palatable than suggesting your investment has fallen.
- Alpha and Beta – Beta is the performance of the market, and alpha is the performance that a fund manager adds over and above the market performance. Both are complex calculations and not necessarily very informative for investors looking at the performance of their portfolio.
- Operational leverage – Operational leverage describes the split between fixed and variable costs for a firm. Fixed costs do not vary with the number of sales while variable costs increase with an increase in sales. A firm with high operational leverage has high fixed costs and low variable costs. Therefore, a small increase in revenue can translate into a large increase in operating income.
- WABUA and FAANGs – Two popular acronyms for groups of companies - Walmart, Amazon, Berkshire Hathaway, United Health and Apple and Facebook, Amazon, Apple, Netflix and Google.
It is important not to be distracted by jargon or let it turn you off investment altogether. The alternative is to have a high weighting in cash, which may feel like the straightforward option, but will not protect against inflation and may see your portfolio lose money in real terms over time.
It is important to remember that investment does involve risk and the value of investments and the income from them can fall as well as rise and you may not receive back the original amount invested.
Nick Murphy, head of charities, Smith & Williamson
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
Please remember investment involves risk. The value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.