Financial and Investing Terms

What you don't know can hurt you.

DaVinci Wealth Financial and Investing Terms

We are often asked about some very basic financial terms and concepts.  In an effort to help inform the public we have created this list of common financial and investing terms. Although thorough and lengthy, this is by no means a complete list.  This list is derived from many client and prospect inquiries we tend to get about topics of interest to our core audience of retirees and pre-retirees.

Accumulation Phase/Preservation-distribution phase

Traditionally, the accumulation phase refers to the period of an annuity contract where it takes payments in from the annuity holder, and the distribution phase refers to the period when it pays money out. However, these terms have broader application to the life cycle of investors. The accumulation phase refers to the period of life when a person is working and regularly depositing money into their retirement account. During the accumulation phase, account values must grow, and most investors can take on more risk because the time to retirement, and therefore the time horizon of investments in the portfolio, is longer. The preservation-distribution phase occurs when the person retires and needs the invested account for income. At this point, risk needs to be kept at minimal levels because a consistent income is needed to meet monthly expenses.


An annuity is a contract issued by an insurance company designed to accept and grow funds during the accumulation phase and then pay out a stream of cash flows during the annuitization phase. Annuities are used in income planning and are commonly structured to provide a consistent series of payments for a specified number of years or even for the lifetime of the investor.


An asset is a resource owned by an individual, government or firm that is held because it is expected to deliver future economic value. In business, assets might be anything from oilfields to manufacturing plants to a software company’s intellectual property. In finance, assets generally refer to stocks, bonds, CDs, shares of mutual funds, annuities: basically anything an investor can own in order to make a profit.

Asset Bubble, Stock Bubble

Bubbles are times when the price of an asset or class of assets, be they commodities, stocks, or some other type of asset, gets bid up extremely high before collapsing. The dot com and housing bubbles are the two most recent examples of times when asset values inflated precipitously before the bubble burst, leaving prices a fraction of what they were only months before.

Asset Allocation

Asset Allocation is basically a term that describes your investment strategy:are you going to put your money into stocks, bonds, or other instruments, and how much in each? Your Asset Allocation is how you have your portfolio divided: what type of assets, which specific products, which specific accounts.

Balance of Trade

The Balance of Trade reflects the ratio of imports to exports between two countries. If a country exports more than it imports, it runs a Trade Surplus. If it imports more than it exports, it runs a Trade Deficit. A trade surplus can be useful during a recession, because strong exports will spur job growth with fresh liquidity from abroad. During an expansion, a country may be willing to run a trade deficit, bringing in more goods than the country could produce on its own, and in turn lowering prices and controlling inflation.

Blue Chips

Blue Chips are nationally recognized, established firms with long records of financial stability and reliable growth. Blue Chips are seen as less risky investments because they are large, established firms that are known to weather downturns and adverse economic conditions. Blue chip stock prices are typically high and closely followed


Bonds are instruments of debt issued by a government or a corporation. They basically represent loans. They include the promise to pay a certain amount of annual interest as well as the original amount borrowed on a specified date.


We all know that cash is money, whether currency or a deposit in a checking account, but when investment advisors use the term, they are often talking about CDs, money market accounts, or even treasury bills: instruments with little to no risk and insignificant growth that are easy to liquidate if emergency funds are needed.

Common Stock

Common stock entitles the shareholder to vote at shareholder meetings (typically to elect the Board of Directors or BoD) as well as to receive dividends. Most stocks are shares of common stock.

Debt-to- Equity Ratio

The Debt-to- Equity ratio is a financial ratio used to measure a company’s financial leverage, calculated by dividing a company’s total assets by its total shareholder’s equity. The result expresses the percentage of the company’s assets that are financed with debt rather than shareholder value, and is a measure of the company’s financial risk. This type of risk is often referred to as “leverage” or “gearing”.


Deflation is a decrease in the overall price level, or put another way, an

increase in the purchasing power of a dollar.


Derivatives are investment contracts whose values depends on fluctuations in some underlying asset. Let’s say a friend pays you $10 and you agree that you’ll buy him an ice cream every time the temperature goes above 100 degrees; that’s a derivative. It’s basically a bet between two investors that a certain condition will or won’t happen. Historically, investors used derivatives to manage risk and hedge against losses, but Warren Buffet called derivatives “financial weapons of mass destruction” because small fluctuations in underlying assets prices could trigger huge losses in the derivative market. The derivative market today is worth hundreds of trillions of dollars, many times the value of the total global economy.

 Discount Rate

The discount rate is a rate used in financial calculations to compute the present value of a stream of future cash flows. What rate is used can depend on a number of factors including opportunity cost and the investor’s cost of capital, and is typically only an educated guess. If an investor can borrow money at 5%, then their discount rate should be no lower than 5%, their cost of capital. However, if an investor has another investment opportunity that was guaranteed to pay 7%, they might use their opportunity cost of 7% as the discount rate because that’s what they would need to forego in order to invest.


A dividend is a portion of a company’s annual or quarterly earnings paid out in cash to shareholders, typically in the form of a payment of “x per share.” A shareholder who had 10,000 shares in a company that paid a $0.60 per share dividend would therefore receive a check for  $6,000. Dividends are declared at a company’s discretion and may or may not be proportional to earnings.


ETF stands for exchange traded fund. ETFs are mutual funds that are broken down into shares which can then be bought and sold on stock markets. ETFs can have all of the characteristics of normal mutual funds, such as having fees or zero fees, load or no load, or be more or less diversified, with the added bonus that they can be easily bought and sold like individual stocks.


Earnings are the after-tax net profit of a company, which can then be distributed to shareholders via dividends, or reinvested into the company as Retained Earnings.

Efficient Frontier

The Efficient Frontier is an idea from Modern Portfolio Theory (MPT) that refers to the set of all efficient portfolios that maximize returns for every level of risk. MPT states that for every level of risk, it is possible to construct an efficient portfolio that maximizes return for that level of risk. However, not all portfolios are efficient: some of them feature lower returns for their level of risk or higher risks than their level of return. On a Risk/Return graph, the Efficient Frontier is the line formed by all efficient portfolios: portfolios to the right of the frontier are inefficient, and portfolios to the left are impossible.

Efficient Market Hypothesis (EMH)

The Efficient Market Hypothesis states that markets will be efficient, which is to say the market price of all securities will correctly reflect their underlying value, as long as financial information is publicly available. The idea is that a large enough number of investors will be researching companies to determine their actual value and either buying them if they think the market price is too low or selling them if they think it is too high, that prices will adjust and come to reflect the actual value as provided by public information. Insider Trading, the use of non-public information for investment decisions, is one thing thought to imbalance EMH. EMH in some form is almost universally accepted by economists, although there is debate about whether markets are perfectly efficient or only quasi-efficient, as well as about the time horizon and degree of market participation required for efficiency. Opponents of EMH point to asset bubbles, times when the price of an asset or class of assets is bid extremely high and then collapses, as evidence that markets are at least not perfectly efficient.


Equity refers to ownership of something. For example, a homeowner who has paid off 30% of a $200,000 mortgage has $60,000 of equity in the home. For investors, equity is conferred by owning stock. For companies, equity refers to the total amount of capital invested by shareholders, as opposed to debt.

Expense Ratio

The expense ratio refers to the amount of money withheld in a mutual fund investment to cover the costs of operating the fund, be that management fees, administrative expenses, or even marketing and promotional costs of the fund. As of 2013, the average stock mutual fund had an expense ratio of 1.25%.

Federal Reserve

The Federal Reserve, or Fed, is the United States Central Bank. It is comprised of a governed agency, the Board of Governors in Washington, DC, and 12 regional Federal Reserve Banks. The Fed is largely responsible for controlling the money supply, but the Fed does not “print” money- instead it regulates the money supply by buying or selling government bonds in the market and by setting the Federal Funds Rate, which is reflected in other interest rates throughout the economy.

Fixed Annuity

A fixed annuity is a simple annuity that will provide a series of fixed payments to the investor, like a bank CD but with more favorable rates. The guarantee of payment is contingent on the financial strength of the insurance company issuing the annuity.

Fixed Index Annuity

A fixed index annuity provides payments that grow with a specified market index, such as the S&P 500, but usually have a certain guaranteed minimum. Unlike variable annuities, they are not market investments, rather the index is basically a way for the issuing company to determine how much to credit the account value. Fixed index annuities can be very useful in retirement planning because they offer investors a way to participate in market growth with no downside risk and no direct exposure to market volatility.


Futures are a type of derivative created in the 1850s to insulate agricultural producers and buyers from price fluctuations. Basically, a producers and a buyer agree to exchange a certain amount of a commodity for a certain price at a fixed future date, protecting the producer from price drops and the buyer from price rises. Investors shortly began trading in futures with no intention of ever taking delivery of the commodity, just speculating on price changes. There are now futures markets for a multitude of things including stock indices and currency exchange rates.

Hedge Fund

A hedge fund is a pooled fund that uses high risk investments in an attempt to make abnormal gains. Hedge funds seek investments that perform better than market benchmarks or that fluctuate inversely to the rest of the market. Investors sometimes use hedge funds to provide diversification.

Income Investing

Income Investing refers to investment strategies designed to provide regular

income payments with minimal risk rather than portfolio growth, common during the preservation-distribution phase.

Index-Based Mutual Fund

An index-based mutual fund is a fund that is specifically constructed to mirror the performance of a certain stock index, such as the S&P 500. These funds invest in all of the companies in the index, assuring investors of returns that track the average of the index.


Inflation is an increase in the overall price level in an economy, or put another way, a decrease in the purchasing power of a dollar. An easy example is if 10 years ago you could buy a hamburger for $0.50 and today that same hamburger costs $1.00, that means that dollar buys half as much as it did before. Note though that inflation is related to the overall price level, not price fluctuations between commodities. If the hamburger costs more because there is a shortage of beef, but other commodity prices remain at historic levels, that’s not inflation. If the hamburger costs more because of incremental changes in prices of all goods across the whole economy, that’s inflation. Most central banks try to hold inflation at 2-3%, widely held to be a healthy level that supports expansion and avoids risk of deflation. High inflation poses a risk to investors, however, because the investment’s rate of return must be at least as high as the rate of inflation in order for the investor to break even. An investment tha earned 5% per year over a period when inflation was 3% per year actually only returned 2%.

Inflation Risk

Inflation risk, as it applies to income investors, has to do with the erosion of purchasing power over time due to the rising cost of goods. An investor with monthly income of $2,000 today will find that, after 10 years of inflation at 3% per year (the historic level), their real income in terms of what they could buy would have decreased to less than $1,500.

Individual Retirement Account (IRA)

A traditional IRA allows someone to invest pretax payments up to a specified annual limit to an account. The account can be invested in a number of different options such as CDs, mutual funds, annuities, stocks, and bonds. The account grows tax-free and withdrawals can begin without penalties after age 59 ½. Taxes are then paid when the money is withdrawn.

Interest Rate Risk

Interest rate risk is the risk that the value of an asset will change due to changes in the over all level of interest rates in an economy. Interest Rate Risk applies most directly to fixed-interest instruments such as bonds, but has impacts on equities as well.

Modern Portfolio Theory

MPT is based on the idea that there is an inherent tradeoff between risk and return in investing, but that through a process called portfolio optimization, a portfolio can be constructed that maximizes return for a given level of risk. An optimal portfolio is said to be efficient, meaning that there is no way to increase expected return without also increasing risk.

Money Market

Money markets are markets for short-term debt securities, such as CDs or bonds with a term of less than one year. Money market investments tend to be fairly low risk, and bring correspondingly low returns, but are useful for large institutions and governments to meet short-term cash needs.

Mutual Fund

A mutual fund is a fund that pools money from multiple investors and then uses it to buy many different assets, usually a portfolio of different stocks. Mutual funds provide diversification and reduced risk for investors with smaller amounts of principal to invest, but often at the cost of management fees. Mutual funds can also be used as portfolios that target different types of investments. There are many different specialized mutual funds, including funds that specialize in energy or agriculture stocks, or even in companies with ethical business practices.

Opportunity Cost

Opportunity cost is an economic concept that refers to the cost of options that are given up in order to do something. For example, take a person who decides to return to college in order to pursue an advanced degree and increase their salary. They pay $20,000 per year in tuition, but they also give up the $35,000 per year job they had been working. That means that the true cost of going back to school is $55,000 per year. Assuming the program lasts two years, that adds up to $110,000. If the salary bump is only $10,000, it will take eleven years before the investment in education has broken even in economic terms.

Preferred Stock

In addition to common stock, some companies also issue preferred stock, or even several different classes of preferred stocks (commonly A, B, C, etc.). Preferred stockholders typically do not have voting rights, but have a higher claim on dividends and assets than common stockholders.

Present Value

In financial calculations, the present value of any asset is the discounted value of its future cash flows, based on the investor’s discount rate. An investment that will pay $1,000 five years from now has a present value of $680.53 if the investor has a discount rate of 8%.


A recession is defined as a time when Gross Domestic Product falls for at

least two quarters in a row, or when unemployment rises by more than 1.5% in a single year. Quarterly data are only available after the fact, so declarations of recession are always retrospective. The US has not been in recession since June of 2009. Recessions are characterized by decreases in demand that drive down output, resulting in higher unemployment and less consumer spending, which itself results in less demand and even further reductions in output in a vicious cycle. Recessions are also characterized by currency deflation as price levels fall in response to low demand.


Risk is the possibility that an asset’s actual return will be different from its expected return. In finance, risk is usually measured using a complex statistical calculation called standard deviation. In a nutshell, standard deviation uses historical values to measure how much an asset’s value fluctuates over time, which is then used to estimate how probable it is that the asset’s return will diverge from expectations.

Roth IRA

A Roth IRA is similar to a traditional IRA except that the contributions are not tax deductible. Instead, qualified withdrawals are tax-free.


Speculators are usually short-term investors who are betting on the price of an asset to rise or fall in the short term. A stock speculator might buy 10,000 shares of a mining company for $4.50 per share and then sell them a week later for $5.00, netting a cool $5000 for a week’s investment. High-risk and volatile, speculation is the polar opposite of what most professionals consider a sound investment strategy. Speculators also contribute to price volatility in speculated commodities.


A stock is a share of ownership, or equity, in a company and entitles its owner, the shareholder, to a share of the company’s profits and assets.

Stock Index

Stock indices measure the performance of a certain portion of the stock market, typically by computing a weighted average from the prices of selected companies. Major indices include the Dow Jones Industrial Average, which shows the performance of 30 large US-based companies at each trading day, and the S&P 500, which is a weighted average made up of 500 large-cap American companies.

Stock Market

A stock market is a place where shares of publicly held companies can be bought or sold by investors. If you own stock in a company, you are entitled to a share of that company’s assets and earnings. If the company does well, you might be able sell your stock for more than you paid for it. The downside is that if the company does poorly, the stock price can also lose value. Stock prices in all companies fluctuate on a daily or even minute-to-minute basis, based on millions of factors in the global economy that might affect the future performance of a certain company. Virtually every developed country and most developing nations have stock markets, of which the largest are the New York Stock Exchange (NYSE), the NASDAQ, and the London Stock Exchange.

Strategic Asset Allocation

A strategic asset allocation is a portfolio diversification strategy that sets target allocations for different asset classes based on factors such as the investor’s time horizon, risk tolerance, and investment goals and then periodically rebalances the portfolio back to the target allocation when it deviates significantly because of differing returns across the asset categories. A strategic asset allocation is more suited to a “buy/hold” strategy, as opposed to a tactical asset allocation, which is more appropriate for actively traded portfolios.

Tactical Asset Allocation

A tactical asset allocation is an active management strategy that regularly changes the percentages of assets held in various classes to take advantage of shifting market prices and sector performance. A tactical asset allocation is more suited to an actively traded portfolio, and is a tool frequently employed by professional portfolio managers.

Variable Annuity

A variable annuity is actually a market investment wrapped inside an annuity contract. The payments the investor receives are variable based on the performance of the underlying portfolio. Variable annuities are often used to replace mutual funds as the performance is very similar but the tax treatment is more favorable. Variable annuities are not principle guaranteed and have market risk.