We’re finance professionals here at Nanalyze, and consequently we’re often tempted to demonstrate how sophisticated we are by using obscure terminology that makes us sound important. The truth is, we’re not experts in anything, not even finance. What we do claim to do well, is to take “sophisticated” concepts and explain them simply. What we’ve observed over time, is that people in finance seem inclined to describe their domain using obscure nomenclature in an attempt to convince you that finance is much more inaccessible than it actually is. The truth is, finance is very simple.
When the best performing accounts at Fidelity were found to be the ones for which the owners either died or simply forgot they had an account, then that should tell you something about how “sophisticated” investing really is. We’re now going to take some financial nomenclature and explain it simply, because the truth is that the most simple investment strategies are the ones that work, Warren Buffet perhaps being the best example of this.
Read any mainstream financial publications or watch the Bloomberg channel and you’re likely to come across the term “basis points”. As an example, you might say “my mortgage is 500 basis points”. What that means is that your mortgage rate is 5%. That’s it. The term “basis points” simply refers to a percentage. If my 500 basis point mortgage increases to 5.5%, it increased by 50 basis points. One basis point is simply .01%. Feel free to abbreviate the term in emails using “bips” or “bps”. Basis points = “an interest rate described in increments of .01”.
This acronym stands for “compound annual growth” and it is a very powerful concept. If you have a company where each year revenues increase by just 10%, in 8.5 years time revenues will have doubled. Let’s say you bought a stock that increased in value every year by 3%. While that number sounds low, in 24 years your investment would have doubled. CAGR = “how much money I stand to make over the long term”.
The best use of this term is to say you “captured some alpha”. What does that mean? Well, alpha refers to the fact that after I conducted a particular transaction, I have more money in my pocket now than I did before. “Alpha” means profits. If I said “last month I captured some alpha with Google”, that means I either went short or long on a position in Google (GOOG) and made money on it. I captured alpha = “I made money”.
If we stuck to the rule of opposites, then “beta” should mean I lost money. That’s hardly the case. Beta refers to the extent to which the price of a stock moves relative to a particular benchmark. Let’s say you own an S&P stock with a beta of .5. That simply means that if the S&P increases by 10%, your stock will only increase by 5% all things being equal. In the same manner, if the S&P loses 10% then your stock will only lose 5%. You’ve probably figured out that beta is actually a stock’s reaction to volatility, and that’s exactly right. Beta = “how my investment will move relative to a particular benchmark” which leads us to our next term.
If you walk into a wealth management office, one question you will surely be asked is how “risk averse” you are. The real question to ask here is how emotional will you become when you see your portfolio has dropped 25%. If you are “risk averse”, you’ll freak out and start grilling your “wealth management advisor” or robo-advisor about why the strategy went wrong. If you’re not risk averse, you’ll see this as an opportunity and increase your position. Risk averse = “how emotional will you get when your investment loses value”.
Now you’re equipped with 5 terms you can interject into a conversation at the next company party and sound like you’re a real finance baller. Don’t be afraid to talk about “what you’re in at the moment” and how “cautiously optimistic” you are.
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