Financial Terms 

An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit. Assets are reported on a company's balance sheet and are bought or created to increase a firm's value or benefit the firm's operations. An asset can be thought of as something that, in the future, can generate cash flow, reduce expenses, or improve sales, regardless of whether it's manufacturing equipment or a patent. 

KEY TAKEAWAYS

• An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.

• Assets are reported on a company's balance sheet and are bought or created to increase a firm's value or benefit the firm's operations.

• An asset can be thought of as something that, in the future, can generate cash flow, reduce expenses or improve sales, regardless of whether it's manufacturing equipment or a patent.

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Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance, and investment horizon. The three main asset classes - equities, fixed-income, and cash and equivalents - have different levels of risk and return, so each will behave differently over time.

There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, the selection of individual securities is secondary to the way that assets are allocated in stocks, bonds, and cash and equivalents, which will be the principal determinants of your investment results.

Investors may use different asset allocations for different objectives. Someone who is saving for a new car in the next year, for example, might invest her car savings fund in a very conservative mix of cash, certificates of deposit (CDs) and short-term bonds. Another individual saving for retirement that may be decades away typically invests the majority of his individual retirement account (IRA) in stocks, since he has a lot of time to ride out the market's short-term fluctuations. Risk tolerance plays a key factor as well. Someone not comfortable investing in stocks may put her money in a more conservative allocation despite a long time horizon.

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An adjustable-rate mortgage (ARM) is a type of mortgage in which the interest rate applied on the outstanding balance varies throughout the life of the loan. With an adjustable-rate mortgage, the initial interest rate is fixed for a period of time. After this initial period of time, the interest rate resets periodically, at yearly or even monthly intervals. ARMs are also called variable-rate mortgages or floating mortgages. The interest rate for ARMs is reset based on a benchmark or index, plus an additional spread called an ARM margin.

KEY TAKEAWAYS

• An adjustable-rate mortgage (ARM) is a type of mortgage in which the interest rate applied on the outstanding balance varies throughout the life of the loan.

• With adjustable-rate mortgage caps, there are limits set on how much the interest rates and/or payments can rise per year or over the lifetime of the loan.

• An ARM can be a smart financial choice for home buyers that are planning to pay off the loan in full within a specific amount of time or those who will not be financially hurt when the rate adjusts.

Amortization is an accounting technique used to periodically lower the book value of a loan or intangible asset over a set period of time. In relation to a loan, amortization focuses on spreading out loan payments over time. When applied to an asset, amortization is similar to depreciation.

KEY TAKEAWAYS

• Amortization typically refers to the process of writing down the value of either a loan or an intangible asset.

• Amortization schedules are used by lenders, such as financial institutions, to present a loan repayment schedule based on a specific maturity date.

• Intangibles amortized (expensed) over time help tie the cost of the asset to the revenues generated by the asset in accordance with the matching principle of generally accepted accounting principles 

Arrears is a financial and legal term that refers to the status of payments in relation to their due dates. The word is most commonly used to describe an obligation or liability that has not received payment by its due date. Therefore, the term arrears applies to an overdue payment. If one or more payments have been missed where regular payments are contractually required, such as mortgage or rent payments and utility or telephone bills, the account is in arrears. Payments that are made at the end of a period are also said to be in arrears. In this case, payment is expected to be made after a service is provided or completed—not before.

Arrears, or arrearage in certain cases, can be used to describe payments in many different parts of the legal and financial industries, including the banking and credit industries, and the investment world. The term can have many different applications depending on the industry and context in which it is used.

KEY TAKEAWAYS

• Arrears is a financial and legal term that most commonly describes an obligation or liability that has not received payment by its due date.

• Being in arrears may not have a negative connotation, as in cases when payment is expected after a service is provided or completed, not before.

• Annuities are called annuities in arrears (or ordinary annuities) when payments are due at the end of the period.

• Arrearage applies to dividends that are due but have not been paid to preferred shareholders. 

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A balance sheet is a financial statement that reports a company's assets, liabilities and shareholders' equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure. It is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders.

The balance sheet is used alongside other important financial statements such as the income statement and statement of cash flows in conducting fundamental analysis or calculating financial ratios.

KEY TAKEAWAYS

• A balance sheet is a financial statement that reports a company's assets, liabilities and shareholders' equity.

• The balance sheet is one of the three (income statement and statement of cash flows being the other two) core financial statements used to evaluate a business.

• The balance sheet is a snapshot, representing the state of a company's finances (what it owns and owes) as of the date of publication.

• Fundamental analysts use balance sheets, in conjunction with other financial statements, to calculate financial ratios.

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A bearer bond is a fixed-income security that is owned by the holder, or bearer, rather than by a registered owner. The coupons for interest payments are physically attached to the security. The bondholder is required to submit the coupons to a bank for payment and then redeem the physical certificate when the bond reaches the maturity date.

As with registered bonds, bearer bonds are negotiable instruments with a stated maturity date and a coupon interest rate.

Bearer bonds are virtually extinct in the U.S. and some other countries as the lack of registration made them ideal for use in money laundering, tax evasion, and any number of other under-handed transactions. They also are vulnerable to theft.

KEY TAKEAWAYS

• The bearer bond is a physical certificate with coupons attached that are used to redeem the interest payments.

• As their ownership is not registered, the owner of a bearer bond is the person in possession of it.

• Bearer bonds are as vulnerable as cash to theft or loss.

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A bear market is when a market experiences prolonged price declines. It typically describes a condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment. Bear markets are often associated with declines in an overall market or index like the S&P 500, but individual securities or commodities can also be considered to be in a bear market if they experience a decline of 20% or more over a sustained period of time—typically two months or more. Bear markets also may accompany general economic downturns such as a recession.

Bear markets may be contrasted with upward-trending bull markets.

KEY TAKEAWAYS

• Bear markets occur when prices in a market decline by more than 20%, often accompanied by negative investor sentiment and declining economic prospects.

• Bear markets can be cyclical or longer-term. The former lasts for several weeks or a couple of months and the latter can last for several years or even decades.

• Short selling, put options, and inverse ETFs are some of the ways in which investors can make money during a bear market as prices fall.

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A beneficiary is any person who gains an advantage and/or profits from something. In the financial world, a beneficiary typically refers to someone eligible to receive distributions from a trust, will, or life insurance policy. Beneficiaries are either named specifically in these documents or have met the stipulations that make them eligible for whatever distribution is specified.

KEY TAKEAWAYS

• A beneficiary is an individual that receives a benefit, which is typically a monetary advantage.

• The distributions typically come with tax consequences and sometimes various stipulations.

• If the distribution is in the form of a retirement account, there are many factors to consider, such as time frame and distribution amounts, depending on the type of account.

• The owner of a life insurance policy can change the beneficiary at any time, though doing so typically requires completing the necessary paperwork with the life insurance company.

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A blue chip is a nationally recognized, well-established, and financially sound company. Blue chips generally sell high-quality, widely accepted products and services. Blue-chip companies are known to weather downturns and operate profitably in the face of adverse economic conditions, which helps to contribute to their long record of stable and reliable growth. 

KEY TAKEAWAYS

• A blue chip refers to an established, stable, and well-recognized corporation.

• Blue-chip stocks are seen as relatively safer investments, with a proven track record of success and stable growth.

• Blue-chip stocks are still nonetheless subject to volatility and failure, such as with the collapse of Lehman Brothers or the impact of the financial crisis on General Motors.

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A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). A bond could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments. Bonds are used by companies, municipalities, states, and sovereign governments to finance projects and operations. Owners of bonds are debtholders, or creditors, of the issuer. Bond details include the end date when the principal of the loan is due to be paid to the bond owner and usually includes the terms for variable or fixed interest payments made by the borrower.

KEY TAKEAWAYS

• Bonds are units of corporate debt issued by companies and securitized as tradeable assets.

• A bond is referred to as a fixed income instrument since bonds traditionally paid a fixed interest rate (coupon) to debtholders. Variable or floating interest rates are also now quite common.

• Bond prices are inversely correlated with interest rates: when rates go up, bond prices fall and vice-versa.

• Bonds have maturity dates at which point the principal amount must be paid back in full or risk default.

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Book value is equal to the cost of carrying an asset on a company's balance sheet, and firms calculate it netting the asset against its accumulated depreciation. As a result, book value can also be thought of as the net asset value (NAV) of a company, calculated as its total assets minus intangible assets (patents, goodwill) and liabilities. For the initial outlay of an investment, book value may be net or gross of expenses such as trading costs, sales taxes, service charges, and so on.

The formula for calculating book value per share is the total common stockholders' equity less the preferred stock, divided by the number of common shares of the company. Book value may also be known as "net book value" and, in the U.K., "net asset value of a firm."

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Capital gain is an increase in a capital asset's value. It is considered to be realizedwhen you sell the asset. A capital gain may be short-term (one year or less) or long-term (more than one year) and must be claimed on income taxes.capital asset.

While capital gains are generally associated with stocks and funds due to their inherent price volatility, a capital gain can occur on any security that is sold for a price higher than the purchase price that was paid for it. Realized capital gains and losses occur when an asset is sold, which triggers a taxable event. Unrealized gains and losses, sometimes referred to as paper gains and losses, reflect an increase or decrease in an investment's value but have not yet triggered a taxable event.1

A capital loss is incurred when there is a decrease in the capital asset value compared to an asset's purchase price.

Tax-conscious mutual fund investors should determine a mutual fund's unrealized accumulated capital gains, which are expressed as a percentage of its net assets, before investing in a fund with a significant unrealized capital gain component. This circumstance is referred to as a fund's capital gains exposure. When distributed by a fund, capital gains are a taxable obligation for the fund's investors.

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A capital loss is the loss incurred when a capital asset, such as an investment or real estate, decreases in value. This loss is not realized until the asset is sold for a price that is lower than the original purchase price.

KEY TAKEAWAYS

• A capital loss is a loss incurred when a capital asset is sold for less than the price it was purchased for.

• In regards to taxes, capital gains can be offset by capital losses, reducing taxable income by the amount of the capital loss.

• Capital gains and capital losses are reported on Form 8949.

• The Internal Revenue Service (IRS) puts measures around wash sales to prevent investors from taking advantage of the tax benefits of capital losses.

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Compound interest (or compounding interest) is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. Thought to have originated in 17th century Italy, compound interest can be thought of as "interest on interest," and will make a sum grow at a faster rate than simple interest, which is calculated only on the principal amount.

KEY TAKEAWAYS

• Compound interest (or compounding interest) is interest calculated on the initial principal, which also includes all of the accumulated interest from previous periods on a deposit or loan.

• Compound interest is calculated by multiplying the initial principal amount by one plus the annual interest rate raised to the number of compound periods minus one.

• Interest can be compounded on any given frequency schedule, from continuous to daily to annually.

• When calculating compound interest, the number of compounding periods makes a significant difference.

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Default is the failure to repay a debt, including interest or principal, on a loan or security. A default can occur when a borrower is unable to make timely payments, misses payments, or avoids or stops making payments. Individuals, businesses, and even countries can default if they cannot keep up their debt obligations. Default risks are often calculated well in advance by creditors.

KEY TAKEAWAYS

• A default occurs when a borrower is unable to make timely payments, misses payments, or avoids or stops making payments on interest or principal owed.

• Defaults can occur on secured debt, such as a mortgage loan secured by a house, or unsecured debt such as credit cards or a student loan.

• Defaults can have consequences, such as lowering credit scores, reducing the chance of obtaining credit in the future, and raising interest rates on existing debt as well as any new obligations.

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A dependent is a qualifying person who entitles a taxpayer to claim dependent-related tax benefits on a tax return. Tests in the Internal Revenue Code (IRC) establish a person's eligibility to be a taxpayer's dependent for dependency claims.

A dependent may be a qualifying child or a qualifying relative with status as determined by Internal Revenue Code (IRC) tests. To qualify their dependent status, the individual must meet specific requirements. Qualifications include passing the dependent taxpayer test of not being the dependent of a taxpayer who is also dependent, being either a qualifying child or qualifying relative, or passing the joint return test, where they cannot have filed specific joint returns. Furthermore, the dependent needs be a U.S. citizen or a North American resident passing the citizen/resident test.2 

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Depreciation is an accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy. Depreciation represents how much of an asset's value has been used up. Depreciating assets helps companies earn revenue from an asset while expensing a portion of its cost each year the asset is in use. If not taken into account, it can greatly affect profits.

Businesses can depreciate long-term assets for both tax and accounting purposes. For example, companies can take a tax deduction for the cost of the asset, meaning it reduces taxable income. However, the Internal Revenue Service (IRS) states that when depreciating assets, companies must spread the cost out over time. The IRS also has rules for when companies can take a deduction.1

KEY TAKEAWAYS

• Per the matching principle of accounting, depreciation ties the cost of using a tangible asset with the benefit gained over its useful life.

• There are many types of depreciation, including straight-line and various forms of accelerated depreciation.

• Accumulated depreciation refers to the sum of all depreciation recorded on an asset to a specific date.

• The carrying value of an asset on the balance sheet is its historical cost minus all accumulated depreciation.

• The carrying value of an asset after all depreciation has been taken is referred to as its salvage value.

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A dividend is the distribution of some of a company's earnings to a class of its shareholders, as determined by the company's board of directors. Common shareholders of dividend-paying companies are typically eligible as long as they own the stock before the ex-dividend date.1 Dividends may be paid out as cash or in the form of additional stock.

KEY TAKEAWAYS

• A dividend is the distribution of some of a company's earnings to a class of its shareholders, as determined by the company's board of directors.

• Dividends are payments made by publicly-listed companies as a reward to investors for putting their money into the venture.

• Announcements of dividend payouts are generally accompanied by a proportional increase or decrease in a company's stock price.

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Dollar-cost averaging (DCA) is an investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset in an effort to reduce the impact of volatility on the overall purchase. The purchases occur regardless of the asset's price and at regular intervals. In effect, this strategy removes much of the detailed work of attempting to time the market in order to make purchases of equities at the best prices. Dollar-cost averaging is also known as the constant dollar plan. 

Dollar-cost averaging is a tool an investor can use to build savings and wealth over a long period. It is also a way for an investor to neutralize short-term volatility in the broader equity market. A perfect example of dollar cost averaging is its use in 401(k) plans, in which regular purchases are made regardless of the price of any given equity within the account.

In a 401(k) plan, an employee can select a pre-determined amount of their salary that they wish to invest in a menu of mutual or index funds. When an employee receives their pay, the amount the employee has chosen to contribute to the 401(k) is invested in their investment choices.

Dollar-cost averaging can also be used outside of 401(k) plans, such as mutual or index fund accounts. Although it's one of the more basic techniques, dollar-cost averaging is still one of the best strategies for beginning investors looking to trade ETFs.

Additionally, many dividend reinvestment plans allow investors to dollar-cost average by making contributions regularly.

KEY TAKEAWAYS

• Dollar-cost averaging refers to the practice of dividing an investment of an equity up into multiple smaller investments of equal amounts, spaced out over regular intervals.

• The goal of dollar-cost averaging is to reduce the overall impact of volatility on the price of the target asset; as the price will likely vary each time one of the periodic investments is made, the investment is not as highly subject to volatility.

• Dollar-cost averaging aims to avoid making the mistake of making one lump-sum investment that is poorly timed with regard to asset pricing.

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Escrow is a legal concept describing a financial instrument whereby an asset or escrow money is held by a third party on behalf of two other parties that are in the process of completing a transaction. Escrow accounts might include escrow fees managed by agents who hold the funds or assets until receiving appropriate instructions or until the fulfillment of predetermined contractual obligations. Money, securities, funds, and other assets can all be held in escrow. A similar process would be a fully funded documentary letter of credit. It is often suggested as a replacement for a certified or cashiers check.

KEY TAKEAWAYS

• Escrow is the use of a third party, which holds an asset or funds before they are transferred from one party to another.

• The third-party holds the funds until both parties have fulfilled their contractual requirements.

• Escrow is associated with real estate transactions, but it can apply to any situation where funds will pass from one party to another.

The term "fixed-rate mortgage" refers to a home loan that has a fixed interest rate for the entire term of the loan. This means the mortgage carries a constant interest rate from beginning to end. Terms can range anywhere between 10 and 30 years for fixed-rate mortgages, which are popular products for consumers who want to know how much they'll pay every month.

KEY TAKEAWAYS

• A fixed-rate mortgage is a home loan with a fixed interest rate for the entire term of the loan.

• Once locked-in, the interest rate does not fluctuate with market conditions.

• Borrowers who want predictability and those who tend to hold property for the long term tend to prefer fixed-rate mortgages.

• Most fixed-rate mortgages are amortized loans.

• In contrast to fixed-rate mortgages, there exist adjustable-rate mortgages, whose interest rates change over the course of the loan.

The Federal Reserve System (FRS), often just called "the Fed," is the central bank of the United States and arguably the most powerful financial institution in the world. It was founded to provide the country with a safe, flexible, and stable monetary and financial system. The Fed is composed of 12 regional Federal Reserve Banks that are each responsible for a specific geographic area of the U.S.

KEY TAKEAWAYS

• The Federal Reserve System is the central bank of the United States.

• The FRS provides the country with a safe, flexible, and stable monetary and financial system.

• Known simply as the Fed, it is composed of 12 regional Federal Reserve Banks that are each responsible for a specific geographic area of the U.S.

• The Fed's main duties include conducting national monetary policy, supervising and regulating banks, maintaining financial stability, and providing banking services.

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A fiduciary is a person or organization that acts on behalf of another person or persons, putting their clients' interest ahead of their own, with a duty to preserve good faith and trust. Being a fiduciary thus requires being bound both legally and ethically to act in the other's best interests.

A fiduciary may be responsible for the general well-being of another (e.g. a child's legal guardian), but often the task involves finances; managing the assets of another person, or of a group of people, for example. Money managers, financial advisors, bankers, insurance agents, accountants, executors, board members, and corporate officers all have fiduciary responsibility. 

KEY TAKEAWAYS

• A fiduciary is legally bound to put their client's best interests ahead of their own.

• Fiduciary duties appear in a range of business relationships, including a trustee and a beneficiary, corporate board members and shareholders, and executors and legatees.

• An investment fiduciary is anyone with legal responsibility for managing somebody else's money, such as a member of the investment committee of a charity.

• Registered investment advisors have a fiduciary duty to clients; broker-dealers just have to meet the less-stringent suitability standard, which doesn't require putting the client's interests ahead of their own.

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A flexible spending account (FSA) is a type of savings account that provides the account holder with specific tax advantages. An FSA, sometimes called a “flexible spending arrangement,” is set up by an employer for an employee. The account allows you to contribute a portion of your regular earnings to pay for qualified expenses related to medical and dental costs.

Another type of FSA is a dependent-care flexible spending account, which is used to pay for childcare expenses for children age 12 and under and can also be used to pay for the care of qualifying adults, including a spouse, who cannot care for themselves and meet specific Internal Revenue Service (IRS) guidelines. 1 A dependent-care FSA has different maximum contribution rules than a medical-related flexible spending account.

KEY TAKEAWAYS

• An FSA is a type of savings account that allows employees to contribute a portion of their regular earnings to pay for qualified expenses.

• Funds contributed to the account are deducted from your earnings before they are made subject to payroll taxes.

• The money in an FSA must be used by the end of the plan year, but employers can offer a grace period of up to two-and-a-half months, through March 15 of the following year.

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Financial Independence, Retire Early (FIRE) is a movement dedicated to a program of extreme savings and investment that allows proponents to retire far earlier than traditional budgets and retirement plans would allow. By dedicating up to 70% of income to savings, followers of the FIRE movement may eventually be able to quit their jobs and live solely off small withdrawals from their portfolios decades before the conventional retirement age of 65.1

Of course, FIRE isn't a surefire plan, and extremely high rates of saving at the expense of current quality of life and lifestyle should be considered.

KEY TAKEAWAYS

• Financial Independence, Retire Early (FIRE) is a financial movement defined by frugality and extreme savings and investment.

• By saving up to 70% of annual income, FIRE proponents aim to retire early and live off small withdrawals from accumulated funds.

• The FIRE movement was born from a 1992 book "Your Money or Your Life," written by two financial gurus.

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An index fund is a type of mutual fund or exchange-traded fund (ETF) with a portfolio constructed to match or track the components of a financial market index, such as the Standard & Poor's 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses, and low portfolio turnover. These funds follow their benchmark index regardless of the state of the markets. 

Index funds are generally considered ideal core portfolio holdings for retirement accounts, such as individual retirement accounts (IRAs) and 401(k) accounts. Legendary investor Warren Buffett has recommended index funds as a haven for savings for the later years of life. Rather than picking out individual stocks for investment, he has said, it makes more sense for the average investor to buy all of the S&P 500 companies at the low cost an index fund offers.

KEY TAKEAWAYS

• An index fund is a portfolio of stocks or bonds designed to mimic the composition and performance of a financial market index.

• Index funds have lower expenses and fees than actively managed funds.

• Index funds follow a passive investment strategy.

• Index funds seek to match the risk and return of the market, on the theory that in the long-term, the market will outperform any single investment.

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Passive management is a style of management associated with mutual and exchange-traded funds (ETF) where a fund's portfolio mirrors a market index. Passive management is the opposite of active management in which a fund's manager(s) attempt to beat the market with various investing strategies and buying/selling decisions of a portfolio's securities. Passive management is also referred to as "passive strategy," "passive investing," or " index investing."

KEY TAKEAWAYS

• Passive management is a reference to index funds and exchange-traded funds, that mirror an established index, such as the S&P 500.

• Passive management is the opposite of active management, in which a manager selects stocks and other securities to include in a portfolio.

• Passively-managed funds tend to charge lower fees to investors than funds that are actively managed.

• The Efficient Market Hypothesis (EMH) demonstrates that no active manager can beat the market for long, as their success is only a matter of chance; longer-term, passive management delivers better returns.

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The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple.

P/E ratios are used by investors and analysts to determine the relative value of a company's shares in an apples-to-apples comparison. It can also be used to compare a company against its own historical record or to compare aggregate markets against one another or over time.

KEY TAKEAWAYS

• The price-earnings ratio (P/E ratio) relates a company's share price to its earnings per share.

• A high P/E ratio could mean that a company's stock is over-valued, or else that investors are expecting high growth rates in the future.

• Companies that have no earnings or that are losing money do not have a P/E ratio since there is nothing to put in the denominator.

• Two kinds of P/E ratios - forward and trailing P/E - are used in practice.

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Analysts and investors review a company's P/E ratio when they determine if the share price accurately represents the projected earnings per share. The formula and calculation used for this process follow.

\text{P/E Ratio} = \frac{\text{Market value per share}}{\text{Earnings per share}}

P/E Ratio=

Earnings per share

Market value per share

​



To determine the P/E value, one simply must divide the current stock price by the earnings per share (EPS). The current stock price (P) can be gleaned by plugging a stock’s ticker symbol into any finance website, and although this concrete value reflects what investors must currently pay for a stock, the EPS is a slightly more nebulous figure.

EPS comes in two main varieties. The first is a metric listed in the fundamentals section of most finance sites; with the notation "P/E (TTM)," where “TTM” is a Wall Street acronym for “trailing 12 months.” This number signals the company's performance over the past 12 months. The second type of EPS is found in a company's earnings release, which often provides EPS guidance. This is the company's best-educated guess of what it expects to earn in the future.

Sometimes, analysts are interested in long term valuation trends and consider the P/E 10 or P/E 30 measures, which average the past 10 or past 30 years of earnings, respectively. These measures are often used when trying to gauge the overall value of a stock index, such as the S&P 500 since these longer term measures can compensate for changes in the business cycle. The P/E ratio of the S&P 500 has fluctuated from a low of around 6x (in 1949) to over 120x (in 2009). The long-term average P/E for the S&P 500 is around 15x, meaning that the stocks that make up the index collectively command a premium 15 times greater than their weighted average earnings.

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A recession is a macroeconomic term that refers to a significant decline in general economic activity in a designated region. It had been typically recognized as two consecutive quarters of economic decline, as reflected by GDP in conjunction with monthly indicators such as a rise in unemployment. However, the National Bureau of Economic Research (NBER), which officially declares recessions, says the two consecutive quarters of decline in real GDP are not how it is defined anymore. The NBER defines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

KEY TAKEAWAYS

• A recession is a period of declining economic performance across an entire economy that lasts for several months.

• Businesses, investors, and government officials track various economic indicators that can help predict or confirm the onset of recessions, but they're officially declared by the NBER.

• A variety of economic theories have been developed to explain how and why recessions occur.

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• A Roth IRA is a special retirement account where you pay taxes on money going into your account, and then all future withdrawals are tax-free.

• Roth IRAs are best when you think your taxes will be higher in retirement than they are right now.

• You can't contribute to a Roth IRA if you make too much money. In 2021, the limit for singles is $140,000. For married couples, the limit is $208,000.3

• The amount you can contribute changes periodically. In 2021, the contribution limit is $6,000 a year unless you are age 50 or older—in which case, you can deposit up to $7,000Internal Revenue Service.3

• Almost all brokerage firms, both physical and online, offer a Roth IRA. So do most banks and investment companies.

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Rebalancing is the process of realigning the weightings of a portfolio of assets. Rebalancing involves periodically buying or selling assets in a portfolio to maintain an original or desired level of asset allocation or risk.

For example, say an original target asset allocation was 50% stocks and 50% bonds. If the stocks performed well during the period, it could have increased the stock weighting of the portfolio to 70%. The investor may then decide to sell some stocks and buy bonds to get the portfolio back to the original target allocation of 50/50.

Primarily, portfolio rebalancing safeguards the investor from being overly exposed to undesirable risks. Secondly, rebalancing ensures that the portfolio exposures remain within the manager's area of expertise. Often, these steps are taken to ensure the amount of risk involved is at the investor's desired level. As stock performance can vary more dramatically than bonds, the percentage of assets associated with stocks will change with market conditions. Along with the performance variable, investors may adjust the overall risk within their portfolios to meet changing financial needs.

"Rebalancing," as a term, has connotations regarding an even distribution of assets; however, a 50/50 stock and bond split is not required. Instead, rebalancing a portfolio involves the reallocation of assets to a defined makeup. This applies whether the target allocation is 50/50, 70/30 or 40/60.

While there is no required schedule for rebalancing a portfolio, most recommendations are to examine allocations at least once a year. It is possible to go without rebalancing a portfolio, though this would generally be ill-advised. Rebalancing gives investors the opportunity to sell high and buy low, taking the gains from high-performing investments and reinvesting them in areas that have not yet experienced such notable growth.

Calendar rebalancing is the most rudimentary rebalancing approach. This strategy simply involves analyzing the investment holdings within the portfolio at predetermined time intervals and adjusting to the original allocation at a desired frequency. Monthly and quarterly assessments are typically preferred because weekly rebalancing would be overly expensive while a yearly approach would allow for too much intermediate portfolio drift. The ideal frequency of rebalancing must be determined based on time constraints, transaction costs and allowable drift. A major advantage of calendar rebalancing over more responsive methods is that it is significantly less time consuming and costly for the investor since it involves less trades and at pre-determined dates. The downside, however, is that it does not allow for rebalancing at other dates even if the market moves significantly.

A more responsive approach to rebalancing focuses on the allowable percentage composition of an asset in a portfolio - this is known as a constant-mix strategy with bands or corridors. Every asset class, or individual security, is given a target weight and a corresponding tolerance range. For example, an allocation strategy might include the requirement to hold 30% in emerging market equities, 30% in domestic blue chips and 40% in government bonds with a corridor of +/- 5% for each asset class. Basically, emerging market and domestic blue chip holdings can both fluctuate between 25% and 35%, while 35% to 45% of the portfolio must be allocated to government bonds. When the weight of any one holding moves outside of the allowable band, the entire portfolio is rebalanced to reflect the initial target composition.

The most intensive rebalancing strategy commonly used is constant proportion portfolio insurance (CPPI) is a type of portfolio insurance in which the investor sets a floor on the dollar value of their portfolio, then structures asset allocation around that decision. The asset classes in CPPI are stylized as a risky asset (usually equities or mutual funds) and a conservative asset of either cash, equivalents, or treasury bonds. The percentage allocated to each depends on a"cushion" value, defined as the current portfolio value minus some floor value, and a multiplier coefficient. The greater the multiplier number, the more aggressive the rebalancing strategy. The outcome of the CPPI strategy is somewhat similar to that of buying a synthetic call option that does not use actual option contracts. CPPI is sometimes referred to as a convex strategy, as opposed to a "concave strategy" like constant-mix. 

KEY TAKEAWAYS

• Rebalancing is the act of adjusting portfolio asset weights in order to restore target allocations or risk levels over time.

• There are several strategies for rebalancing such as calendar-based, corridor-based, or portfolio-insurance based.

• Calendar rebelancing is the least costly but is not responsive to market fluctuations, meanwhile a constant mix strategy is responsive but more costly to put to use.

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Target-date funds are mutual fund or exchange-traded funds (ETFs) structured to grow assets in a way that is optimized for a specific time frame. The structuring of these funds addresses an investor's capital needs at some future date—hence, the name "target date." Most often, investors will use a target date fund to apply to their onset of retirement. However, target-date funds are more frequently being used by investors working towards a future expense, such as a child's college tuition.

KEY TAKEAWAYS

• A target-date fund is a class of mutual funds or ETFs that periodically rebalances asset class weights to optimize risk and returns for predetermined time frame.

• The asset allocation of a target-date fund is typically designed to gradually shift to a more conservative profile so as to minimize risk when the target date approaches.

• The appeal of target-date funds is that they offer investors the convenience of putting their investing activities on autopilot in one vehicle.

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