Personal Finance Terms To Know For Investing And Trading
Don't let finance jargon around trading & investing deter you from participating in it! Here, we explain some of the more common personal finance terminology.
Outside of working in finance or having enthusiasm for the stock market or cryptocurrency trading, talking about finances isn’t usually considered the most exciting topic at a picnic or cocktail party.
Here at Bakkt, we're all about putting the power of your digital assets into your hands (quite literally, thanks to the soon-to-launch Bakkt App and decreasing the barrier to entry for trading and investing. It's your money, and armed with the right information, you’ll be better able to trade it however you please. Don't let the jargon around trading and investing deter you from participating in it — while the language and terminology surrounding finances may sound intimidating, it’s a lot less confusing once you understand it in layman’s terms. After reading our Terms to Know, you’ll be armed with information about some common personal finance terms that apply to both the stock market and crypto trading. Of course, all investing is subject to risk, including the possibility of losing the money you invest.
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Stock Market Terms to Know
A stock represents ownership of a fraction of a corporation entitling the owner of the stock to a proportion of the corporation's profits and assets. One usually purchases stock (or units of stock referred to as shares) through a broker that trades on stock exchanges like the NYSE. Corporations sell stock to raise funds needed to maintain their business, allowing a shareholder to become a partial owner of the company. For example, you may have a mix of stocks in your portfolio, and therefore have ownership interests in each of those underlying companies.
Bid and Ask
A bid price is the maximum price that a buyer is willing to pay for an asset or security, whereas the ask price is the minimum amount that the seller is willing to take for the same asset in question. The trade or transaction occurs after the buyer or seller agrees on a price. The difference between the bid and ask prices is known as the bid-ask spread — the smaller the spread, the greater the liquidity. A bid-ask spread widens more than normal during times of market volatility.
Return on Investment
Return on investment (ROI) measures the performance of an investment and can help you compare it against other investments you may be holding. To calculate ROI, the benefit or return on the investment is divided by the original cost of the investment. The result is a percentage that can be easily compared against other investments, allowing you to measure their effectiveness against one another.
A cost-benefit analysis is a way to analyze potential investments. You measure the benefits of the decision or action minus the costs associated with going through with it. Essentially, you’re evaluating the potential cost, opportunity cost (what will it cost you to miss this opportunity?) as well as the potential revenue and earnings from the decision. It’s kind of like making a pro/cons list, but with your finances and what you can and can’t afford to invest considering your goals and risk tolerance.
Diversification is an investment strategy of spreading out investments among different asset types, so your exposure in any one asset type is limited. This helps balance your risk with the comfort level that's right for you and your timeline. You may be able to balance your risk by diversifying your portfolio among assets that you think will not move in the same direction at the same time — for example, if you think that the prices for certain stocks, cryptocurrencies, bonds, and short-term investments are not likely to all decrease at the same time, you might consider spreading out your investments among them. This way, if one asset class gets hit harder during a particular time period, the rest of your investments may help reduce the impact of market volatility.
Asset allocation is related to diversification. It is the strategy of dividing your investments across various asset types to maximize returns and minimize risk. By diversifying your investment portfolio among asset classes such as stocks, crypto, bonds, cash, and real estate, you may be better optimized for risk in case some assets prove less profitable than others. For example, during a “bull market” (discussed below), stocks generally appreciate and bonds generally lose value, and during a “bear market,” stocks generally lose value while bonds generally increase in value. By diversifying your investments, you're balancing risk and not putting all your eggs in one basket, so to speak.
If you’ve ever traveled to Wall Street in Manhattan, you’ve probably seen the large bronze bull watching over its neighbors and tourists eager to snap a photo. The statue is an homage to the bull market, which is when the stock market’s overall prices are rising and are expected to continue to rise. A bull market usually describes the stock market, but can refer to anything that’s traded, such as bonds or commodities. Bull markets are usually discussed with optimism and expectations that the market should be offering strong returns in the near future.
A bear market is the opposite of a bull market — it's when a market is experiencing prolonged price declines. Again, a bear market usually references the stock market, but it can apply to other sectors or commodities that have experienced a decline of ~20% for at least two months or more. Bear markets are associated with pessimism by investors and a slowing economy, low employment, and a drop in profits.
A money market refers to trading short-term debt investments (ranging from overnight to under a year), including ones bought by individual investors and bank customers. You can invest in a money market fund by buying a treasury bill, opening up a money market account at a bank, or purchasing a money market mutual fund.
A derivative is a financial security or asset whose value is derived from an underlying asset, or group of assets, otherwise known as a benchmark. Some well-known types of derivatives include futures and options. Futures (like the Bakkt® Bitcoin Futures) trade on an exchange, and are used to speculate on the future price of an asset (such as bitcoin). A futures contract enters the trader into an obligation to buy or sell the asset at the agreed-upon price at a specified later date. Options contracts are similar to futures, except with an option contract the buyer has the right, but is not obligated, to buy or sell the asset during the life of the contract. Options create an opportunity to buy or sell, while futures create an obligation to buy. The advantages of derivatives include locking in prices for the future and possibly mitigating risk, as well as the diversification of a portfolio.
A commission is a service charge and is how brokerages and commission-based advisors make their money. In exchange for providing investment advice or managing purchases and sales, the advisor or broker may receive either a flat fee or a percentage of the total value of the trade or the account balance. A commission-based advisor (or broker) makes money by conducting financial transactions on behalf of a client, like executing stock trades for a client’s portfolio. A fee-based adviser charges a flat rate, such as a fixed amount or an amount based on a percentage of the assets under management (AUM).
Crypto Terms to Know
A custodian is a financial institution that holds its customers’ assets for safekeeping to minimize the risk of loss or theft. Bakkt operates a custodian of bitcoin that is regulated by the New York State Department of Financial Services. Why does this matter? Because a regulated custodian is generally required to meet certain standards, including security, governance, and risk, that are designed to help safeguard the assets that it holds. We're backed (see what we did there?) by Intercontinental Exchange, Inc., which operates over a dozen of the world’s most prominent exchanges, including the New York Stock Exchange (NYSE). At Bakkt, the security of your digital assets is our priority, and we employ sophisticated information security and fraud protection measures to protect them.
Fiat money is government-issued currency (physical cash) that isn't backed by a physical commodity, such as gold or silver, but by the government that legally issued it. The stability of the government plus the laws of supply-and-demand are what determine the value of fiat money, giving central banks greater control over the economy, as the government determines how much money will be printed or taken out of circulation. Most modern currencies, such as the U.S. dollar and Euro, are fiat currencies.
Unlike fiat money, cryptocurrencies are decentralized, which means they aren't issued by a central government. Generally, the government that issues a fiat currency decides how much to print (or retire from circulation), which can affect the value of that currency. In contrast, many cryptocurrencies control this through their software - for instance, Bitcoin’s algorithm limits both the total amount of bitcoin that can ever be created, as well as the rate at which new bitcoin is created, in an attempt to limit the effects of inflation that are caused by creating vast amounts of new currency. Historically, cryptocurrencies have experienced greater volatility than most fiat currencies.
Liquidity refers to how easily an asset can be turned into cash without its market price being affected. Liquidity is important when cash is needed quickly (say, in the event of unanticipated financial challenges). A liquid asset ensures funds are available right when you need them, so you're not dependent on additional outside factors, such as the financial market. With the Bakkt App, you will be able to achieve instant liquidity with your digital assets by converting your portfolio of rewards, points, miles, gift cards, and crypto from one to another – or straight into cash. How cool is that?
Volatility measures the riskiness of an investment — the higher an investment’s volatility, the riskier that investment is. Generally, people with a higher risk tolerance are comfortable taking on more volatile investments. Conversely, investors with lower risk tolerance (for instance, those investors who may be close to retirement) may find investments with lower volatility to be more suitable.
Capital gains are the rise in value of a capital asset, like stock or a piece of real estate, that gives it a higher worth than the price you paid to buy it. For example, if you bought one bitcoin for $9,000 and later sold it for $10,000, the $1,000 difference would be deemed capital gains. The gain is not realized until the asset is sold. An unrealized capital gain, sometimes referred to as paper gains, reflects the increase in value of an asset that you have not sold. And yes, the profits made from your crypto trades qualify as capital gains, and must be included in your taxes!
Capital losses occur when a capital asset, like stock or real estate, decreases in value after you buy it. The loss isn't realized until you sell the asset, and the capital loss is the difference between your original purchase price and what you later sold it for. For example, if you bought one bitcoin at $9,000 and sold it for $7,000, your capital loss would be $2,000. The good news is, you can report your capital losses on your personal income taxes as an offset to your income, reducing your taxable income (subject to applicable limits). In some cases, net losses can be moved to the next taxable year to reduce income or to offset any capital gains realized that year. You should consult a tax professional for more information on capital gains and losses.
Now that you have a solid foundational understanding of personal finance jargon, are you ready to dip your toe into investing in and trading bitcoin? We’re counting down until we can convert your digital assets into a crypto investment with the Bakkt App.
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The contents of this post are provided for informational purposes only and do not constitute, and should not be construed as, investment advice or a recommendation to buy, sell, or otherwise transact in any investment, including any of the products mentioned herein, or an invitation, offer or solicitation to engage in any investment activity. This information is provided solely on the basis that you will make your own investment decisions, and Bakkt does not take account of any investor’s investment objectives, particular needs, or financial situation. It is strongly recommended that you seek professional investment advice before making any investment decision.