The finance world has this special language that can sometimes feel like it's designed to keep the average Aussie out of the investing club. So, in this week’s episode, we’re taking a cue from a community member to explain financial terms and jargon you need to know. We list out essential financial terms that you will likely encounter as you begin to ask questions about long-term investing.

So, bring a popcorn along and grab a notebook. Stick with us, and by the end, you'll be fluent in finance – or at least not totally lost at sea.

Shares

First up, let’s talk about shares, or as some folks like to call them, “stocks”, “equities”, or “securities”. The investing world loves to keep it interesting, but don't let that confuse you. These are all fancy ways of saying you own a slice of the company pie through the share market.

Index

An index gives you a benchmark to measure how well an entire financial market or a subset of it is performing. Think of it as a collection of or leaderboard for individual shares, showing you who's leading the pack and who’s falling behind.

Yield

Yield is the amount of cash your investment kicks back to you. It’s expressed in percentage form, and it feels a little like a reward for investing for the long term.

Dividends

Dividends... the cherry on top of your investing journey. These are your share of a company’s profits, handed out just for holding onto their shares. If you love the sound of retiring early and living off passive income, dividends are your best friends.

Of course, dividends aren’t guaranteed; if a company doesn’t earn any profit, it has no dividends to pay. It’s also worth noting that not all shares pay dividends. Instead, some companies reinvest any profit they earn into further growth, with the aim of increasing the value of the shares.

If you’re seeking dividends, always research your potential investment before you buy.

Risk and return

Risk is like the financial equivalent of a blind date. There's potential for a great night out, or you might end up wishing you'd stayed home with a good book. In investment terms, it's the chance your money might decide to take a little (or a big) dive. The higher (lower) the risk, the more (or less) returns you could receive from your investments.

Speaking of returns, it’s what we’re all chasing after – those gains (or losses, but who’s aiming for those?) expressed in percentages that make our investments worthwhile. Seeing a 7% or 10% return pop up is like getting a high-five from the universe. With that said, over the short term, we try not to focus too much on market fluctuations.

Diversification

Diversification is simply about not putting all your eggs in one basket. Or, in finance-speak, spreading your investments across various assets to dodge market risks or firm-specific risks.

By spreading your investments across different assets, you're making sure one bad egg (a.k.a. share) doesn't decide the fate of your portfolio. It's why we're head over heels for ETFs, but more on that later.

Volatility

And then there’s volatility. If the market were a person, volatility would be its mood swings. It’s all about the ups and downs, the peaks and valleys, the thrilling climbs, and the heart-dropping descents of share prices.

Now, you might see those dramatic headlines screaming “Market Crash!” or “Stocks Soar!”. However, as long-term investors, we take those headlines with a grain of salt. We're in it for the long haul, remember? We keep our eyes on the horizon regardless of the noise, knowing that every dip could lead to a new peak.

Exchange-traded funds (ETFs) and index funds

Next, we have ETFs, or exchange-traded funds for those who haven’t been formally introduced. Imagine you’ve got a shopping basket, and instead of filling it with groceries, you’re loading it up with bits of companies, commodities, or bonds. ETFs give you the chance to own the entire market (or a subset of it) without buying each slice individually. They’re designed to track the performance of indexes, sectors, or commodities.

While ETFs enjoy the limelight, index funds remain a steadfast choice for those who appreciate simplicity. They follow the crowd (or in this case, a specific index like the ASX 200) to mirror its performance. The beauty? They're low-cost because they're not trying to beat the market, just match it.

Key differences between ETFs and index funds

At first glance, ETFs and index funds might look like mirror images of each other. However, much like comparing a crocodile with an alligator, the devil’s in the details. And if you ever need it, we’ve written a general guide on how to choose between ETFs and index funds.

• Liquidity: ETFs are available for buying and selling anytime the market's open. Index funds? Not so much. They're more of a "settle the score at the end of the day" type. Index funds are traded based on their Net Asset Value (NAV) after the market closes.
• Flexibility: ETFs give you the flexibility to act on market changes as they happen. With index funds, you wait till the day's end to see how your investments have fared.
• Transparency: ETFs are an open book. They reveal their contents daily, so you know exactly what you're getting into, down to the last share.
• Cost-efficiency: Generally, ETFs have lower expense ratios compared to actively managed funds. It means more returns in your pocket and less going to management fees. With that said, always check the fees of both.

(And about that expense ratio – it's the introduction to understanding the cost of managing your fund. Essentially, it tells you how much percentage of the fund’s assets is used for management and operating expenses. Ideally, the expense ratio of your chosen ETF or index fund should stay low so your investments can aim high.)

ESG (Environmental, Social, Governance) funds

ESG refers to a set of standards that evaluates a company’s (or fund’s) sustainability and ethical impact in three areas: environmental, social, and governance. In personal investing, ESG is an ethical investing strategy used to filter investments based on performance (or willingness to commit) in these three areas. It’s a way for investors, especially among the younger generations, to send a message that they do care about the planet and its people.

The E in ESG: Earth-friendly investing

Starting with 'E', we're talking about how companies in the fund treat our planet. Do they have the lowest exposure to oil and gas production and services? Are they treating waste management not as an afterthought but as part of innovation? These are some of the things you need to consider if you want to make your money truly work for the planet’s interests.

The S stands for social

‘Social’ in ESG is the heartbeat, focusing on how companies treat their people and the communities they touch. Are they all about diversity and treating everyone fairly, or is it more like a scene from a Dickens novel? Additionally, it looks at how these companies hear, support, and connect with the community around them.

G is for governance

Lastly, ‘Governance’ – this is the behind-the-scenes, the rulebook guiding companies. It's about who's making the decisions and how. We're looking for a diverse and inclusive workforce, a board that represents customers’ interests, and fair exec pay. You want businesses that don't just talk the talk but walk the walk on transparency and ethics.

Note: Surprisingly, many funds out there claim to be sustainable and ethical while also having a majority of their assets invested in fossil fuels. There’s also the risk of the ESG label being used merely as a cover up for a company’s (or a fund’s) poor performance.

That being said, your money can do good as long as it’s actually going to where it’s intended. So, it’s important to do research about the content and risks of ESG funds you’re eyeing before investing.

It’s also worth mentioning that what “ethical” or “sustainable” means may vary from person to person. Some may also have a different but valid opinion about whether it’s worth investing in ESG in the first place. In the end, ESG investing is worth trying if you’re happy to accept the short-term pain and focus more on chipping away at the bigger existential costs.

We've chewed over this topic in a couple of episodes already. We recently had a chat with Nick from Pearler about where he tands on ethical or ESG investing. For a deeper dive, our convsersation with Erica Hall explores how to invest in ESG ETFs and things you need to consider.

Bear and bull markets

When you think of a bull, it’s usually one charging forward with its horns pointed to the sky. That's your market on a good day, and everybody’s feeling like the next Warren Buffett. Specifically, you’re in a bull territory when a broad market index jumps by 20% or more over a two-month stretch.

Now, imagine a bear swiping down with its mighty paws. This is your market taking a hit. Prices are dropping, and not just a little stumble. We're talking about a 20% plunge from the market's latest peak. It's a prolonged break in soaring prices, which makes investors a tad nervous.

However, if you're in it for the long haul, a bear market isn't the end of the world. For those with an eye on the horizon, bear markets sound like clearance sales. It's your chance to grab ETFs or shares at lower prices – so long as it falls within your risk appetite.

Basis points

Basis points, or as the cool kids say, "bips" (or BPS, if you're not into the whole brevity thing), are like the metric system for finance nerds. One basis point is just a fancy way of saying 0.01% in their language. So, if the news says interest rates on loans have increased by 25 basis points, it just means a 0.25% increase.

Why do finance folks love to talk in basis points? Well, it’s not because they want to confuse you. It’s actually to avoid confusion. Sometimes, they're dealing with changes that are smaller than a percent but mightier than a milli-percent. Basis points give them the ability to be as precise as possible (especially when a misplaced period could send markets into panic).

Ticker symbol

Moving on, a ticker symbol is just an easier way to identify a company or fund listed on a sharemarket. Every company traded on the stock exchange has one. So, instead of typing out "Vanguard Australian Shares Index Fund ETF" every time, you just search "VAS" to find out the latest information.

Quantity

Quantity is the number of shares or contracts you’re looking to buy or sell. In large numbers, quantity specifies the volume or “how much” the trade is going on at that moment.

Value

And then there’s value – the "how much" in dollars and cents. Value represents the monetary worth of your financial assets. It can be determined by multiplying the quantity of what you have by its price tag.

Imagine you’re at an auction. The price of that vintage lamp you’ve been eyeing gets multiplied by how many you want to take home. That’s value in a nutshell.

Order and order types

Placing an order in the sharemarket is simply telling your brokerage platform exactly how you like a transaction to be done. You’re telling the broker to buy or sell shares at certain conditions.

These conditions include:

1. The quantity of shares (that's your "how many")
2. The order of type (the "how and when do you want it")
3. The price (your "at what cost")
4. And the duration of that order (the "until when")

Types of orders

• Limit order

You set a price, and if the market doesn’t hit that target, your order sits tight. It’s a good option for those who know what they want and are willing to wait for it.

• At-market order

Market orders execute at the next available price. You want your shares pronto, no price haggling. It’s fast, it’s efficient, and it's like saying: "I trust you, market. Do your thing.”

• Conditional order

These are your if-this-then-that orders that lean towards active investing rather than long-term passive investing. You set conditions, like "If the share price moves by this much in percentage, then buy or sell”. Or something like: “Buy or sell this share at this specific time”. If everything aligns, your trade executes.

If you like more control in your investing without having to watch the pot boil, this option can automate your strategy.

Then again, not everyone wants to micromanage their investments in the sharemarket. That’s why brokers like CommSec Pocket or Pearler offer simpler options like at-market order by default. However, if you’re feeling adventurous or have specific needs, other options are there for you too.

Contract For Differences (CFD)

Contract for Differences, or CFD is something like the financial world's version of betting on your favourite sports team, except instead of sports, it's the share market. You're speculating on price movements of assets without actually owning them. And just like any form of speculating, the stakes are high for active investors taking part in this.

CFD involves something called leverage, meaning you can magnify your gains (or losses) without forking out the full amount upfront. We're looking at a usual leverage ratio of 10:1, which allows you to borrow ten times what you've got to invest.

All things considered, the potential for a windfall is there, but so is the potential for – you guessed it – a financial wipeout. And it seems we're not the only ones giving CFDs the side-eye. The Australian Securities and Investments Commision (ASIC) is currently giving eToro a legal nudge for pushing these high-risk CFD products onto everyday investors.

Margin loans

A margin loan involves borrowing money to invest in shares, options, or managed funds. Unlike in Contract for Difference (CFD), you use the securities you have as a collateral to actually buy and own more securities.

However, the moment things go south, brokerage firms are knocking on your door asking for the money back. A drop in share price could mean you need to fork out extra cash to keep your loan in good standing. And if you can’t? You might have to sell off your investments at the worst possible time.

So, here’s our take: stick to investments you understand and can manage without losing sleep. In the end, we're all about building wealth at a pace that won't give you whiplash. The allure of quick wins is tempting, but the house always wins in the end.

Take action this week

The finance world loves its baffling jargon, and many people are missing out on ways to compound their wealth over time because of it. However, once you get the basic concept of financial terms like we mentioned, it becomes easier to overcome fear and just get started.

So, every time you're feeling a bit confused about other terms, just Google it. Or better yet, head to the Pearler Exchange where you can ask questions and find support from fellow long-term investors.

If you're finding value in our chats, consider sharing this podcast. A five-star review or simply passing this along to a friend can help more people reach Financial Independence. For the newcomers in the long-term investing world, our first 10 episodes will guide you about the basics. You can also follow us on Instagram at @getrichslowclub or Tash ( @tashinvest ) and Ana ( @anakresina ) to continue the conversation.

Happy investing!

Tash & Ana