Financial Definitions Glossary

401k Plan – A type of defined contribution pension plan provided by most corporations for employees. The plans allow employees to set aside a percentage of their salaries, pre-tax, into an investment account which can grow tax-deferred until retirement age. Most corporate 401k plans allow the employee to manage their investment choices from a specified list of fund options.

Active Asset Allocation – (Also known as Tactical Asset Allocation and Dynamic Asset Allocation.) A form of asset allocation that seeks to increase returns and reduce risk by actively shifting allocations within a portfolio as market conditions change. This updated approach to asset allocation has become more popular as computerized techniques have evolved that proved its ability to deliver higher risk-adjusted returns than traditional fixed asset allocation.

Allocation Shift – A change in the percentage allocation of a particular investment within an overall portfolio. For example, changing a portfolio’s allocations from 60% Large cap stocks and 40% Bonds to 70% Large cap stocks and 30% Bonds would be an allocation shift.

Annualized Return — “Annualized” return is different from “annual” return. The term annual return is usually meant as a simple average of an investment’s returns in each annual period. As a simple average of annual returns, the statistic does not take into account the reinvestment of each year’s return and the resulting earnings on those returns. By contrast, the term “annualized” returns assumes the reinvesting of returns and their compounding over a given period of time. Therefore, you cannot make sense of an Annualized Return statistic without knowing over what period of time it is measured. Annualized Return is mathematically derived from the “total return” calculated for an investment over a given period of time. The mathematical equation for Annualized Return simply finds the one, single amount of return which compounded annually will bring you to the exact Total Return amount for the investment.

Asset Allocation – The most common technique for structuring an investment portfolio that involves dividing the total portfolio among different asset classes, such as between stocks, bonds, real estate and cash. The objective is to balance total portfolio risk versus return depending upon the investor’s return requirements and risk tolerance. Traditionally, this technique involves setting unchanging allocations for each asset class that the investor maintains throughout varying market conditions over time.

Asset Class – A type or category of investment. We think of stocks, bonds, real estate, commodities and cash as being the most general types of investment asset classes. At a finer level of distinction, we think of Large cap, Mid cap and Small cap stocks as being important asset classes. Other examples are International stocks, High Yield Bonds, Precious Metals and Emerging Market Bonds.

Back Testing – The process of testing an investment or trading strategy on historical market data. Typically using computers, a back test simulates how the actual strategy would have performed, allowing the comparison of multiple strategy options.

Bear Fund – A type of mutual fund that is structured to go up in value when the stock market goes down in value. They are called Bear Funds because they make money during bear markets. Also known as Inverse Funds and Short Funds.

Bear Market – A prolonged period during which market prices fall.

Bull Market – A prolonged period during which market prices rise.

Buy and Hold – An investment strategy in which investments are bought and then held for a long period, regardless of the market’s fluctuations. The buy and hold approach to investing rests upon the assumption that in the very long term (over the course of, say, 20 or 40 years) prices will go up, and the investor will make a positive return.

Buy and Sell Signals – Signals provided by an investment strategy to either buy or sell a particular asset.

Capital Preservation Objective – A type of investment objective that emphasizes investments that are least likely to reduce in value either because of market price fluctuations or because of credit losses. Investors with this objective are willing to accept a lower rate of return on their investments in order to increase the safety of their principal, or capital.

Churing — Excessive trading. Churning generally refers to an illegal practice by brokers to maximize commissions by trading excessively in a client’s account. It is also applied to mutual fund managers when they seem to trade in and out of their investments at an excessive rate which drives up the fund’s transaction costs and lowers net return to the owners.

Closed-end Fund – Similar to a mutual fund but different because it maintains a fixed number of outstanding shares and is listed on an exchange like a stock. A closed-end fund trades at a market price that usually differs somewhat from its underlying net asset value. Mutual fund shares always transact at their net asset value.

Compounded Returns – Compounded returns are higher than non-compounded returns and begin to grow exponentially after a long-enough period of time. Compounding assumes the reinvestment of earnings from any period in the next period. For example, if a $100 investment earns 8% annually, we assume that the $8 return in Year 1 is reinvested at the beginning of Year 2. Therefore, during Year 2 there will be a total investment balance of $108 ($100 + $8) actually earning interest at a rate of 8%. If you had not reinvested the $8 return from year 1, then your investment balance earning interest in year 2 would have only been $100 rather than $108. By reinvesting the $8 return, your 8% interest in year 2 would actually be $8.64 rather than only a flat $8.00 if you hadn’t reinvested. If you carry this example out for several more years, you will see that the difference between the compounded and non-compounded return gets bigger and bigger each year. After a larger number of years, you will see that the compounded return each year is growing exponentially faster than the non-compounded return. It is this exponential effect of compounded returns that accounts for what many financial advisors refer to as the “Magic of Compounding” because after 10, 20 or 30 years, the difference becomes absolutely huge.

Computer Simulated – Investment strategy logic that is based upon market statistics and indicators can be reduced to mathematic formulas and “run” against a database of historical data to simulate the behavior and performance of the strategy. Therefore, many investment strategies can be computer simulated. And the individual parameters within a strategy can be systematically varied by a computer program to determine which set of parameter settings result in the best overall performance.

Correction – See “Market correction”

Conservative Growth Objective – A type of investment objective that seeks growth in portfolio value over time, using more conservative investments that carry less risk of loss and/or market volatility. Investors with this objective are not seeking a stable current income in the form of an interest return. Instead, they seek portfolio growth but have a lower risk tolerance.

Current Income Objective – A type of investment objective that seeks a stable “interest” return in the current period and also in future periods. Investors with this objective typically purchase bonds, annuities or high-dividend stocks with a stable return. In many cases, investors seeking current income will reach for higher levels of income by accepting some risk of loss or market volatility in the investment asset. They are typically not interested in growing the value of the portfolio, but rather in earning the highest current return.

Drawdown Risk – See Maximum Drawdown

Dynamic Asset Allocation – (Also known as Tactical Asset Allocation and Active Asset Allocation.) A form of asset allocation that seeks to increase returns and reduce risk by actively shifting allocations within a portfolio as market conditions change. This updated approach to asset allocation has become more popular as computerized techniques have evolved that proved its ability to deliver higher risk-adjusted returns than traditional fixed asset allocation.

Exchange Traded Fund (ETFs) – A new type of fund that is similar to an index mutual fund. Exchange Traded Funds (ETFs) are designed to track different indexes, such as the Russell 2000 Index or the S&P 500 Index, or alternatively a particular industrial sector such as Utility stocks or Biotechnology stocks. ETFs are different than index funds and sector funds because they are legally structured as stocks and are traded on stock exchanges just like any other stock. Unlike mutual funds, ETFs can be traded intra-day and also sold short just like a stock. ETFs are also more tax-efficient than most mutual funds and require much lower management fees because of the lack of active management.

Fixed Asset Allocation – The traditional approach to the discipline of asset allocation in the management of investment portfolios. The traditional, “fixed” approach involves setting unchanging allocations for each asset class that the investor is expected to maintain throughout varying market conditions over time

Fundamental Analysis – A method of stock market analysis that focuses upon “fundamental” economic variables such as Sales, Earnings, Interest Rates, Inflation, and Debt. For example, a Fundamental Analyst might be bullish on the stock market’s prospects if the economy is expected to grow at a faster rate or if interest rates are expected to drop.

Growth Objective – A type of investment objective that emphasizes the long term growth of an investor’s principal balance through capital appreciation (unlike owning bonds or CDs which do not increase in value). Investors with a growth objective want to see the value of their investments grow over time and they are usually willing to forego a current interest return on their investment. Having a growth investment objective also involves accepting some “market risk” on the value of the investment. Growth investing usually involves investing a portion of a portfolio in the stock market.

Growth with Hedging Objective – A type of investment objective that seeks to use stock market hedging techniques to improve the risk vs. return characteristics of a “growth” portfolio. The hedging techniques may seek to protect the value of the portfolio during declining markets and/or make profits during declining markets.

Hedging – An investment made in order to reduce the risk of adverse price movements in another investment, by taking an offsetting position in a related security, such as an option, a short sale or an “inverse fund”.

Index Fund – A certain type of mutual fund that is structured to mirror, or track, the performance of a given market index such as the S&P 500 or the Russell 2000. Some index funds are designed to track industry indexes such as Banking or Utilities.

Inverse Fund – (Also known as a Bear Fund or Short Fund). A special type of index fund that is structured to go up in value when a given market index goes down in value, and vice versa. There are popular inverse funds for Large cap stocks, Mid cap stocks, Small cap stocks and Over-the-counter stocks (Nasdaq). Inverse funds are used to establish a hedge position within stock portfolios to protect their value during market declines. They can also be used to speculate and profit from market declines.

Investment Objective – The result desired by an investor. Some examples of investment objectives are Growth, Current Income and Capital Preservation.

Investment Strategy – A methodical approach or plan for investing and managing an investment portfolio. “Buy and hold” and “dollar-cost-averaging” are both examples of simple strategies. By contrast, the investment strategies that we offer are based upon highly sophisticated computer models. But the results of these models are offered to you in the form of simple Model Portfolios, making it easy for you to have a methodical approach to your own investing.

Investment Time Horizon– The period of time an investor expects to be able to grow a portfolio before needing the money. The length of time available will influence the investor’s investment objective, their tolerance for risk and the optimal investment strategy.

Large Cap Stocks– Stocks of companies with a large market capitalization, or market cap. Large cap stocks are usually very large industrial enterprises with individual business lines that cross multiple market sectors and international boundaries. Because of their typically strong internal diversification, and long operating track records, their common stock is usually broadly held by institutional and individual investors; and the price volatility of their stocks is usually less than for “Mid cap” and “Small cap” stocks.

Leveraged Index Fund – A special type of index fund that employs “financial leverage” to increase the performance of the fund relative to a given market index. Most leveraged index funds are designed to deliver 1.5 times or 2 times an index. For example, there are such funds designed for the Russell 2000 small cap stock index which will go up or down by 2 times the rate of change of the index. Leveraged index funds are typically used by investors using mechanical investment strategies designed to take advantage of the leveraged returns while managing the inherent increase in risk.

Long Term Market Timing – A type of market timing designed to capture longer-term trends in a market rather than short-term fluctuations. Typically, a long term market timing system will seek to identify market trends at least several months in duration, in not much longer.

Market Bottom – The end of a declining market trend. As seen on a stock chart, a market bottom is followed by a positive market trend. A market bottom also identifies a price level generally understood to provide psychological “support” in the future until such support has been “broken”. Market bottoms come at the end of both long-term negative trends and short-term negative trends.

Market Correction – A temporary reversal of the prevailing trend in price movement for a market or security. The term is most often used to describe a decline after a period of rising prices. A correction is often considered beneficial for the long term health of the market, in that prices had risen too quickly and the drop put them back to more realistic levels where investors again see attractive value.

Market Sector – A distinct subset of a market, whose components share similar characteristics. Stocks are often grouped into different sectors depending upon the company’s business. Standard & Poor’s breaks the market into 11 sectors. Two of these sectors, utilities and consumer staples, are said to be defensive sectors, while the rest tend to be more cyclical in nature. The market can also be broken down into different sector categorizations, such as Large cap, Mid cap and Small cap stocks.

Market Timing – A strategy of moving in and out of a given market in order to take advantage of the market’s positive (bullish) and negative (bearish) trends. As a strategy, market timing is the opposite of “buy and hold” investing and seeks to benefit from the bullish trends without suffering from the bearish trends. Market timers aim to buy “low” and sell “high” by following a consistent, or mechanical, strategy. Studies have found that most average investors are “inadvertent market timers” because they react emotionally to market fluctuations and end up buying “high” and selling “low”, the reverse of an effective market timing strategy. This is why many advisors say that market timing is a bad idea. Without an effective, mechanical timing strategy, it is indeed difficult to successfully time a market on a consistent basis that results in long term profitability.

Market Top – A peak in prices that ends a prevailing period of increasing prices in a market. As seen on a stock chart, a market top is followed by a negative trend in prices. A market top also identifies price level generally understood to provide psychological “resistance” to further price appreciation in the future, until such resistance has been “broken”. Market tops come at the end of both long term bullish trends and short term positive trends.

Maximum Drawdown – A measure of the riskiness of a mechanical investment system/model. Drawdown is simply the percentage drop from any peak in portfolio value to any valley (bottom). The maximum drawdown of a mechanical investment strategy is the largest percentage loss experienced by the strategy over a specified period of time. It is expressed as a percentage (such as 9%) and can be directly compared by an investor with their percentage risk tolerance. It can also be used to compare the inherent riskiness of different mechanical strategies.

Mechanical Investment Strategy — An investment strategy is said to be “mechanical” when it is based upon the mechanical application of logical decision rules to quantifiable data and statistical indicators. A mechanical investment strategy works like the mechanical gears of a machine and allows no extraneous inputs into the decisions it produces. Therefore, a mechanical strategy makes its own decisions, based upon its own internal logic, and does not take the investor’s thoughts, ideas or emotions into account. Mechanical investment models are popularly referred to a “black boxes”. Mechanical investment strategies have become a lot more popular since the advent of personal computers. Many investors have found a real benefit from mechanical strategies because their mathematical logic can be easily optimized by computers against many years of historical market data. Moreover, many investors have found that their emotions get in the way of effective investment decisions; and mechanical strategies are a great way to eliminate the emotional element. Another reason for their popularity is the fact that using a mechanical strategy takes the burden off of the investor to constantly pay attention to the market and make decisions on a real-time basis. A mechanical strategy allows the investor to put their attention on other matters and only have to respond when the strategy triggers some kind of change.

Model Portfolio – A model portfolio is how we communicate to you what specific investments you should have in your portfolio at any given time. When one of our investment strategies recommends a change, the model portfolio for that strategy will reflect the change. The model portfolio will tell you what specific funds you should own in your portfolio and what percentage to allocate to each fund.

Moving Average — A technical analysis term meaning the average price of a security over a specified time period (the most common being 20, 30, 50, 100 and 200 days), used in order to spot pricing trends by flattening out large fluctuations. This is perhaps the most commonly used variable in technical analysis. Moving average data is used to create charts that show whether a stock’s price is trending up or down. They can be used to track daily, weekly, or monthly patterns. Each new day’s (or week’s or month’s) numbers are added to the average and the oldest numbers are dropped; thus, the average “moves” over time. In general, the shorter the time frame used, the more volatile the moving average will appear, so, for example, 20 day moving average lines tend to move up and down more than 200 day moving average lines.

Mutual Fund — An open-ended fund operated by an investment company which raises money from shareholders and invests in a group of assets, such as stocks, bonds and money market instruments. For most mutual funds, shareholders are free to sell their shares at any time, although the price of a share in a mutual fund will fluctuate daily, depending upon the performance of the securities held by the fund. Benefits of mutual funds include diversification and professional money management. Mutual funds offer choice, liquidity, and convenience, but charge fees and often require a minimum investment.

Mutual Fund Company – A company that manages and sells mutual funds. Well know examples of mutual fund families are Fidelity Investments, Vanguard and T. Rowe Price.

Portfolio Diversification – a method of reducing the overall risk of an investment portfolio by holding a range of different types of assets. By diversifying, a portfolio’s value will not be entirely dependent upon the value of one asset.

Portfolio Risk – the risk of a portfolio as a whole … a combination or blend of the individual riskiness of each of the assets held in the portfolio.

Principal – the amount of your investment expressed in dollars. If you invest $100,000 in a mutual fund, then your initial principal balance is $100,000. If you make $20,000 on your investment, then your new principal balance will be $120,000. Your principal will be the amount of money you have at risk at any point in time.

Rate of Growth – the rate of percentage change in the price of an investment, usually expressed as an annual rate.

Relative Sector Strength Optimization — A mathematical technique we use to compare the relative growth rates of different sector funds and determine when to move from one sector fund into another. Since the growth rates of different sector funds vary over time, certain funds will outperform for a period of time and then fall out of favor. Our technique seeks to optimize our investment over time by switching investments on a timely basis to capture the period of over-performance in a given sector fund and then switch again to capture the over-performance of a different sector, etc.

Risk-Adjusted Return — A measure of how much an investment returned in relation to the amount of risk it took on. Often used to compare different kinds of investment that involve different levels of risk. A risk-adjusted return measure will put the two different investments on the same footing (by eliminating the difference in risk) and tell you which investment produces a better return relative to the risk it takes.

Risk Tolerance – an investor’s ability to handle a decline in their portfolio value. If you can handle a 15% decline in your portfolio, then you have a risk tolerance of 15%.

S&P 500 Index — Standard & Poor’s 500. A basket of 500 stocks that are considered to be widely held. The S&P 500 index is weighted by market value, and its performance is thought to be representative of the stock market as a whole. The S&P 500 index was created in 1957, although it has been extrapolated backwards to several decades earlier for performance comparison purposes. This index provides a broad snapshot of the overall U.S. equity market; in fact, over 70% of all U.S. equity is tracked by the S&P 500. The index selects its companies based upon their market size, liquidity, and sector. Most of the companies in the index are solid mid cap or large cap corporations. Like the Nasdaq Composite, the S&P 500 is a market-weighted index. Most experts consider the S&P 500 one of the best benchmarks available to judge overall U.S. market performance.

Sector Fund — A mutual fund which invests entirely or predominantly in the stocks of companies in a single industrial sector. Sector funds tend to be riskier and more volatile than the broad market because they are less diversified, although the risk level depends on the specific sector. But since they own a large number of stocks in a sector, they are less risky than holding just one stock within that sector. Investors generally choose sector funds when they believe that a specific sector will outperform the overall market. Some common sector funds include financial services funds, gold and precious metals funds, health care funds, and real estate funds, but sector funds exist for just about every sector.

Small Cap Stocks — Stocks of companies with a smaller market capitalization, or market cap. Small cap stocks are usually more recently-established companies and are typically focused on one, single industrial sector. Small cap stocks are more likely to be “emerging” companies, selling new types of technology or services, and will likely still be in the early, growth phase of their history. Because they tend to grow faster than mature, large cap companies, the share prices of small cap companies also tend to grow faster, particularly during bull market conditions. However, because small cap companies tend to be less diversified and more dependent upon a single business line, their shares also tend to be more volatile than large caps. Their higher degree of price volatility is also exacerbated due to the fact that small cap companies typically have fewer public shares trading, so that the market for their shares is less “liquid” and their share price must react more to accommodate a given amount of trading activity.

Speculative Growth Objective — A type of investment objective that emphasizes the use of riskier strategies to accelerate the long term growth of an investor’s principal balance through capital appreciation. This type of investment objective is usually only suitable for investors with a higher net worth; and then, it would generally only apply to a portion of the investor’s overall portfolio. Because riskier strategies have the potential of losing a larger percentage of the original investment, the typical investor should follow a “speculative growth” strategy with only the portion of their overall portfolio they can afford to put at risk.

Standard Deviation — A type of statistical measure used extensively by investment professionals to measure risk. Mathematically, standard deviation measures the degree of variation around a mean. The statistic can be applied to the historical price variability of different types of investments to determine how “variable” or risky they have been. The standard deviation of a portfolio of investments can also be determined based upon history. The shortcoming of standard deviation as a measure of risk is that it statistically treats variations above the mean just as importantly as variations below the mean. This means that is does not differentiate between movements up in price (which we like) from movements down in price (which we don’t like). Most investors think of risk as the potential for downward movements in price only. As a result, a number of other statistical approaches have evolved that measure only the downward deviation in price.

Stock Market Index — A representation of the value of securities that constitute a given market sector or industry. Indexes often serve as barometers against which financial or economic performance is measured. For example, the Russell 2000 Index is a popular representation of Small cap stocks in the U.S. against which many Small cap mutual funds are bench-marked for performance. The Dow Jones Industrial Index is the most widely followed representation of the performance of Large cap stocks in the U.S. The Standard & Poors 500 Index (S&P 500) is probably the most popular index used by professional money managers because it is deemed to be broadly representative of Large and Mid cap stocks in the U.S. An example of a “sector index” is the XAU which tracks the performance of a basket of precious metals companies.

Tactical Asset Allocation – (Also known as Active Asset Allocation and Dynamic Asset Allocation.) A form of asset allocation that seeks to increase returns and reduce risk by actively shifting allocations within a portfolio as market conditions change. This updated approach to asset allocation has become more popular as computerized techniques have evolved that proved its ability to deliver higher risk-adjusted returns than traditional fixed asset allocation.

Technical Analysis — A method of evaluating investments by analyzing technical market data, such as charts of price, volume, and open interest. Unlike “fundamental analysis”, the intrinsic value of an investment is not considered. Technical analysts believe that efficient markets accurately reflect all of the known fundamental information about an investment in the price of that investment. Therefore, technical analysts believe they can accurately predict trends in the future price of an investment by looking at its historical prices and other trading variables. Technical analysis assumes that market psychology influences trading in a way that enables predicting when an investment is likely to rise or fall. For that reason, many technical analysts are also market timers, who believe that technical analysis can be applied just as easily to the market as a whole as to an individual stock.

Ticker Symbol — A system of letters used to uniquely identify a stock or mutual fund. The ticker symbol are generally needed by the brokerage company when you wish to make a purchase or sale transaction. Symbols with up to three letters are used for stocks which are listed and trade on an exchange. Symbols with four letters are used for Nasdaq “over-the-counter” stocks. Symbols with five letters are used for Nasdaq stocks other than single issues of common stock. Symbols with five letters ending in X are used for mutual funds.

Total Return – The accumulated investment return of an asset over a given period of time, assuming the continual reinvestment of earnings. A 5-year total return, for example, assumes the reinvestment of returns in each period in the same investment and incorporates the earnings on each reinvested amount over the remaining period — and tells you the cumulative amount of growth in your original investment after 5 years, including that on all of the reinvested amounts. Total Return, as a measurement of an investment’s return, approximates what actually happens in an investor’s account when they allow the earnings to be accumulated in the account and periodically reinvested in the same investment, never drawing on the account to cover living expenses or taxes. Total Return also provides a measurement of return that takes into account the compounding of returns (the reinvestment of returns). When people speak of “compounded returns” they mean Total Return. To calculate the Total Return of an investment over 2 years (assuming annual reinvestment), you would take 1 plus Year 1’s Return multiplied by 1 plus Year 2’s Return, Minus 1. For example, if you have a CD that returns 6% per year, the 2-year Total Return would be: (1+.06) X (1+.06) – 1 = .1236 or 12.36%. If you had not reinvested the CD’s 6% annual return, then you have earned a total return of only 12% (6% + 6%). By reinvesting the earnings, you would increase your 2-year total return from 12% to 12.36%.

Trend Change – (Also called a trend reversal) A change in the generally prevailing trend direction of prices … from up to down, or down to up. We generally apply this term in the context of intermediate market trends of about 3 to 6 months in duration. On a grander scale, when a market reverses out of a Bull Market and moves into a Bear Market, or vice versa, that would also be a trend change. Day traders are likely to even focus on “intra-day” trends and seek to take advantage of changes in trend that occur in the middle of a day of trading.

Ulcer Index — A sophisticated measurement of risk designed to measure the degree of stress experienced by an investor when the value of an investment goes down (is “underwater”). This statistic defines stress as the combination of two factors: 1) the amount by which the value of an investment goes down and 2) the length of time during which the investment’s value has dropped below a previous peak in value (in other words, is “underwater”). By taking into account the length of time an investment is underwater, the statistic tries to measure the real-life emotional impact on an investor’s state-of-mind. Clearly, there is a significant difference for an investor between … on one hand, having an investment go underwater for a period of a month, compared with having the investment underwater for 5 years. And clearly, the more underwater an investment is, the greater is the emotional stress on the investor. So, the Ulcer Index measures both the degree of loss and the length of time. One investment that has a higher Ulcer Index than another, could have experienced a larger degree of loss, or it could have been underwater in value for a longer period of time … or both. The lower the Ulcer Index of an investment, the less emotional stress experienced by the investor.

Volatility — This term technically means the rate and degree of which the price of an investment moves up and down over time. It is also commonly used in investment circles as a term signifying that markets have a tendency to go down periodically, which is a bad thing. We use this term in both ways. Technically, volatility is found by calculating the “standard deviation” of the daily change in price. If the price of an investment moves up and down by large percentage amounts, and in short periods of time, it has high volatility. If the price almost never changes, or only by very small amounts, then it has very low volatility. Volatility, measured as standard deviation, is the most commonly accepted statistical definition of “risk” in an investment. The weakness of this measure is that it equally captures both the up and down price movements of the investment. When it comes to risk, we are really more concerned about the downward movement than the upward movement. As a result, the investment management industry has evolved other statistical measures that measure only the downside movement. The measure we like to use is called “Maximum Drawdown” because it is the most straightforward to interpret relative to an investor’s level of risk tolerance.