Investment Glossary
Quick definitions for common investment and portfolio management terms.
A
Alpha
The excess return of an investment relative to the return of a benchmark index. Positive alpha indicates outperformance, while negative alpha indicates underperformance.
Asset Allocation
The strategy of dividing an investment portfolio among different asset categories such as stocks, bonds, and cash. It is widely considered the most important determinant of long-term portfolio performance.
B
Benchmark
A standard or reference point, typically a market index, against which the performance of an investment portfolio is measured. Common benchmarks include the S&P 500 for U.S. stocks and the Bloomberg Aggregate for U.S. bonds.
Beta
A measure of an investment's sensitivity to market movements. A beta of 1.0 moves in line with the market; above 1.0 indicates higher sensitivity, below 1.0 indicates lower sensitivity.
Bond Duration
A measure of a bond's sensitivity to changes in interest rates, expressed in years. A higher duration means the bond's price will change more for a given shift in interest rates.
C
Compound Interest
Interest calculated on both the initial principal and all previously accumulated interest. Often called the "eighth wonder of the world," it is the primary driver of long-term investment growth.
Correlation
A statistical measure ranging from -1 to +1 that describes how two investments move relative to each other. Low or negative correlation between assets improves diversification.
Credit Spread
The difference in yield between a corporate bond and a comparable-maturity government bond. It reflects the additional compensation investors demand for taking on the credit risk of a non-government issuer.
D
Diversification
An investment strategy that spreads risk by allocating capital across different asset classes, sectors, geographies, and securities. It aims to reduce the impact of any single investment's poor performance.
Dividend Yield
The annual dividend payment of a stock divided by its current share price, expressed as a percentage. It represents the income return on an investment, excluding any capital gains.
E
ETF (Exchange-Traded Fund)
A type of investment fund that trades on stock exchanges like individual stocks. ETFs typically track an index, sector, commodity, or other asset class and offer diversification with low expense ratios.
Expense Ratio
The annual fee charged by a mutual fund or ETF, expressed as a percentage of the fund's average assets under management. It covers operating costs including management fees, administrative expenses, and distribution charges.
M
Market Capitalization
The total market value of a company's outstanding shares of stock, calculated by multiplying the current share price by the total number of shares. It is used to classify companies as large-cap, mid-cap, or small-cap.
Max Drawdown
The largest peak-to-trough decline in portfolio value over a specific period, expressed as a percentage. It measures the worst-case loss an investor would have experienced.
Monte Carlo Simulation
A computational technique that uses repeated random sampling to model the probability of different outcomes. In finance, it projects the range of possible portfolio values under thousands of simulated market scenarios.
Mutual Fund
A pooled investment vehicle managed by a professional that collects money from many investors to purchase a diversified portfolio of stocks, bonds, or other securities.
P
Portfolio
A collection of financial investments including stocks, bonds, cash, real estate, and other assets held by an individual or institution. The composition reflects the investor's goals, risk tolerance, and time horizon.
Price-to-Earnings Ratio (P/E)
A valuation ratio calculated by dividing a company's current stock price by its earnings per share. It indicates how much investors are willing to pay for each dollar of earnings.
R
Rebalancing
The process of realigning the weights of assets in a portfolio back to their original target allocation. This typically involves selling assets that have grown beyond their target and buying those that have fallen below.
Risk-Adjusted Return
A measure of how much return an investment has generated relative to the amount of risk it has taken. It allows comparison of investments with different risk levels on an equal footing.
S
Sharpe Ratio
A measure of risk-adjusted return calculated by subtracting the risk-free rate from the portfolio return and dividing by the standard deviation of returns. Higher values indicate better compensation for the risk taken.
Standard Deviation
A statistical measure of the dispersion of returns around the mean. In investing, it quantifies volatility—higher standard deviation means more unpredictable returns.