Top 5 Financial Terms You Should Understand

In recent weeks, you may have heard the word recession. You may even have a vague understanding of what a recession is, but would like a better understanding of the terminology. What is the Dow Jones Industrial Average? You probably hear that every night on the news and you know that it has something to do with the stock market, but aren't really sure of the details or how it relates to your portfolio.

Here are some common terms you hear frequently, along with a simple explanation:

Recession – In simple terms, a recession is a decline in economic activity. This decline can be for any number of reasons and usually includes a drop in gross domestic product, a rise in unemployment, a decline in manufacturing production, a decline in personal income and a decline in retail sales. While a drop in any of these can occur at various times and do not indicate a recession, a continued decline of these indicators, usually over several months, can indicate that a recession is beginning. 

Dow Jones Industrial Average – The Dow Jones Industrial Average measures the daily value of 30 large, publicly held companies in the U.S. Named after Charles Dow and Edward Jones, the index was created in order to get a better sense of the U.S. economy as a whole. In general terms, if the Dow is performing well, so tends to be the economy. The original Dow Jones Industrial Average included 12 stocks, and was later expanded in 1916 to include 20 stocks. The final update to 30 stocks occurred in 1928, and remains at 30 today. 

Blue Chip Stock – A blue chip stock is typically stock that is offered by financially sound businesses that have been around for a long time. Blue chip stocks are popular with new investors because they tend to be stable and have less risk than other types of stock.  Another benefit to purchasing a blue chip stock is that it tends to pay dividends to stockholders. Like any stock, the value can fluctuate, but their performance tends to be more stable. 

Bonds – When you buy a bond, you're actually lending money to the bond issuer. The issuer agrees to pay you a specific rate of interest during the length of time that you hold the bond. The issuer also agrees to repay the principal once the bond has matured. In many cases, bonds are considered a safer investment than a stock and usually pay interest twice a year. 

Hedge Funds – A hedge fund is set up as a limited partnership or limited liability corporation. This is done to protect both the hedge fund manager and the investor.  There are a limited number of investors involved in a hedge fund, which is operated by a professional manager, who is responsible for making the investments. Because of their risk, a hedge fund investment is only open to qualified investors with a significant amount of assets, usually in excess of $1 million. Because hedge funds are not regulated by the U.S. Securities and Exchange Commission, the hedge fund manager can invest in a wider range of securities that carry more risk than more traditional investments. 

As always, it is important to be an informed investor. Take the time to familiarize yourself with the markets and the terminology or work closely with a CFP(R) professional that has your best interest at heart!

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