Review the core investing, portfolio, account, and market terms used throughout Foundations of Investing.
This glossary is meant to support review, not replace the main lessons. Use it when a question turns on a definition, when two terms sound similar, or when you need a quick reminder of how a product, risk, or account feature works in practice.
flowchart TD
A["Investment vocabulary"] --> B["Portfolio construction"]
A --> C["Markets and trading"]
A --> D["Risk and return"]
A --> E["Accounts and taxes"]
A --> F["Regulators and resources"]
The most useful approach is to read definitions in context:
When two terms look related, slow down and ask what decision each term actually helps you make.
Asset allocation: The planned split of a portfolio among major asset classes such as stocks, bonds, cash, and sometimes alternatives.
Diversification: Spreading exposure across different holdings so that one issuer, sector, or market shock does not control the whole outcome.
Rebalancing: Bringing a portfolio back toward its target allocation after market movements or cash flows create drift.
Risk tolerance: The amount of volatility and temporary loss an investor is willing to endure.
Risk capacity: The amount of investment risk an investor can afford to take based on time horizon, income stability, and financial reserves.
Time horizon: The length of time before invested money is expected to be used.
Investment policy statement (IPS): A written plan that records goals, risk limits, allocation targets, and review rules.
Bull market: A sustained period in which prices generally rise and investor sentiment improves.
Bear market: A sustained period of broad market decline, often accompanied by weaker sentiment and higher risk aversion.
Liquidity: How easily an asset can be sold for cash without forcing a large price concession.
Market order: An order to trade immediately at the best available price.
Limit order: An order that sets the highest price a buyer will pay or the lowest price a seller will accept.
Volatility: The degree to which prices move up and down over time.
Bid-ask spread: The gap between the highest current bid and the lowest current offer in the market.
Stock (equity): A security representing ownership in a corporation.
Bond: A debt security under which the issuer promises scheduled interest payments and repayment of principal at maturity.
Mutual fund: A pooled investment vehicle priced once each trading day at net asset value.
Exchange-traded fund (ETF): A pooled investment vehicle that trades intraday on an exchange like a stock.
Yield: Income produced by an investment, usually shown as a percentage.
Total return: The combined effect of income plus price change over a measurement period.
Expense ratio: The annual operating cost of a fund expressed as a percentage of assets.
Credit risk: The risk that a borrower or issuer will fail to make required payments.
Interest-rate risk: The risk that bond prices will fall when prevailing interest rates rise.
Inflation risk: The risk that rising prices will reduce the real purchasing power of investment returns.
Sequence risk: The risk that poor returns early in a withdrawal period will damage long-term retirement sustainability.
Price-to-earnings (P/E) ratio: A common valuation measure that compares a stock’s price to earnings per share.
Margin of safety: A cushion between estimated value and purchase price that helps absorb analytical error or bad outcomes.
Taxable brokerage account: A nonretirement investment account in which interest, dividends, and realized gains may create current tax consequences.
Tax-deferred account: An account structure in which taxes are generally postponed until withdrawal, such as a traditional IRA or many employer retirement plans.
Tax-exempt or tax-free growth account: An account structure in which qualified withdrawals may avoid federal income tax, such as a Roth IRA.
Capital gain: Profit realized when an asset is sold for more than its tax basis.
Cost basis: The starting tax value used to measure gain or loss when an investment is sold.
Qualified dividend: A dividend that may receive favorable federal tax treatment if holding-period and issuer rules are met.
SEC: The federal agency that oversees securities markets, disclosure rules, and investor protection at the national level.
FINRA: The self-regulatory organization that oversees broker-dealers, runs BrokerCheck, and enforces member rules subject to SEC oversight.
SIPC: The organization that provides limited protection if a brokerage firm fails financially. It does not protect against market losses.
BrokerCheck: FINRA’s free tool for researching brokerage firms and registered representatives.
Prospectus: A disclosure document describing a fund or offering’s objective, fees, risks, and operating structure.
EDGAR: The SEC’s database for company and fund filings.
Asset allocation vs. diversification: Allocation decides the high-level mix. Diversification describes how exposure is spread within and across those categories.
Yield vs. total return: Yield measures income. Total return includes both income and price change.
Risk tolerance vs. risk capacity: Tolerance is emotional willingness. Capacity is financial ability.
Taxable account vs. retirement account: A taxable account can create current tax obligations. Retirement accounts usually have special tax treatment and withdrawal rules.
SIPC vs. FDIC: SIPC relates to brokerage failure protection for customer assets within limits. FDIC protects eligible bank deposits, not securities market losses.
An investor says, “My portfolio is diversified because I own only a stock fund, a bond fund, and a cash fund.” Which response is most accurate?
A. The investor is describing risk tolerance, not diversification.
B. The investor is describing yield management, not asset allocation.
C. The investor is describing market timing, not portfolio structure.
D. The investor is describing asset allocation at a high level, but true diversification also depends on how concentrated each holding is internally.
Correct Answer: D
Explanation: A portfolio can have more than one asset class and still be poorly diversified if each sleeve is narrow, concentrated, or highly correlated.