The investment industry is terrible when it comes to lingo and technical terms. Jargon can be intimidating, which unfortunately, can often be the intent. This is the first in a series of posts from Peloton Wealth Strategists which will form Peloton’s Investment Glossary, intended to help investors understand some of the most common and confusing investment terms. We’ve shared the facts, plus our own perspective on the terms. Our goal is to help you – the investor – become a more knowledgeable consumer of financial services.

A

A-Shares: A class of broker-sold mutual fund shares in which the commission (“load”) is charged at the time of purchase. A-share commissions can be as high as 5.75%. Peloton’s take: That’s almost six years of management fees at 1% per year, charged all at once and up front, in addition to ongoing management fees. See also: B-Shares and C-Shares.

ADR: American Depositary Receipts are interests in foreign securities which are denominated in U.S. dollars and traded on U.S. exchanges. Each ADR may represent one or more foreign shares. Peloton’s take: We invest in both U.S. and foreign companies as long as they trade in ADRs on domestic exchanges.

Algorithmic Trading: An investment strategy which relies on mathematical rules to determine the trading times and prices for securities. Peloton’s take: These are also known as “quantitative” or “quant” or “black box” strategies. As such, they do not take into account the operating metrics of the companies. These trading machines likely contribute to short-term market volatility.

Annuity: A financial product which combines elements of a life insurance policy and mutual funds. Between investment management expenses, mortality costs, and the expense of certain riders, the total expense of annuities commonly exceeds 3% per year. A favorite of commissioned salespeople, annuities have commonly been described as products which are “always sold, but never bought.” Peloton’s take: Insurance and investing are two separate things.

B

B-Shares: A class of broker-sold mutual fund shares in which the commission is charged only if a customer sells the shares before the end of the multi-year commission period. B-Shares convert to A-Shares at the end of the period, however their far higher annual expenses make them a more expensive product than A-Shares. Unlike A-Shares, B-Shares typically do not offer discounted commissions for large purchases. Peloton’s take: Charges that penalize investors for selling an investment “early” restrict flexibility and undermine investment decisions. See also: A-Shares and C-Shares, Deferred Load.

Beneficiary: A legal designation specifying who is to benefit from a financial asset under certain conditions. Beneficiaries are commonly designated in trusts and retirement accounts. Retirement assets pass directly to designated beneficiaries upon the death of the account owner. Bottom line: Ensure all of your accounts include up-to-date beneficiary information that matches the intent of your estate plan.

Bond Discount: The dollar amount by which a bond is trading below the face value of the bond (i.e. the amount returned at maturity). Bonds trade at a discount when their coupon rate is lower than the prevailing market interest rate. See also: Bond Premium.

Bond Interest: (Coupon Rate) The contractual amount a bond issuer is obligated to pay an investor each year until the bond matures. A 5% bond will pay bondholders 5% of the face value of the bonds each year until maturity. See also: Bonds, Municipal and Bond Rating,

Bond Premium: The dollar amount by which a bond is trading above its par value. Bonds trade at a premium when their coupon rate is higher than the prevailing market interest rate. Peloton’s take: Often advisors buy their clients bonds at significant premiums in order to show a high rate of interest. If the rate on your bonds seems abnormally high, you probably paid a hefty premium for it. See also: Bond Discount.

Bond Rating: An estimate of a bond issuer’s ability to make timely interest and principal payments to its investors. Bonds rated AAA by Standard and Poor’s or Aaa by Moody’s are judged to be of the highest quality and lowest risk. Only bonds rated BBB-/Baa- or higher are considered “investment grade,” while lower rated bonds are deemed to be “speculative,” “high-yield,” or “junk.” Bottom line: Lower quality bonds generally sport higher yields but also present higher risk of default. See also: Bond Interest.

Bond Yield: Often called “yield to maturity.” The calculated return per year that will be earned by the owner of a bond if the bond is held until it matures. Yield takes into account the stated interest rate or “coupon rate” and any offsetting premium or additive discount. See also: Bond Premium and Bond Discount.

Bonds, Municipal: Bonds issued by local authorities such as school corporations or hospital systems. Most often the interest paid on these bonds is exempt from tax. Often referred to as “tax-exempt” bonds. Bottom line: municipal bonds are most appropriate for investors in higher tax brackets.

Borrowing from 401(k): Many company retirement plans allow participants to “borrow” from their accounts. This is a bad idea because while many think they are simply paying themselves interest, they will eventually have to pay back the money that was originally contributed on a pre-tax basis with after-tax dollars. Bottom line: Don’t do it.

 

C

C-Shares: A class of broker-sold mutual fund shares in which a marketing or distribution fee is charged annually and paid to the broker-of-record. Often this annual sales charge exceeds the fee paid to the fund manager. Peloton’s take: It doesn’t take long for the high annual expenses to more than offset the lack of a front-end load and/or minimal deferred load associated with this class of shares. This is a common way for advisors to build-in a recurring revenue stream. Often with C-share funds, clients think they’re not paying their advisors a fee because they’re not directly. See also: A-Shares, B-Shares.

Capital Gains/Losses: The appreciation or depreciation of the value a financial asset incurred after purchase. Only when gains or losses are “realized” by selling the investment do capital gains and losses have tax implications in certain accounts. While the asset is being held, gains and losses are “unrealized” (often referred to as “paper” gains or losses because they’re only on paper and not yet tangible). Peloton’s take: Investment decisions have tax consequences, not the other way around. Minimizing taxes is important but should not take priority over investment decisions.

Carried Interest: The portion of investment gains received by investment managers in incentive-based fee arrangements – most often alternative investment pools like hedge funds – above the amount that accrues to the investor. Some argue that incentive fees are compensation and should be taxed as ordinary income to hedge fund managers. Others contest that it should be taxable to the manager as it is taxable to the investor – at capital gains tax rates, which are lower. Fee structures such as “2 and 20” are common with hedge fund managers under which “2” represents 2% per year and “20” means 20% of the gains above a certain watermark. In this arrangement, the “20” is carried interest. Peloton’s take: Incentive management fees can incent managers to take undue risk. See also: Capital Gains/Losses.

Cost Basis: The amount paid for a financial asset. This is used to calculate the realized gain or loss when an asset it sold to determine tax implications.

Creditor vs. Equity Interest: Bond owners are creditors. In return for lending money to a bond issuer, creditors most often receive a consistent rate of interest over the life of the bond/loan and their money back on a specified date. They do not have any ownership in the borrowing company. Equity investors own stock in a company and therefore have a claim on the company’s profits. In the event of bankruptcy and liquidation of a company, creditors are repaid before equity owners. Bottom line: Creditors are said to be “senior” to equity owners in the capital structure because their claim comes first.

Custodian: (account custodian, custody) The entity having physical control of financial assets. Most commonly banks, brokerage houses, and trust companies. Custodians take custody or “hold” clients’ assets (e.g. stocks and bonds) in an account for the beneficial owner and are responsible for collecting and posting dividend and interest payments, and executing transactions. Peloton’s take: We don’t maintain custody of client assets. We have trading authority and discretion to trade within client accounts, but we do not hold the assets. Most schemes to defraud investors involve entities or individuals granted both discretion and custody. See Ponzi Scheme and Bernie Madoff.