Investment Terms for Beginners: From Bonds to IRAs & 401(k)s

If you're a first-time investor, it can be intimidating to enter this arena if you don't understand the industry vocabulary. To help get you up to speed, here are some investment terms for beginners and their definitions.

Bonds

Bonds are debt obligations that a company or the government uses for its borrowing needs. Essentially, a bond is a type of loan. Government savings bonds, for example, are loans that the government borrows to fund infrastructure and capital projects, and other activities that are necessary for it to function and provide services to citizens.

As an investor, you can buy either a corporate bond or a government bond. The borrower (in this case, a business or the government) must promise to repay the bond with interest by a specified maturity date.

Bonds come with repayment risk, or the risk that the issuer is unable to make payments on the bond. Some types of bonds will also fluctuate in value based upon the market or interest rates.

Cash

Unlike stocks, mutual funds and IRAs, cash is a tangible financial asset. It exists on paper, but cash can also refer to checks and your bank accounts, which can be converted into cash.

Changes in the market don't affect the value of cash as significantly as they affect the value of assets like stocks or mutual funds. However, over time, inflation, which occurs when the price of goods and services increases, can depreciate cash.

Stocks

Stocks are a type of security that grant you ownership in a company. A share is the equivalent of a single unit of stock, so if you own 1,000 shares of a company, for example, that's how much stock or ownership you have in the company.

Each stock is worth a certain dollar amount. Stock prices increase and decrease based on market changes or bad news, such as lower-than-expected sales, a manufacturing issue that affects production, or a health outbreak related to a food product. Good news could also affect share prices.

Mutual Funds

A mutual fund is a professionally managed fund that combines money from different investors to buy stocks, bonds and other investments.

For beginner investors, one of the main benefits of mutual funds is the diversification. Your money is invested in different types of securities, such as stocks and bonds. Diversifying your portfolio does not ensure a profit or protect yourself against losses, but your risk is more dispersed.

IRAs

IRAs, or individual retirement accounts, allow you to save a portion of your pretax or after-tax income for retirement. There are several types of IRAs, but the two main ones are traditional IRAs and Roth IRAs.

1. Traditional IRAs. You invest pretax money. When you invest in a traditional IRA, your money grows tax deferred.
2. Roth IRAs. You invest after-tax dollars. Roth IRAs offer tax-deferred growth, and unlike a traditional IRA, the money you invest may not be taxed when you withdraw it during retirement as long as you are age 59 1/2 or older and have had the Roth IRA for at least five years.

IRAs have limitations on the age you can withdraw money without penalties and the amount you can contribute annually. If you withdraw from the account prior to age 59 1/2, you'll typically be subject to a 10% penalty. For 2023, the federal government limits IRA contributions to $6,500 per year if you're under age 50, and $7,500 per year if you're age 50 or older (because you can contribute up to $1,000 in catch-up contributions).

401(k)s

Like IRAs, a 401(k) is another type of retirement account. People typically have a 401(k) account through their employer and regularly contribute a portion of their income to this account to save for retirement. Some companies even match employee contributions. For example, if you contribute 5 percent of your biweekly salary to a 401(k), your employer may make a 5 percent matching contribution up to a certain dollar amount for the year.

Getting Started With Investing

Knowing investment terms for beginners can help you feel more comfortable deciding which investment option to use for building your retirement strategy. Now that you know these basic investment terms, consider continuing to educate yourself on the investment world to help make sure you're making knowledgeable financial decisions with your hard-earned money.