Bull versus bear? Mutual fund versus ETF? How do they work out the inflation rate? How many times have your eyes skimmed cluelessly over an article or nodded in meetings at investment terms that are familiar but mean nothing to you?
Let’s be clear, a good advisor, with your best interests at heart, should be speaking in a language you understand or explaining terms they know may leave you befuddled. But there’s a lot of information out there to digest, much of it relevant to your retirement savings portfolio. With that in mind, here is part 1 or our rundown of some basic investment terms you may or may not think you understand, so you can get a firm understanding of what they’re really talking about on BNN.
Think of your mood if you came, unexpectedly, face to face with a bear in the Canadian wild. It would likely be pessimistic at best, which is the sentiment that drives bear markets. Typically called as such when markets fall 20% from recent highs, they are typically short, painful and associated with recessions. They are characterized by job losses, declining GDP and the stock market losing value. They do, however, represent buying opportunities for a skilled investor.
The flip side is optimism – think a bull building up (hopeful) steam as it charges its target. A bull market takes effect when stock prices broadly increase by at least 20% since the last market downturn. They can last decades, taking into account minor corrections. The last one was prolonged, lasting from the 2008 global financial crisis to the crash of 2020. During bull markets, life for investors is typically sweet (a rising tide lifts all boats), and businesses are expanding and hiring.
We live in a period where every sentence seems to contain this word, and we all know what it basically means: things have got more expensive, and your purchasing power has declined. But how is this calculated? To work out the rate of inflation, the prices of a representative “basket” of goods and services are tracked and compared on a year-over-year basis (6% increase, for example). The most common one used is the consumer price index (CPI), which has a fixed “basket” including: food, shelter, furniture, clothing, transportation; and recreation.
Again, a term used by every newsreader right now. In simplest terms, an interest rate is the cost of borrowing money. You pay interest on the money you borrow but you can also earn interest on your money in certain bank accounts. What is often confusing are the different types of rates. The Bank of Canada’s widely covered announcement focuses on their benchmark rate, or overnight rate, which sets the tone for major deals and institutions. The recent hike cycle has, of course, made borrowing money more expensive. Various interest rates can vary, though, whether that’s through different mortgage brokers, loans or the bond market (see below). For the central banks, it’s also a monetary policy tool – raising rates can lower the demand for money, cool off the economy and keep inflation under control.
A portfolio is typically made up of bonds (fixed income), stocks, (equities), and alternatives. A bond is a type of debt security that companies and governments use to raise capital. When they issue bonds, they are essentially borrowing money from its investors, who receive interest payments during the life of the bond, and their full investment back once the bond reaches maturity. Traditionally the portfolio safety net for when stocks drop, that role is under scrutiny given recent performance. Interest rate increases have also shone a light on the bond market. Sold at a fixed rate to maturity, those offering lower rates than are now being offered are forced to sell at a steep discount (good for buyers, bad for sellers), but rising yields (returns) mean good duration management (understanding how the length of the bond can impact yield) offers opportunities. Many now believe the asset class is an attractive place to be once again.
Where the biggest winners and losers reside. Stock refers to equity investments and, in general, a single stock is the same thing as a single share of ownership in a company. It’s also used to describe the asset class as a whole. Stock represents equity in a company, meaning investors are owners of the company and can have certain rights like voting power and dividends. Stocks are bought and sold on exchanges and the owner can hold them indefinitely, while companies issue stock to raise funds to operate their business. Historically, stocks have outperformed most other investments over the long term and, therefore, are the foundation of most people’s portfolio.
The “sexy” alternative to the traditional mutual – the TikTok to the text message, if you like. An exchange-traded fund (ETF) is a basket of securities that trades on an exchange just like a stock does. This basket can be made up of stocks, bonds, other asset classes, or a combination of some or all. Unlike a mutual fund, for which trades close at the end of the day, ETFs trade throughout the day. Some are passive funds that track an underlying index or sector, while some are active with managers making decisions on underlying portfolio allocation. Fun fact: the first ETF was the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index, and which remains an actively traded ETF today.
The granddaddy of the investment world – a mutual fund is a pooled investment that holds many underlying assets. Typically, investors pool their money together in a fund, which is operated by a professional money manager, who buys the stocks, bonds, or other assets and who attempts to produce capital gains or income for the fund’s investors. Funds can usually be purchased or redeemed at the fund’s current NAV (net asset value), which doesn’t fluctuate during market hours but is settled at the end of each trading day.
Particularly relevant right now, given the volatility in the stock market and the fact bond yields are still not enough for many retirement portfolios. Instead, more investors are looking at alternatives - financial assets that don’t fall into one of the conventional investment categories (stocks, bonds, cash). Examples include private debt, private equity, hedge funds, real estate, art and antiques, commodities, and cryptocurrency. Characterized by fewer regulations and illiquidity, they have traditionally been aimed at institutional or accredited investors. However, there has been a “democratization” of alternative funds to retail investors via liquid alts (in mutual funds, ETF form) that provide daily liquidity.