Investing Definitions – Investment Basics for Beginners

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I put off investing for a long time because I was intimidated. I didn’t know where to begin and what stocks to buy.

This is one of my biggest money regrets! Nothing can grow your money and net worth quite like investing. The goal of this post is to cover some basic investing definitions to help you feel more comfortable with investing.

I have another post regarding investment basics which talks about how you can get started investing asap as well as a post dedicated to the difference between saving and investing (aka why to invest), check out those posts too!

Learn how to invest so your money can work for you!

*This is not financial advice, this is meant for education purposes only. Investing involves risk*

investing definitions - learn how to invest

Table of Contents

Index Funds

The first investment definition you need to know is index fund. An index fund is an investment fund that was constructed to mimic a financial market.

What does that mean? An index fund will track the performance of a specific group of stocks, bonds or other investments.

For example, you want to invest in a particular industry, let’s say tech. Instead of only purchasing one specific company’s stock, you can purchase a tech index fund. This will allow you to follow the ups and downs of the entire industry as opposed to just one company.

More than just specific industries, there are index funds for the overall stock market, the largest 500 US companies and pretty much any other bundle of stocks you could want!

Advantages of Index Funds

Investing in index funds instead of a handful of individual stocks has many advantages.

First: Market Returns.

On average in the long term, the market as a whole has a 7% annual return (with inflation). This means, if you’re investing in an index fund that follows the market, you’ll see a 7% increase in your investments every year (on average).

95% of the time, investing in an index fund will get you larger returns than individual stocks. Because of this, investing in index funds for the long term can really benefit you!

They say it takes about 10 years to double your money in the stock market. How awesome is that? You get to do nothing and 10 years later you have twice as much!

Second: Diversification.

Diversification means you’re not putting all your eggs in one basket. If you’re only purchasing one stock and that stock plummets, you’ve lost all your money. However in an index fund, you’re following the entire market or an entire industry, so you have a large variety and are less likely to see big fluctuations.

This makes your investment safer. Which provides peace of mind when you’re risk averse.

Disadvantages of Index Funds

Average Market Returns: Yes market returns are also on the advantages list but it can also be a con. Because indexes track a variety of different stocks, or the entire market; it is inevitable to avoid the not so great stocks. You will be seeing average returns (that 7% we discussed) and not massive 30% returns because everything is included.

As a note, I will say although average doesn’t sound great when it’s written like that, average is much better than what the majority of investors who choose individual stocks make. Average is safe and reliable.

Don’t be deterred by hearing the word average!

How to Buy Index Funds?

Now that we know the awesomeness that is an index fund, how to invest?

The two major ways to invest in an index fund is through purchasing a mutual fund or etf (exchange traded fund). Which are our next two investing definitions!

Mutual Funds

A mutual fund is both a company and investment vehicle that is professionally managed.

Mutual funds pool together money from different investors; then the manager will take that money and invest it in stocks, bonds and other assets with the hopes of providing income (aka capital gains) to its investors.

When you buy into a mutual fund you are becoming a partial owner of that company and the assets it holds. Mutual funds are cool because as an individual investor just starting out, you are able to get professional management for a relatively small fee.

Mutual Fund vs. Index Fund

A popular question is which is best? Mutual fund vs. index fund? Well many mutual funds are index funds, however not all of them are. It’s one of those examples, every square is a rectangle but not every rectangle is a square.

A mutual fund can vary in investment styles, meaning it can be an index fund (passively managed) or an actively managed fund.

Actively managed means the manager of the fund is making decisions about where to invest and what to sell regularly! It can be their full time job to run the mutual fund.

So which is best? A passively managed mutual fund that follows an index or an actively managed mutual fund (Mutual fund vs. index fund). In my opinion a passively managed mutual fund (aka index fund) is the better choice.

Statistically speaking, on average an index fund will see higher returns than 95% of actively managed mutual funds. So the choice is yours, would you rather have steady growth or take the 5% chance and see if you can beat the index?

Advantages of Mutual Funds (As Opposed to Stocks)

Professional Management: As mentioned before, a mutual fund is professionally managed. That means you don’t have to worry about buying and selling stocks because someone else is doing the work for you!

Diversification: As we discussed above, diversification means not all your eggs are in one basket. A mutual fund immediately lowers your risk of losing money. Mutual funds are typically invested in 50-200 stocks with some invested in over 1,000!

Convenience: When you are first starting out it can be difficult to know where to begin. Investing in a mutual fund is an easy way to get started at a relatively low risk. All the difficult steps are taken care of for you!

More Ways to Make Money: Traditional stocks make money in two ways. When companies pay out dividends and when the stock price increases. With mutual funds, there is a third way to make some extra cash. If the mutual fund manager sells a stock for a gain, they will pay out that gain to its investors!

Disadvantages of Mutual Funds (As Opposed to Stocks)

High Fees: Because mutual funds are professionally managed they charge a fee. Sometimes they even charge a fee for buying and selling stocks, which you don’t have any control over. These fees can sometimes get way out of hand, making the investment not worth making.

Minimum Purchase Amounts: A lot of mutual funds have minimum purchase requirements. This means, in order to invest, you will have to commit a certain amount of money. A common minimum requirement amount tends to be 3,000 dollars minimum.

Purchase Limitations: Unlike stocks and ETFs, a mutual fund doesn’t trade throughout the day. They trade once a day at 4pm Eastern.

Taxable Events: Typically you would only pay taxes when you decide to sell your investment. However, if the investment manager decides to sell a stock within the mutual fund, that means a taxable event for you.

Which Mutual Fund is Best?

*This is not financial advice, meant for educational purposes only*

Which mutual fund is best depends on your investment needs. Below are some popular mutual fund index funds. Do your own research to figure out if any work for you and your investment needs.

FXAIX: Tracks the S&P 500, meaning the 500 largest US public companies.

VTSAX: Tracks the total stock market.

SWISX: Tracks large publicly traded non-U.S. companies

Exchange Traded Funds (ETFs)

What is an ETF in investing?

As a general definition, an exchange traded fund (ETF) is a basket of assets that can be bought and sold the same way as any other stock.

An ETF pools the money of multiple investors, similar to a mutual fund, and tracks the performance of a specific group of stocks, bonds or other investments.

When you invest in an ETF (which is a type of index fund) you can follow the ups and downs of an entire industry, or the entire market, as opposed to just one company.

Benefits of ETFs:

Diversification: Like we keep mentioning, diversification! You’re not putting all your eggs in one basket. Instead of only holding one stock and hoping it does well, an ETF has a much larger variety; you can join the entire market or an entire industry with only one purchase.

No Minimum Spend If you only want to buy one share, you can do that! You get to choose how much to invest. Unlike mutual funds that often require a minimum purchase amount, ETFs have more flexibility. You are able to purchase as little as one share.

Low Fees: Index fund ETFs are passively managed. They track an index, they don’t have someone actively sitting there deciding what to invest in. Because of this, you don’t have to pay a high management fee for them.

Tax Benefits: You typically will only have to pay taxes when you sell the investment.

Trades Like a Stock: If you have access to the internet, you can see the price go up and down at any point throughout the day. Additionally, you can purchase or sell your shares at any point throughout the day.

Disadvantages to ETFs

Average Market Returns: The same disadvantage that applies to index funds applies to ETFs. If you are investing in an ETF index fund you will be seeing average 7% returns in the long run. Like I mentioned before, it might sound like you could do better than 7% but typically the average is pretty damn good!

It’s quite rare to beat that number in the long run.

Which ETF is best?

Below are some popular / well known ETFs; all of which I personally invest in!

*This is not financial advice, meant for educational purposes only*

SPY: Tracks the S&P 500, meaning the 500 largest US public companies.

VTI: Tracks the total stock market.

XLF: Tracks the financial sector.

IEMG: Tracks emerging markets. Securities from countries with emerging economies.

VEA: Tracks international developed market equities.

Mutual fund vs ETF vs Index Fund – My Personal Investments

This is our “where to invest” / “learn how to invest” investing definitions recap with my personal recommendations (again, not investment advice! This is just what works best for me)! Mutual fund vs. ETF vs. Index Fund.

Investing in index funds is the best way to go, especially when it comes to retirement. If you are investing in index funds you are tracking the market. This is significantly less risky than any individual stock. Additionally, you’ll see 7% annual returns, on average, in the long run.

The best way to invest in an index fund is through a mutual fund or ETF.

Mutual funds and ETF index funds are essentially the same thing. They are both passively managed and track an index. The only difference is how you buy and sell them.

With an ETF you can buy and sell them like a stock, at any point throughout the day, with no minimum spending. Mutual funds however, set their price once a day, have larger fees and have minimum spending requirements.

Because of this I personally prefer ETFs. You get all the benefits of mutual funds with none of the disadvantages. All the disadvantages that ETFs have, mutual funds have too.

Investing in an ETF and holding it for years to come is an incredible way to grow your wealth!

Final Thoughts

Alright, are we learning all the basics of investing?

Hopefully the answer is yes!

This post should help you learn some basic terminology commonly used when investing. However, the most important thing is to actually begin investing in the stock market!

Time is incredibly valuable when it comes to investing so now that you know how to buy index funds and where to invest for retirement, set up your auto-transfer asap! No excuses!

I’m here to answer any clarifying questions so leave me a comment, send me an email or a DM!

Lastly, snag my free budget templates for google sheets from my resource library by signing up for my email list! Alternatively shop my budget templates from The Budget Empire! I personally use the Ultimate Wealth Planner to track my finances.

(If you’re wondering, I use Betterment to invest.)