Investors routinely encounter obscure financial-industry terms. This may be off-putting, and may even discourage people from learning more about investing and personal finance.
Advisors recognize that jargon-filled conversations are counterproductive.
“Although personal investing is complicated, explaining it should not be,” says Hank Mulvihill, principal at Mulvihill Asset Management in Richardson, Texas.
“In plain English, your advisors should be able to tell you what they do, and what tools they use to do the work,” Mulvihill says. “You say that you don’t know the difference between, or even the definition of mutual funds, annuities, stocks, bonds, cash-value policies, partnerships, managed accounts, options, futures, hedge funds? Or the endless variations of all of these? Your advisors should be able to tell you without using strange-sounding terminology. Your responsibility in the conversation is to stop them when they use terminology you don’t understand. It is your money.”
He also cautions investors to be wary of unfamiliar terms. “Don’t be bamboozled by fancy words. Advisors love to show off the buzzwords of the business. Most of the time such jargon is either insecurity on the part of the advisor, inflated description of the investment choice, marketing, or all of these together,” Mulvihill says.
Here are some common terms that may be confusing:
Active versus passive management. Broadly speaking, an actively managed mutual fund holds investments chosen by managers with the intention of beating a benchmark. Passive management typically refers to an investment style that aims to capture market performance – not outperform the market – by tracking an index. “Advisors often use these terms and I do not think that investors are always clear about what they are referring to,” says Jimmy Lee, CEO at Wealth Consulting Group in Las Vegas.
Fiduciary. In the financial world, a fiduciary is legally and ethically obligated to act in the best interest of his or her client. “Consumers often do not understand this term,” says Will Kelly, managing director at United Capital in Baltimore.
Kelly frames the difference by contrasting the role of a registered investment advisor versus a stock broker. “All Securities and Exchange Commission registered investment advisors are held to the fiduciary standard,” he says. State-regulated advisors are also held to the fiduciary standard.
“There is a lesser standard in the brokerage landscape referred to as suitability. As long as the broker reasonably believes an investment to be ‘suitable’ for a client, he or she may buy or sell it,” Kelly says.
Exchange-traded fund. An exchange-traded fund is a basket of investments that tracks an index, either a widely commercial product or one that’s created specifically for the fund. ETFs may be traded throughout the day, the same as a stock. That’s one key difference between an ETF and a mutual fund. ETFs often have lower fees than actively managed mutual funds.
In recent years, many advisors have gravitated away from more expensive, actively managed funds, and toward ETFs.
“When explaining ETFs to consumers, I explain that they are essentially index investments that trade like stocks. An index mutual fund gets re-priced once daily, following settlement of all of the funds underlying holdings. An ETF on the other hand, trades all day long on an exchange so the price varies throughout the day,” Kelly says.
Managed account. Many registered investment advisors have discretion over a client’s account. That means the advisor has the authority to buy, sell and rebalance, without getting the client’s permission before each trade. That is a very different process than working with a stock broker, who requires permission prior to each trade, or from managing one’s own brokerage account.
“I often hear advisors use the term to their clients, and sometimes wonder if the investor understands what that means versus any other type of account they have,” Lee says. “In my experience, when advisors use the term, they are referring to accounts managed on a discretionary basis by the advisor, compensated by a fee, rather than commissions. But I am not sure that investor knows the difference between this and a standard brokerage account that is not a part of any advisory agreement.”
Market cycle. This is a term investment managers and the financial media often use to describe the performance of an investment over some period of time, which is dubbed a market cycle.
“Simply put, a market cycle is the time period during which the market rises to a peak – a bull market – then falls to a trough – a bear market – and then prices begin to rise again – a bull market,” Kelly says. “We never know the exact length of time over which a market cycle will occur.”
