Financial advisors don't talk so much about "story stocks" or "megadeals" anymore. In the post-crash era, the financial clichés they use are more often about rebuilding trust than creating sizzle.
But some clients or prospects say the new jargon can be as big of a turnoff as the whispered deals and hot tips of the past. The softer sell is a tactic aimed at the same outcome: build confidence by sounding smart and certain about what you are selling. Understanding the meaning of the jargon can help you avoid investing mistakes.
To be sure, the new language is often derived from well-founded investing principles like diversifying investments and avoiding risk. Still, people should never be satisfied by something that just sounds right. "If you don't understand the investment, you should do what Warren Buffett does," says Anthony Webb, senior research economist at the Center for Retirement Research at Boston College. "You should run in the other direction."
Here are 10 terms financial advisors often use, and sometimes overuse, and that investors can find confusing or just plain annoying.
Alternatives. This is catchall buzzword that covers everything from commodity funds to real estate trusts. In simplest terms, it refers to investments that are not everyday stocks or bonds, and it's a category that's appealing to people shell-shocked by the financial turmoil of the past five years. Commodities have been especially popular in the post-crash era as investors worried that easy money would boost inflation. But that alternative burned big holes in many portfolios as commodities plunged this year.
Diversification. Diversifying your investments is a sound, time-tested idea everyone should follow. But it shouldn't be complicated. "If an advisor can't explain it in a simple sentence about not putting all your eggs in one basket, there is something wrong," Webb says. Rita DiMatteo, a retired New York garment industry executive, says she took up her fund company's offer of a free financial plan from a local branch. She left the office with a two-page computer printout with 15 recommended funds her advisor said she needed to be "fully diversified." Despite her years of handling business deals, she says, "That was way too much diversity for me." The American Association of Individual Investors figures eight funds should be sufficient for most people, and that includes a money market fund. Nearly all fund companies also sell target-date funds that provide a mix of diversified assets in a single fund.
Duration. With interest rates rising, experts say to put money in "low-duration bond funds." It's a good way to limit losses as bond prices rise. But many advisors say duration tells you the interest-rate "sensitivity" of a fund. It's doesn't, really. Duration is a simple measure of how long it takes a bond to reach maturity. Morningstar's investment guide says it should be "straightforward." It explains: "A fund with duration of 10 years is expected to be twice as volatile as a fund with a five-year." It's simple math. And the equation never changes. Fixed-income investments always lose value when rates rise, even those with low duration.
Momentum. This trading term has become a mainstream buzzword over time, and seemingly more meaningless. Stock prices sometimes seem to possess "momentum" in one direction or the other, and there is no doubt traders use such trends to guide short-term buy and sell decisions. But applying this physics term to the decidedly unscientific world of markets and economics is a stretch. Science only shows that you can measure the speed and velocity of an object and calculate its next movement. But stocks are not objects in space. When a broker uses the term, ask how that one works.
Hidden fees. Some advisors have moved to charging fees instead of commissions. Fees are usually a set percentage of funds managed for clients, usually about 1 percent a year. It's led to a war of words over whose fee structure is best. Don't get caught in the crossfire. It's complicated. Big fund companies make a lot of money on the cash and investments they manage, just as banks have always done. Each company differs on how it shares those trading profits. What matters is the net amount you pay, which is a figure companies must disclose. Investment advisors and firms are required to disclose fees and commission arrangements to regulators, but sometimes they give the information selectively to prospective clients. New Jersey English teacher Laurie Albanese says when she shopped for a financial advisor, "They all said their fees were lower and that their competitors charged hidden fees. It got so annoying. I didn't believe any of them."
Compound rates. The simple economic truth is that an interest-rate investment that reinvests the yield, including most money market funds and certificates of deposit, grows at a mathematically faster rate. But it doesn't apply to other kinds of investments. Stock prices go up and down. They don't get any direct benefit from compounding interest. But that doesn't stop financial advisors from making the claim.
Headwinds. When investments are under pressure, this is a favored buzzword. It's supposed to work like the calm voice of the airline pilot saying, "We're going to be experiencing a bit of turbulence for a few minutes up ahead here." Financial advisors will also borrow pilot-speak for the opposite effect: Tailwinds means it's a good investment. But wind factors are a lot easier to measure than economic factors. So be wary when they are used to explain investments.
Risk. To be sure, everyone wants to make money and no one wants to lose it. Regulators have clamped down on investment managers' unproven guarantees of positive returns, but have said less about the risk-related claims, which can also be misleading. "I manage my own risk," Albanese says. "If I don't understand it, I don't buy it."
Large cap (and mid cap, and small cap). An explosion of new funds has created a Babel of names. But fund companies each use their own definitions in naming fund categories. It's confusing for investors, and funds don't always fit into neat boxes. For example, small-cap funds that hold fast-growing stocks can really be a mix of small- and mid-cap stocks. The only way to know what you are buying is to read the fund prospectus and scour a fund's holdings. But most people reading them "won't have a clue what they are all about," Webb says. If you don't feel like mastering that essential homework, you're probably better off sticking to broad index funds, he says.
[Read: The New Science of Stock Charts.]
Alpha. It's what everyone wants, in a sense, and it's probably the ultimate investing buzzword. It's defined as the measure of how much your investment outperforms the averages, also known as benchmarks (it can also measure underperformance, but the buzzword usually refers to positive returns). Beta is a similar term. It measures how volatile a stock is versus the average. They are both based on past performance, so they only tell you so much.
There was serious buzzkill for "alpha" two years ago when savvy Goldman Sachs posted big losses and shut its highly touted Global Alpha hedge fund, which once had $16 billion in assets. Still, new "alpha" funds have been launched, and advisors continue to use alpha as a term of endearment. It shows the danger of buying into buzzwords: They might have a long shelf life, but it doesn't mean they don't eventually go stale.