Three Terms to Make You Sound Smarter About Investing

No industry does jargon better than finance. You can start with the ETF's, the PFI's and OsMA's and move right on to the "fill-and-kill's" and candles (not the lovely, romantic kind). The implication seems to be that people who work in finance are just too busy to speak English, because you know, the extra 1/10th of a second to spell out that acronym could cost millions. If you want to become an insider in the world of financial acronyms, Investopedia will happily share with you a term of the day (I notice today's term is "topless meeting," which sound pretty juicy). But if you just want a few terms to throw around at cocktail parties, I've made up this helpful quiz (in multiple choice format, of course) to make you feel smarter:

Question One

You are introduced to a guy at a cocktail party who, after bringing up the topic of his stellar investing strategy, explains that he's got great alpha. You:

A. Pretend to receive a text from your "boyfriend" and get away as efficiently as possible;

B. Congratulate him on his spiritual awareness;

C. Ask him what sort of product "Alpha" makes;

D. Congratulate him on beating his benchmarks and lowering his investment risk.

Answer: D. Technically, anyway. Alpha is a favorite term throughout the investment community for saying that the investment strategy you are using is calculated to get the same or better returns than others like it but with less risk. I will leave you to guess how often this claim holds true over time—obviously, Answer "A" also works.

Question Two

A stockbroker offers to get you in on stock in a privately-held company she thinks will become the next Uber. The question most likely to bring her up short is:

A. How much do I need to invest?

B. What kind of liquidity does the stock have?

C. How do you know the stock value will go up?

D. What is Uber?

Answer: B. A stockbroker gets paid a commission every time she sells someone on a stock. If she's any good at her job, she will have ready-made answers to most of your questions: "The minimum investment is $10,000, but I would buy more right now while you can still get a deal—once people know about it, the price will skyrocket"; "the founders  were involved with [insert earlier hot start-up here], so they really know what they're doing"; "we hear they're in talks with [insert well-known corp. here]."

But whether you believe in this new company or not, liquidity is going to be an issue. Liquidity means "how easily and quickly can I get my money out if I want it?" With a privately-held company the answer is almost always "not very." Privately held companies almost always make it very hard to sell your shares, in part because it's just too difficult to figure out what they're worth. Even private funds (like hedge funds) generally require you leave your money in for a certain period (often 10 years). To be able to put your money away and take it out again on demand, go for the publicly traded stuff you see on the stock exchanges.

Question Three

Your broker hears you are about to inherit money and offers to set you up with a margin account. You:

A. Say yes, assuming this is some type of account for inherited money;

B. Say no, assuming that anything called a "margin account" must be marginal, at best;

C. Tell her you'll update your financial plan and see if you want to be that aggressive with your investments;

D. Ask if that comes with an all-you-can-eat buffet

Answer: C. A margin account lets you borrow money from the broker who is selling you the stocks. Say you have $50k in cash and $200k in stocks in your brokerage (stock trading) account. You would normally have up to $50k to buy a new stock unless you wanted to sell some of the other stock. But in a margin account, the broker loans you money to buy more than the $50k worth of stock. This means that if your new stock's price goes up, you can make even more money (!). It also means that if your stock's price goes down, you could lose a whole lot more money. Every margin account comes with a maintenance margin—a ratio between how much your whole account is worth at a given moment and how much you have borrowed. If the value of any of your stocks go down below that level, your Broker will automatically call in their loan, leaving you with a choice of selling off your stocks (often at the worst time) and adding more cash to the account.

All this means that answer D makes sense, as well—if you are just looking for a good way to gamble with your money, the casinos will generally throw in a good buffet for your trouble.