Financial Literacy Month Glossary of Financial Terms: Educate and Empower
April 1, 2019 |
Today is April 1, which marks the beginning of Financial Literacy Month! For the third year in a row, BCM will be posting dedicated content about macroeconomics, investing, and personal finance topics to help educate investors and advisors.
Financial Literacy Month is typically geared towards the average American to highlight the importance of making and maintaining healthy financial decisions. However, as investment professionals, we know that investing is a critical component of building wealth. So, this year, we want to leverage our investment expertise to educate and empower people to invest. Additionally, we hope this content can serve as a useful tool for advisors to facilitate conversations about investing with clients and prospects. While many will have already mastered these topics, a refresher can never hurt!
As advisors, we know that even accomplished clients can have a lack of understanding of investing principles and risks, industry buzzwords, and jargon used by the financial media. Not to mention the current economic and political climate, which is amplifying emotion and reducing confidence.
Over the next month we will be posting content about a variety of Financial and Investment Literacy topics to help educate and empower investors. Check in on the BCM Blog each week or subscribe to get these insights delivered right to your inbox.
Glossary of Terms 2019:
To kick things off, we are expanding on one of our top posts from the last two years of Financial Literacy content—our Glossary of Financial and Investing Terms. The increase in industry innovation, changes in economic and political policy, and speculation of a shift to late stages of the economic and business cycles have sparked the proliferation of new buzzwords, industry jargon and concepts that have not been top of mind for some time. Here are some of the most relevant terms for 2019. If you scroll all the way to the end of the post, you can find a printable PDF version of these terms and more in alphabetical order:
- Budget Deficit is when a nation’s current expenses exceed revenue during a fiscal year.... A budget deficit requires funding in the form of debt which is usually a Treasury Bill (short term), Note (Intermediate term) or Bond (long term). A high budget deficit can lead to inflation, higher interest rates and slower economic growth which in turn hurts consumers and businesses alike. Ways to reduce a budget deficit would be to raise taxes, cut spending, lower interest rates (a large part of our current deficit is caused by interest due on existing debt) or find other revenue generating activities.
- Consumer Price Index (CPI) expresses the current prices paid for a basket of goods and services versus the prices paid during the same period in a previous year. CPI is a measure of inflation and is used by the Government to increase social program benefits such as Social Security and Welfare.
- Deflation is the decline in prices for goods and services or the opposite of inflation. It is usually caused by over production (too much supply) or an economic slowdown where demand decreases. Modest deflation for a short period of time could be beneficial but generally sustained deflation hurts the economy.
- Dividends are a portion of the company’s earnings that are paid to the shareholders as a reward for their investment in a company’s stock. Dividends are paid out by publicly listed companies, mutual funds and exchange traded funds (ETFs) and are typically paid in cash. Larger, established companies with more predictable profits are often the most consistent dividend payers and stocks of these cash flow generating companies typically hold up better in volatile or declining markets. Dividends can be paid regularly (monthly, quarterly or annually), or companies can issue non-recurring, one-time dividends based on performance.
- Dovish is one of three (Dovish, Neutral, Hawkish) general outlooks of economic policy advisors (typically a country’s central bank or in the U.S. the Federal Reserve) that indicates an easier monetary policy going forward (less expensive and more plentiful money). A change to a Dovish stance usually means the economy is slowing and these policy advisors want to guard against deflation and/or a recession. Policy makers will try to stimulate the economy (get people to spend money) by lowering interest rates, increasing the money supply, or more recently by buying bonds on the open market (Quantitative Easing or QE). If it is cheaper to borrow money, businesses can expand and consumers may spend more with credit cards or loans to finance larger purchases such as homes and cars.
- Earnings refers to a company’s after-tax net income, sometimes known as the bottom line, or a company’s profits. Earnings have a dramatic effect on a company’s stock price because it is an indicator of the company’s profitability and recent success. Earnings are a hot topic right now as earnings expectations are declining. Since investors want future earnings to increase, declining earnings expectations can put pressure on stock prices. We explain this in a more bit more depth in this short article.
- Economic Cycle is the fluctuation of the economy between periods of growth and contraction (recession). The four stages of the economic cycle include early, mid, late, and recession (others may refer to see these stages as expansion, peak, contraction and trough). The biggest factors that help determine which stage we are in are Gross Domestic Product (GDP), interest rates, employment and consumer spending. Different industries and sectors perform differently during each phase of the market cycle. If you can identify which stage we are in, it can add value as part of an investment strategy. However, this is a difficult task and often the change in cycle stage is not known until well after the fact.
- European Central Bank (ECB) is the central bank of the 19 European Union (EU) countries that have adopted the euro. It administers monetary policy of the Eurozone, one of the largest currency areas in the world. The ECB is the Eurozone counterpart to the Federal Reserve Bank (FED) here in the U.S. According to several sources, almost 99% of the world population lives in a country or region with a central bank.
- Federal Funds Rate is the interest rate that banks charge other banks for lending them money from their reserve balances on an overnight basis. A bank is required by law to keep a certain percentage of their deposits (money they hold for customers) in an account at a Federal Reserve bank. Any money above that amount can be made available for lending to other banks that may have a shortfall in that reserve. When the FED raises or lowers interest rates, this is the rate that the FED is adjusting. This rate can have a significant effect on the U.S. economy because it is used as a base for the interest rates offered by financial institutions to businesses and consumers.
- Federal Open Market Committee (FOMC) is the twelve-member committee, including five Federal Reserve Bank Presidents, within the Federal Reserve System, responsible for open market operations and determining the direction of monetary policy. They are often referred to as “the FED” and they meet eight times a year to decide whether to maintain or change current monetary policy in the U.S.
- Hawkish refers to one of three (Dovish, Neutral, Hawkish) general outlooks of economic policy advisors (typically a country’s central bank or in the U.S. the Federal Reserve) that wants to guard against excessive inflation when the economy is growing too fast or with too much inflation. The Central bank will try to slow the economy/inflation by raising or maintaining higher interest rates. Hawkish is the opposite of dovish (explained above) and, by raising interest rates and making borrowing more expensive, it curtails excess inflation.
- Inflation refers to a general increase in prices paid during a period of time. Inflation indices can also measure the fall in the purchasing power of a currency over time as goods and services become more expensive. Modest inflation is required for economic growth, but high inflation can be detrimental to the economy because prices rise faster than incomes, goods and services become un-affordable, and thus the quality of life deteriorates. Rampant inflation stifles demand, businesses’ costs go up while sales slow, and profits fall. This may lead to rising unemployment and business failures.
- Liquidity refers to how quickly or easily an asset or security can be converted into cash without unduly affecting the asset’s price.
- Long only refers to an individual security, mutual fund, ETF or a strategy that is owned outright. There is no margin or borrowing used to buy the security nor are there more exotic entanglements such as inverse, futures or shorting (borrowed stock). An owner of a long position expects the investment to increase in value over time.
- Monetary policy is typically determined by the central bank of a country where the central bank formulates, announces and implements any actions that will be taken to achieve macroeconomic objectives like controlling inflation, consumption and growth. These objectives are typically achieved by modifying interest rates, buying or selling government bonds, controlling the money supply, regulating exchange rates and other similar actions, and all of these have a significant impact on the economy.
- Net returns are the return from an investment after deducting all fees and expenses incurred by an investor from the gross return.
- Nominal Gross Domestic Product (Nominal GDP) is a measurement of the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, evaluated at current market prices.
- OECD (Organization for Economic Cooperation and Development) is a group of 35 member countries that discuss and develop economic and social policy. OECD members are democratic countries that support free market economies.
- Purchasing Managers’ Index (PMI) focuses on the whole output of producers in the United States or another country. This index is very broad, including not only the goods and services purchased by producers as inputs in their own operations or as investment, but also goods and services bought by consumers from retail sellers and directly from the producer.
- Quantitative Easing (QE) is when a central bank purchases Treasury bonds, other bonds or even stocks from the market with the goal of lowering interest rates and stimulating economic activity. QE can also take the form of increasing the money supply to facilitate loans and stimulate economic activity.
- QE Reversal (Quantitative Tightening or Reverse QE) is a tool of monetary policy to shrink a Central Bank’s Balance Sheet (Balance Sheet Normalization). When central banks use QE, it can create imbalances that need to be remediated over time and QE reversal is one way to do that.
- Real Gross Domestic Product (Real GDP) is the inflation adjusted measure that reflects value of all goods and services produced by an economy in a given year. Unlike nominal GDP, it accounts for changes in prices (inflation) to provide a more accurate measurement of economic growth.
- Stagflation is the state in which an economy is experiencing slow, no or modestly negative economic growth and relatively high unemployment, while being accompanied by rising prices, or inflation. This is the “worst” of many economic scenarios for businesses and consumers as prices keep rising while the economy, income and profits do not keep pace.
- Stock buybacks are another form of capital return to equity investors similar to a dividend. When buying back stock, a company shrinks its outstanding shares, so remaining owners now own a larger portion of the company. By lowering the number of shares in the market, buybacks increase reported earnings per share (assuming all else equal).
- Treasury Yield is the return on investment on the U.S. government’s debt obligation. In simpler terms, it’s the interest rate the government pays to borrow money or pays an investor who buys “Treasuries”. Treasury bills and notes are often thought of as risk-free investments because they are backed by the U.S. Government, which has the ability to print the money required to pay down the debt. The Treasury yield is a benchmark rate which influences other interest rates that individuals pay to borrow money for real estate, vehicles, equipment and the like.
- U.S. Treasury is the government department responsible for issuing all Treasury Bills, Notes and Bonds. The IRS and U.S. Mint are among the organizations under the U.S. Treasury umbrella.
- United States Mexico Canada Agreement (USMCA) is the trade deal between the USA, Mexico and Canada that was signed on November 30th, 2018 that effectively replaced the NAFTA agreement.
Sources and Disclosures:
Fidelity Investments, Investopedia, DOL, U.S. Treasury, S&P Global Inc.
Copyright © 2019 Beaumont Capital Management (BCM). All rights reserved.
This material is provided for informational purposes only.
The information presented in this report is based on data obtained from third party sources. Although it is believed to be accurate, no representation or warranty is made as to its accuracy or completeness.