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What’s what: A simple guide to key terms about investing

Published October 3rd, 2022

Do all those financial terms you encounter every day make your head spin? And even though you have a vague idea what each of these individual terms means, you’re not entirely sure? If this sounds familiar, then check out our glossary, which provides explanations for many of the terms you will encounter in the world of finance.

BörseWhat are shares?

When you buy a share, you acquire a tiny part of a stock company. The more shares a shareholder holds, the more of the company they own. For instance, companies can raise capital for new investments by selling shares on the stock market. At the same time, people who want to invest their money profitably can buy shares as an investment or speculation.

What exactly is the stock exchange?

The stock exchange (or stock market) is essentially a marketplace where people come together to buy and sell securities. The prices are determined by supply and demand. Today, however, virtually all transactions are handled electronically. Shares and other securities rarely exist in physical form anymore. To ensure fair and transparent trading on the stock exchange, there are precise rules and institutions monitoring transactions there.

DAX: Definition and function

The DAX is Germany’s leading share index. Its name is an abbreviation of Deutscher Aktienindex (German share index). The stock market barometer DAX currently summarizes the shares of the 40 largest and most successful German stock companies (in terms of stock exchange turnover and market capitalization). This gives a good overview of the state of the German economy at any given time. Internationally renowned companies such as Daimler, Deutsche Telekom are listed in the DAX.

What are securities?

A ‘security’ is a collective term for shares, bonds, funds, ETFs, certificates and warrants. They indicate a participation in a company, an obligation or right in written form. For example, shares – a very common security – certify the rights that shareholders have vis-à-vis the stock company. Securities can change hands and are traded on the stock exchange.

What exactly are bonds?

Bonds are fixed-income securities with a fixed term, which are usually traded on the stock exchange. The difference between bonds and other securities such as shares is that bonds specify exactly when the amount invested is to be repaid and how much interest will be paid regularly over a predetermined time. On average, price fluctuations for bonds are lower than for shares. Bonds that are traded on the stock exchange can be sold by investors.

What are funds and what different types exist?

One way to envisage an investment fund is as a pot in which many investors place their money. A distinction is made between actively and passively managed funds. With actively management funds, fund managers select several shares, bonds, real estate properties or other securities, depending on their strategy. They then invest the money with the aim of yielding the best possible return for investors. By contrast, passively managed investment funds merely track an index (in simple terms, an index shows a market situation and development in condensed form). In other words, no active selection is made. As there is less administration involved, passively managed investment funds incur lower costs.

By investing in such funds – i.e. not just in one, but several shares – you have a more diverse investment base and your risk is lower. Accordingly, the major advantage of funds is that the risk is spread more effectively.

Index funds: Definition and explanation

Index funds are a kind of investment fund. They aim to track a specific stock market index (e.g. the DAX) as accurately as possible. This means that companies buy securities in volumes that correspond to their exact share of the index. For example, a DAX index fund would acquire all DAX-listed shares in the same weighting as in the index. Index funds are managed passively and investors can participate in an index’s performance. As with traditional investment funds, investors’ capital is collected and managed by an investment company. The management fee for an index fund, which is passively managed, is generally lower than that of an actively managed investment fund. Index funds are not traded on stock exchanges, but rather via principal banks or fund providers.

Exchange Traded Funds (ETFs) explained

ETFs have the same aim as index funds, i.e. to track an index as closely as possible while keeping costs to a minimum. They are also managed passively. The terms ETF and index fund are often incorrectly used as synonyms because they are similar in many respects. However, the main difference between the two products is in their stock exchange listing: ETFs, which are traded on stock exchanges, can be bought and sold continually during trading times. As ETFs are classified as ‘special assets’, the money invested is protected in the event that the provider should become insolvent.

What exactly is fund management?

Professional fund managers actively manage investment funds. In addition to administrative tasks, fund management focuses primarily on selecting securities for the fund. Fund managers constantly analyze the capital markets and global affairs and need to understand the complexities of the market to be able to anticipate future developments as early as possible. Digital fund management is also a reality today. Here, artificial intelligence helps human fund managers by analyzing huge amounts of data and predicting probabilities based on earlier developments.

Accumulation funds: Importance and comparison with distribution funds

Investment funds can be accumulation or distribution funds. With distribution funds, your dividends from securities are paid out in the form of cash or shares. By contrast, accumulation investment funds automatically reinvest your returns directly – adding to the money that continues to work for you and increasing the total fund volume. As with dividend distribution, investment funds usually reinvest returns once a year.

What is a securities account? 

Everyone who deals in shares or who wants to buy fund units needs a securities account. This is the place where your securities are kept; it is managed digitally via a customer account at your custodian bank. You can open a securities account at your principal bank, at an internet direct bank or with a broker directly. It is an account through which investors can handle securities transactions (i.e. purchase, sale, transfer) and securities such as shares, ETFs or bonds. Here, you can constantly keep track of the performance and current value of your investments, e.g. shares or funds.

What is a broker? 

Brokers place securities orders on behalf of their customers. Private individuals are not permitted to trade securities directly. Brokers work as an intermediary between investors on the one hand and stock exchanges and trading partners on the other. While traditional brokers place their clients’ orders, an increasing number of online brokers and neo-brokers merely provide the technology for trading in securities. This allows investors to place their own orders and to trade without any time or place restrictions. The costs of the various brokers – known as ‘brokerage’ or ‘courtage’ – vary widely. This means that it is always a good idea to compare the different available offers.

What does diversification mean for your portfolio?

Diversification is important for minimizing the risk of your investment. It means that the capital is invested in very different regions and investment types, ideally ones that are barely connected with one another. A diversified portfolio consists of at least two different individual investments, ideally more. To maximize the impact of diversification, the capital in your portfolio should be spread among as many different individual investments as possible. This reduces the exposure to loss in a portfolio (a collection of different investments) without having to forgo return opportunities. The opposite of diversification would be to invest in just one share. In this case, the invested amount would be entirely dependent on the performance of this specific share, resulting in a high exposure to loss.

Dividends: Definition and explanation

Dividends are part of a stock company’s profit that it pays out to its shareholders. The size of the dividend is determined by the company’s annual general meeting. Most companies pay a dividend once a year. Others distribute part of their profits throughout the year – for example paying out a dividend every quarter. As well as cash dividends, there are stock dividends which are distributed in the form of shares. This means that, instead of having the dividends paid into their accounts in cash, shareholders have additional shares in their securities account. If the stock company doesn’t make a profit, no dividend is paid.

What does ‘return’ mean?

The return expresses the annual profit in relation to the invested capital and, ideally, deducts all incurred costs (net return). It is given as a percentage. This allows very different investments like shares, bonds or ETFs to be compared with one another. The return on an investment can be determined with the aid of a simple basic formula: Profit x 100 / invested capital = return as a percentage. For example, if you invest €5,000 and generate profit of €500, your return will be 10%.

Were we able to shed a little light on the darkness of financial terms? These were the first terms from the stock market world - there will be more soon!

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