10 investing terms every college saver should understand

http://www.savingforcollege.com/articles/10-investing-terms-every-college-saver-should-understand

In honor of Financial Literacy Month, let’s make saving for college a little less painless. Here’s a quick rundown of ten often-misunderstood investing terms that you’re likely to come across when choosing a saving strategy (in alphabetical order):

• Age-based portfolios

  As your child gets closer to starting college, it’s a good idea to shift the money in your 529 account toward more conservative investments. Fortunately, since many of us tend to be forgetful most 529 plans offer age-based portfolio options, which automatically adjust allocations based on the age of the beneficiary.

• Asset allocation

  Asset allocation is a type of investment strategy that aims to balance risk and reward by dividing up money in a portfolio between asset classes such as stocks, bonds and cash. The percentages of each asset class are determined by the investor’s goals, risk tolerance and time horizon.

• Compound interest

  Compound interest is one of the best parts about investing. The investment return of a 529 account represents the rate at which the money will grow annually. Compounding means that the interest is calculated on the initial money you put into the account and also the accumulated interest from previous years (Think of it as “interest on interest”).

• Diversification

  Diversifying your portfolio is a way to minimize risk by spreading your money across different types of investments. The way it works is that if one type of investment is doing poorly, it will be offset by another type that is doing well. A diversified 529 plan helps protect your investment under all market conditions.

• ETFs

  An exchange-traded fund (ETF) is a security that tracks an index, commodity or basket of assets and is traded like a stock on an exchange. ETFs are similar to mutual funds, but have lower expenses and better tax treatment. In recent years ETFs have been introduced into 529 plans as a way to lower plan costs and help boost performance.

• Equities

  When researching your 529 plan investment options, you may see that a portion of the fund is invested in equities. This simply refers to the portion that invests in stocks, or an ownership of interest in a company. Equities are considered a riskier asset class than bonds because they do not guarantee interest or returns. As you near your first tuition payment, the equity portion of your 529 account should be reduced.

• Fees

  You guessed it – lower is better. But what do 529 plan fees pay for? Typical 529 plan costs include asset-based fees like program manager fees, underlying fund expenses, and state fees as well as an annual account maintenance fee for non-residents. If you purchase your plan through a financial advisor you may also be charged commissions or a flat fee based on a percentage of the assets invested.

• Mutual funds

  Mutual funds are one of the most common types of investments that make up a 529 plan. They are simply are a collection of stocks, bonds or other assets that are sold in shares. While some people choose to save by directly investing in mutual funds, they miss out on the tax benefits offered by a 529 plan.

• Risk tolerance

  In the finance world, the more risk you are willing to take on, the greater your potential return will be. 529 plans offer many different investment options with varying degrees of risk. Your risk tolerance is based on of factors including your income, savings habits, years until college, age and willingness to accept a loss.

• Time horizon

  Your time horizon represents the length of time over which the investment is held. For college savers, this number is determined by the number of years until your last tuition payment. The younger the child is, the longer the time horizon.

What investor words do you find confusing or intimidating?