Do you want to do more with your money than just let it sit around in your checking account – but you’re new to the world of investing? Don’t worry, it’s easier than you think once the essential terms of the investing world are explained.
Table of Contents
#1 Shares and Bonds
You’ve probably come across these terms before. Shares refer to the stakes that make up a company. With a share, you participate in the so-called equity of the corporation and thus become a co-owner of the company. You legally own an (often very small) part of the company. This also means that you participate directly in the company’s success and growth – either through an increase in the value of the share price and/or through the company paying out so-called dividends. Did you know that over 630,000 shares of various companies are traded on the stock exchange worldwide?
With a bond, money is made available to a company or even a state. Unlike shares, however, this is done for a specific term and in the form of so-called debt capital. You do not become a co-owner, but a creditor of the company, as in the case of a loan, which is called in at the end. In return, you receive interest that is fixed in advance. The interest rate can vary depending on the risk.
While both forms of participation, i.e., shares and bonds, help companies obtain fresh capital, shares can only be issued by stock corporations listed on a stock exchange and thus traded. Due to the fixed interest rates at the beginning of the term for bonds, the company’s success is much less relevant than for shares. It can be stated that bonds are comparatively less risky than shares, but this also limits their success, the so-called return. But more about that later…
#2 Dividends
Dividends are great because they represent a distribution of profits from companies to their shareholders. For example, Europe’s largest carmaker Volkswagen pays a dividend of EUR 4.80 per share this year. A nice thank you from Volkswagen to its shareholders.
As a rule, distributions are typically decided at the annual general meeting of the stock corporation, and the amount reflects the current earnings situation of the company. Therefore, there is no guarantee for dividend payouts. Nevertheless, Microsoft was the top dividend payer in 2020 with 15.8 billion U.S. dollars.
#3 Securities index or stock index
You have certainly come across terms such as DAX, Dow Jones, or S&P 500, which are often used to reference the current economic situation, especially in the stock market news. However, these somewhat unwieldy names refer to nothing more than a security or stock index. These indices track the performance of a particular selection of stocks or bonds. As a rule, they are the most prominent companies listed on the stock exchange in a specific country, geographical region, or industry (for example, technology).
While the DAX “summarizes” the 30 most significant and most liquid German companies listed on the stock exchange, the Dow Jones and S&P 500 are at home in the U.S. and track the share prices of 30 and 500 of the largest U.S. listed companies, respectively.
The relevant key figures for the composition differ in each case, but in total, it can be said that a kind of sentiment barometer is derived from them and can be compared. Another very well-known index that you should know is the MSCI World. As the “World” in the name suggests, it represents almost 1,600 listed companies from 23 industrialized countries. It is thus considered a kind of leading index for the world economy.
Fun Fact: Over an investment period of 30 years, the DAX has generated an average return of around 8% per year on the money invested. Since its introduction in 1988, it has thus increased more than ninefold within this period.
Deutsches Aktieninstitut e.V. 2021
#4 Risk-Return Ratio
One of the most important things that we always keep in mind when investing is the risk-reward ratio (or risk-return ratio). The term originally comes from portfolio theory: any investment always comes with a certain amount of risk. Increasing return expectations are always associated with higher risk. So if someone promises you an above-average return with little or no risk, you should be very suspicious.
Typically, the risk-return ratio is compared with the return of a risk-free investment. However, since risk-free investments currently yield a whopping 0% interest (or negative interest, but that’s another topic) and thus remain unproductive, we are convinced that low to medium risk makes sense to avoid demonetization through inflation in the first place. The magic word to keep risk “in check” and minimize it as much as possible is diversification. The more you spread your capital, the higher is your risk diversification due to the distribution in different countries and industries. Freely according to the motto, “Don’t put all your eggs in one basket.”
#5 ETFs (Exchange-Traded Funds)
From our point of view, one of the best innovations on the stock market in the last decades are ETFs, so-called Exchange-Traded Funds. Instead of buying individual stocks, ETFs allow you to invest directly in securities indices and thus in a wide range of companies. Since they track the performance of an index, they are also often called index funds. Therefore, in the case of a DAX ETF, 30 companies are directly included in the share price, and we can participate in their success. ETFs are available for many asset classes, i.e., stocks, bonds, and commodities, as well as for specific sectors, e.g., renewable energies.
Like stock prices, ETF prices fluctuate. However, the risk for a total loss of your money is much lower with purchasing ETFs because you have your money spread across many companies. A total loss from one company is much less of an issue than if you had only purchased stocks from that one failing company. Think about the eggs and the basket.