If you're at all interested in investing, you probably hear all kinds of jargon about different types of investment funds and strategies. In order to get, and keep, your investment plans on track, it's important to understand what these terms mean. Here are some common investment terms being used today and an explanation as to what they mean.
Exchange-Traded Funds
Exchange-traded funds - also referred to as ETFs - have become one of the fastest growing investment vehicles with reportedly more than 900 ETFs being traded today. An ETF is similar to a mutual fund in that it represents a group of securities. It is a "basket" of stocks which has its own ticker symbol and trades on a stock exchange. An ETF often follows the performance of an index, such as the Standard and Poor's 500 Stock index. Like an individual stock, ETFs can be bought or sold at any time of the trading day with the price determined at the time of the transaction based on supply and demand for the fund.
Two other investment terms you may be hearing are Asset Allocation and Target Date mutual funds. More than an investment, these are managed strategies that can help you reach your investment goals. A mutual fund is an investment vehicle made up of a pool of money collected from many investors. The pooled assets are then invested into various securities and managed by professional fund managers.
Asset Allocation Funds
All investors should understand the importance of "asset allocation," which means ensuring that your investment portfolio is properly diversified into a number of securities (securities here are defined as mutual funds, stocks, bonds and cash equivalents). Having a well-diversified portfolio with a variety of assets can help protect your investments from being wiped out if a single security depreciates quickly.
An Asset Allocation Fund is a mutual fund that combines various asset classes - stocks, bonds and sometimes cash equivalents - from a variety of securities to create a fund that targets a very specific level of risk. Asset Allocation Funds are professionally managed to maintain a specific mix of asset classes over time. The goal is to consistently deliver a measured level of risk regardless of market conditions.
Target Date Funds
A relatively new and unique type of mutual fund is a Target Date Fund. These funds are becoming popular because they automatically reset the asset mix (of stocks, bonds, mutual funds and cash equivalents) into a portfolio according to a specific time frame. Investors determine which Target Date Fund is appropriate for them based on the time frame of when they will need the money. For some, Target Date Funds provide a way for 401(k) plan investors to select a retirement date and then basically put their investment plans on autopilot.
A fund's target date is the approximate year when the investor plans to start withdrawing their money. For example, a person who is 25 years old, may choose a Target Date Fund with a maturity date 40 years down the road. As the fund works through its lifecycle, it constantly adjusts its level of risk to protect the assets the closer it gets to the maturity date. The principal value of the investment is not guaranteed at any time, including at the target date.
As part of a diversified portfolio, these investment types and strategies should be considered only if you fully understand the risks associated with the investment and realize it could lose value.