In simple terms, what is investing?
Investing is putting your money into assets, such as stocks or bonds, with the expectation that your money will grow.
Personal finance is full of concepts that can intimidate newcomers. In reality, being smart with money doesn’t require being a genius or getting an MBA.
A lot of complex-sounding financial principles are actually pretty simple, and understanding how they apply to your finances can pay huge dividends.
Ready to learn more? We’ll define other financial terms in a straightforward way.
Investing definitions everyone should know
Active investing: Active investing is a hands-on approach to investing. Active investors frequently buy and sell stocks or other investments. Active stock traders might look at trading volume, price trends and past stock market data to help anticipate where market prices might go.
Alternative investments: Any assets that aren’t stocks, bonds or cash. Bitcoin, real estate, rare art and other collectibles are all examples of alternative assets.
Asset: Something you can invest in, such as stocks, bonds and cash. Broadly speaking, an asset can be anything that has economic value, including a home or car.
Asset allocation: This investing strategy balances the assets in your investment portfolio based on your age, goals, risk tolerance and other considerations.
Bonds: One of the three main asset classes frequently used in investing. A bond is a loan to a company or government that pays investors a fixed rate of return over time.
Broker: A stockbroker is a person or firm licensed to buy and sell stocks and other securities through stock market exchanges. In the past, the only way for people to invest directly in stocks was to hire stockbrokers to place trades on their behalf. Today, most investors place their trades themselves, through a brokerage account at an online stockbroker. (Are you feeling lost? Read our explainers on brokerage accounts and buying stocks.)
Compound interest: The interest you earn on both your original deposit and on the interest that original deposit earns. For example, a single $1,000 investment earning 6% compounded annually could become roughly $4,300 in 25 years. Commit to adding an extra $100 a month in savings and, thanks to compound interest, the balance will swell to more than $70,000. (Experiment with this compound interest calculator to see how it works.)
Diversification: The act of spreading your money across a range of assets to reduce investment risk. That means having a mix of asset classes — stocks, bonds, mutual funds and cash. You can also diversify within those classes, especially with stocks, by varying factors such as industry, company size and geographic location.
Dollar-cost averaging: This strategy involves investing set amounts of money at regular intervals, such as once per week or month. Having money diverted from each paycheck into a 401(k) plan is an example of dollar-cost averaging. It’s a smart strategy in all market conditions, but especially during periods of market volatility. Since the set amount of money buys more shares when investment prices are down and fewer shares when prices rise, the average price you pay evens out, ensuring you don’t buy only at high prices.
ETFs: An exchange-traded fund, or ETF, is a fund that can be traded on an exchange like a stock, which means it can be bought and sold throughout the trading day (unlike mutual funds, which are priced at the end of the trading day). ETFs give you a way to buy and sell a basket of assets without having to buy all the components separately, and they often have lower fees than other types of funds.
Expense ratio: An expense ratio is an annual fee charged by mutual funds, index funds and ETFs as a percentage of your investment in the fund. If you invest in a mutual fund with a 1% expense ratio, you’ll pay the fund $10 per year for every $1,000 invested. If high, these fees can significantly drag down your portfolio returns.
Funds: A fund is cash saved or collected for a specified purpose, often professionally managed with the goal of growing the value over time. In investing, the most common example is a mutual fund, which pools money from shareholders to invest in a portfolio of assets, such as stocks and bonds.
Index fund: A type of mutual fund that tries to mirror the performance of a market index, such as the S&P 500 index.
Market index: A market index is a basket of investments that represent a portion of the market. The S&P 500 is a market index that holds the stocks of roughly 500 of the largest companies in the U.S.
Opportunity cost: The value of the choice you didn’t make compared with the option you chose. For example, the opportunity cost of your takeout lunch is the $20 you could have spent on anything else. Sometimes the true cost of an opportunity not taken is apparent only over time, such as choosing the “safe” investment of cash versus investing money in the stock market. Over the short term, you avoid the sometimes harrowing ups and downs of the market. But over the long term, cash diminishes in value because of inflation. And you can lose out on the long-term returns of a diversified stock portfolio.
Options: A contract to buy or sell a stock or any other underlying asset, usually in increments of 100 shares per contract, at a pre-negotiated price and by a certain date. An option allows you to bet on which direction you think the price of a stock or other asset will go.
Passive investing: A hands-off approach to investing that typically tracks a benchmark index, such as the S&P 500. Often passive investors invest in index funds, or through a robo-advisor, which uses algorithms to manage your portfolio with little human interaction. This approach requires a long-term mindset that disregards the market’s daily fluctuations.
Risk: The possibility that an investment will perform poorly or even cause you to lose money. In general, a low-risk investment will deliver lower potential returns. The more risk you’re willing to take on, the more potential upside there is — and the higher the likelihood that you could lose your investment. Learn more about the trade-offs between short-term and long-term investing goals.
Robo-advisor: Also known as an automated investing service or online advisor, a robo-advisor uses computer algorithms and advanced software to build and manage your investment portfolio. Robo-advisors are often much cheaper than an in-person financial advisor.
Stocks: Securities that represent an ownership share in a company. For companies, issuing stock is a way to raise money to grow and invest in their business. For investors, stocks are a way to grow their money and outpace inflation over time.
Tax-loss harvesting: An investment strategy that can significantly reduce capital gains taxes. In taxable accounts, the practice involves selling losing investments to offset the gains from winners.
Yield: The annual percentage rate of return earned on an investment bond or other interest-paying asset.