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MIDYEAR INVESTMENT OUTLOOK AND FUND REVIEW

A Guide to the Language of Investing

July 06, 1999|DANIEL GAINES and PAUL J. LIM

Investing has a language all its own. Which means if you're new to investing, financial advisors, mutual fund managers and publications such as this one, you are probably seeing unfamiliar terms.

As a reference or refresher, this glossary sets out to define some of those terms.

Definitions for mutual fund categories discussed throughout this section can be found at the top of each table on S12-15.

* Actively managed funds: Most mutual funds are actively managed. This means the fund's managers can use their discretion to buy and sell stocks, bonds or other investments within the fund. Depending on the bylaws of the fund, an active manager may have extremely broad leeway in deciding how the fund will be managed.

The main selling point of an actively managed fund is the stock-picking skills of its managers.

Actively managed funds stand in stark contrast to passively managed funds that might follow an index, a formula or, in some cases, not change holdings at all. Index funds don't try to pick stocks. Rather, they simply buy and hold shares of investments found in a benchmark, such as the Standard & Poor's 500 index of large U.S. stocks.

* Annualized returns: An investment's total return is the yield it generates plus or minus the change in principal, over a specific period.

Returns for periods greater than one year in this section--and in The Times in general--are annualized.

This means the figure represents the total return the investment would have had to have earned each year to produce the actual change in value for that investment between the start and end of the period.

These returns include the effects of compounding, so the numbers are lower than what you would get by simply dividing the total return for a period by the number of years. Average annualized returns are also called compound annual returns.

Using annualized returns makes it easy to compare long-term returns and annual yields. Do not infer from annualized return figures that returns were the same each year; returns might be very different each year of the period in question.

* Asset allocation: Refers to how your portfolio is constructed--what percentage is held in stocks versus bonds versus cash, and within each of those asset classes, what percentage is held in different types of stocks and bonds.

* Benchmark: An appropriate stock or bond index used to gauge the performance of an investment such as a mutual fund.

Fund managers that invest in small-company stocks, for instance, are often evaluated based on how well they perform against the benchmark Russell 2,000, an index of 2,000 small stocks.

* Global, foreign, international and world mutual funds: These terms refer to funds that invest at least a portion of their assets outside the United States.

These terms are often interchangeable in casual conversation, but among fund companies, a foreign fund generally refers to a portfolio that invests exclusively outside the U.S. Global or world funds are those that are allowed to invest anywhere--including, to some extent, the U.S.

In the Morningstar tables in this section, "international" is used as an umbrella term that includes both foreign and world funds.

* Market capitalization: The market value of a company, or how much it would cost, in theory, to buy the company outright. A company's market capitalization can be computed by multiplying its current per-share stock price by the number of shares outstanding.

A company's market cap is not to be confused with its book value, which refers to the value of its actual assets, minus liabilities.

The terms "large-cap," "mid-cap" and "small-cap" refer to a company's capitalization size.

Although precise definitions vary, Wall Street generally regards companies with market capitalizations of $1 billion or less as small-cap companies. Those with market capitalizations of between $1 billion and $7 billion are considered mid-caps, and anything larger falls in large-cap territory.

* Revert to the mean: Over short periods, investments may do considerably better or considerably worse than their historic average. Eventually, though, stock and bond performance reverts to the mean, meaning it falls back in line with its historic norms.

For example, the real, after-inflation returns for U.S. equities (stocks) for the last century has been rising from 7% to 8% annually. In the last five years, though, stocks have done considerably better, generating double-digit annual gains. Eventually, academics expect that stock prices will do considerably worse, reverting to the mean.

* Style: Refers to the type of investments a manager buys and the methods for choosing them.

Fund tracker Morningstar Inc. categorizes funds based on their definitions of style. See the domestic equity categories on S12-13.

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