Investing jargon explained

What you’ll learn:

• How actively and passively managed funds differ.
• What the PE ratio means and how it can help with investment decisions.
• How pound cost averaging works.

There are lots of bewildering words and phrases you might discover along your investing journey. However, it’s essential to get to grips with investment jargon and the various acronyms that are often used if you want to become a successful investor. These are some of the most common you might come across.

Actively-managed funds

When you invest in an actively-managed fund, a professional fund manager will choose which investments to hold in the fund. The manager’s aim is to deliver a performance that beats the fund’s stated benchmark or index and they will ‘actively’ buy, hold and sell investments to try to achieve this goal. Investors in actively managed funds will typically have to pay higher annual charges than for passive funds that simply track a particular market index.

AIM

AIM stands for Alternative Investment Market, a sub-market of the London Stock Exchange. There is no minimum size the company needs to be to list on AIM and they also don’t require a trading record, which means many of the companies which join the market have only been around for a short period of time.

AMC

The Annual Management Charge (AMC) is the percentage charge per year removed from a fund by its manager for their running of the fund.

Asset allocation

When you invest, you must decide how much of your money you want to allocate to different assets. Assets are the things you’re investing in, such as shares, bonds, cash or property. You decide on what the right investments are for you depending on your timescale – how long you plan to invest, your investment objectives, and your approach to risk. The right asset allocation for you will depend on your particular circumstances.

Bid-offer spread

The ‘bid’ refers to the price the market is willing to pay you if you want to sell your shares, whereas the ‘offer’ is the price the market will sell you shares if you wish to buy them. The gap between the two prices is known as the ‘spread’. For shares that trade very frequently, this difference is likely to be quite narrow.

Dividends

Dividends are payments made by companies to their shareholders out of their profits or reserves. They are not guaranteed. Investors can either take dividends as a cash payout, or reinvest them to boost the potential for growth over time.

Exchange-Traded Funds (ETFs)

An Exchange Traded Fund (ETF) is a type of fund that tracks an index or market such as the FTSE 100 or S&P 500. ETFs are traded in the same way as individual shares, which means they can be bought and sold on the stock market. The share price changes throughout the day, depending on market movements. As with any other type of investment, the value of ETFs can go up or down so you could get back less than you invest.

Initial Public Offering (IPO)

An Initial Public Offering (IPO) occurs when a business comes to the market for the first time and sells shares to the public just before they become available on a recognised stock exchange.

Multi-asset funds

Multi-asset funds invest in a range of different asset classes rather than just one. The aim is that the asset types that are performing well can offset those which at the same time are performing less well. These funds typically invest in shares or bonds, but can also invest in other funds. A professional fund manager will decide the split of the fund investments, and monitor their performance on behalf of the investors in the fund.

Ongoing Charges Figure (OCF)

The Ongoing Charges Figure (OCF) tells you how much it costs to have an investment in the fund over one year. As well as any Annual Management Charge (AMC) it includes the main ongoing costs that were taken from the fund in the previous year. You can use this information to work out the impact that these costs will have on your returns. You can find the charges for any fund you are considering in its Key Investor Information Document (KIID). You must confirm you’ve read this document before you purchase the fund.

Passive funds

Passive ‘tracker’ funds aim to deliver a return that’s in line with the market they’re tracking. A tracker fund will buy shares in all the companies of the index it's tracking, such as the FTSE 100 index of Britain’s biggest companies, and in the same proportions as their market value. The value of the fund therefore, will move in line with the change in the value of the index. Charges for passive funds are usually lower than for actively-managed funds.

PE ratio

The PE ratio (price-to-earnings ratio) of a stock is a measure of the price paid for a share relative to the annual net income or profit earned by the company per share. It is worked out by dividing a company's share price by its earnings per share. The PE ratio is often used by investors to help them decide whether they are getting value for money on the stock they are investing in/selling. For example, a particularly high PE ratio could be a sign that the share is overvalued, suggesting there is more risk attached to investing. However, a company PE ratio should always be considered alongside the sector’s PE to determine how a business is performing in comparison to its peers.

Pound cost averaging

When you invest a set sum on a regular basis, you buy fewer units when the market is up and more when it is down. When you make your investment as a single lump sum, the whole quantity you purchase will be affected by whether the share price increases or falls. Investing regularly therefore helps smooth out market volatility, as you effectively end up paying the average price for units over a fixed period, rather than buying at just one price. However, this effect won’t always work in your favour.

Of course, there are numerous other investing terms you might come across, but always make sure you do plenty of research and get to grips with what they mean before you invest. If you’re unsure, seek professional financial advice.