The mumbo-jumbo used in the stock market can stop many potential investors in their tracks. So is deciphering the lingo so you make smarter investment decisions.
Today, we’ll start with three basic terms that define the investment strategy of many mutual funds: large cap, mid cap and small cap.
“Cap” is short for capitalization and basically describes the size of the company in terms of its stock market value. Market cap is determined by multiplying the number of shares of stock a company has issued by the stock price. That means a company’s market cap can fluctuate, but those daily moves don’t usually change its place in these three categories.
A Capital Idea
Apple (AAPL), Exxon Mobil (XOM) and General Electric (GE) are three of the biggest companies in the world. Apple, the world’s largest company, has a market cap of approximately $570 billion.
Such giant companies make up the large cap sector. Large caps generally have a market value of more than $10 billion — maybe $15 billion, by some definitions. That means they tend to be well-established companies with strong financial profiles, and many pay regular dividends.
The mid-cap sector is an often-unloved group in the investment world.
But how about well-known names such as Sears (SHLD) and U.S. Steel (X)? Both were once market giants, but they are both valued at about $4 billion. They are now part of the vast middle class of stocks: the mid-cap sector. This is an often-unloved group in the investment world because the companies are not big enough to be leaders in their industries or new enough to be considered small cap.
Small caps are generally valued at less than $4 billion. Many aggressive investors favor this group because these stocks are considered to have greater growth potential, but their stock prices are generally more volatile, so both the reward and the risk can be greater. In addition, they do not have consistent earnings and rarely do they pay dividends.
“Over the long term, small caps have tended to outperform large caps,” said Matthew Coffina, editor of the Morningstar StockInvestor newsletter, even though some of the premium has become less prominent over the past decade or so. He also notes that small caps “appear relatively expensive right now.”
Using This Information
How do you use market capitalization in making investment decisions? Most individual investors like you and me make our stock market bets by using mutual funds. There are thousands (that’s for another day), but many stock funds have a mission to invest primarily in one group or another. Some use that in the name (Vanguard Small Cap Index (VSMAX) for example), but for the most part you have to read a bit of the fund’s prospectus to understand its mission.
Very often, when people refer to “the market,” they’re talking about the Dow Jones industrial average (^DJI) or the Standard & Poor’s 500 index (^GPSC) — both made up of large cap stocks. And most investment advisers think that area should be in everyone’s portfolio. Many recommend buying an index fund of large cap stocks and then diversifying with funds from the other groups.
“The larger caps have been around longer. They’re financially stronger. They are lower risk,” according to Marc Salzinger, publisher of The No-Load Fund Investor newsletter. He says that because people tend to think about the market in terms of large cap benchmarks like the S&P 500, investing in other types of funds raises your risk “of not earning what you expect” based on the year-to-year variations in performance between the stock groups.
While small cap stocks tend to outperform over the long-term, the year-to-year fluctuations for those stocks and mutual funds fluctuate more. The key to long-term investing success, according to Salzinger, is to “invest steadily, not panic and pick something decent.”
In the next post of this series, we’ll take a look at another way to divvy up your mutual fund investments by style — growth, value, balanced and core funds.
For small costs that can quickly add up over time — like that daily latte habit or weekly apps and music purchases — consider buying yourself a gift card and load it with a set, budgeted amount at the start of each month. Then go ahead and enjoy those treats until your card runs out. "This makes it easy to keep track of small, daily expenditures," says Natalie Taylor. "Plus, it feels more special and guilt-free when you’re paying with a gift card."
1. Use gift cards for guilt-free spending
If you’re just starting to share in financial decisions with a significant other, Stephany Kirkpatrick suggests keeping a "slush fund" bank account into which you each set aside money every month to use for one or two joint expenses. "You can use this to pay for date nights, a vacation or a bigger purchase you want to make together," she suggests. "It helps take away the burden of wondering who is going to pay for certain things — and it’s a great way to get your feet wet when it comes to joint finances."
After a few months, you can graduate to contributing enough to the account to cover larger household bills if you live together, and before you both know it, the concept of combining your finances probably won’t be as overwhelming.
2. Ease into merging your money
"So many people get talked into buying extended warranties on electronics or insurance on their cell phones," says Tom Gilmour, who tells his friends to skip these purchases and use that money to buy term life insurance and disability insurance instead.
David Blaylock agrees. "Life and disability insurance are often overlooked and shouldn’t be," he says. "For most of us, the greatest asset we have is our ability to earn income. If we become sick (or die) and we lose that ability, it can be financially devastating. I see clients all the time who have these benefits available to them through their employers and simply haven’t signed up for them."
3. Be smart about insurance
"Jot down all of the things under $30 that are little, feel-good splurges — and when you need to treat yourself or someone special, pull from this list," Kirkpatrick says. "Whether it’s frozen yogurt, an impromptu yoga class, a few copies of recent New York Times best sellers or a nice bottle of wine, $30 can give you the happiness boost you need — without derailing progress you’ve made on your financial goals."
4. Treat yourself
"I recommend prenups and postnups," says Brandie Farnam. "If you think about it, people are most inclined to be fair and equitable when things are happy and stable in a relationship — not when you’re fighting for things while parting ways." She notes stay-at-home moms need to protect themselves financially if they opt to leave the workforce for an extended period to raise a family.
5. Draw up a postnup
Thinking of having a baby and trying to decide whether you can afford for one parent to scale back at work or quit altogether? Farnam tells her friends to completely bank the income they’re thinking of dropping (or reducing) for six months — and rely on the other salary to cover expenses during that period. "This will give you a sense of how it’ll feel before you make such a huge, potentially irreversible [career] decision," she says.
6. Practice living on one income
Speaking of kids, Gilmour tells all of his new-parent friends to consider setting up a 529 plan — even if they can’t afford to start saving for college themselves. "You can use it to deposit monetary gifts received from grandparents, aunts, uncles and friends."
7. Set up a 529 plan for a new baby right away
Taylor tells all of her friends to consider opening a "fun account," so they can splurge without guilt every once in a while. Taylor and her husband used their own fun account to buy a used elliptical machine, pay for a private Pilates trainer and go on a post-maternity wardrobe shopping spree. If it works for your budget, "Dedicate a certain percentage of your income and all money windfalls, like bonuses, to put into this account," Taylor suggests. "10 percent is a great place to start."
You may be able to accomplish the same idea the old-school way too. "One of my friends was able to treat a few of us to a poolside cabana when we were on vacation because she’d been putting small bills into a ‘fun jar’ for guilt-free splurges just like that," Farnam says.
8. Save for fun
Don’t want to hire an investment adviser or don’t have the confidence to manage your own portfolio? "Consider using an all-in-one asset allocation fund to help ensure you always have a diversified asset allocation," says Elizabeth Sklaver. "When buying investments, be sure to check your firm’s [no-transaction-fee]/commission-free list, so you’re not paying fees you may have avoided. If you are contributing regularly and paying a fee for each trade, it may be worth it to switch firms."
9. Help make investing mindless
Staying home to raise the kids? If possible, you should still be saving for your golden years, notes Kirkpatrick. "I tell my girlfriends that if they choose to leave their jobs, they should maximize a Spousal IRA or Spousal Roth IRA," she says. "This way, retirement savings is accumulating in their name, in addition to what their spouse saves for the future."
10. Make sure both partners are saving for retirement
Kirkpatrick says she’s amazed by the number of people who skip the simple step of filling out a beneficiary form for their retirement plan or life insurance. "Since a beneficiary form is a substitute for a will, this is a critical document that allows money to transfer to a beneficiary directly — without the overhead or complexities of probate," she says. This can become especially important, if you aren’t married or if you want someone other than your spouse to inherit your money. "Just remember that if something changes — say, you get married or divorced — you need to update paperwork everywhere."
11. Fill out beneficiary forms — and keep 'em current
Remember to donate some of your hard-earned money. "People who set aside money to support various organizations live richer lives," Blaylock says. Choose an amount you can afford to donate each year — and consistently give it away. "I hear people say that they will give when they are older," he says. "But I find that those who don’t get into the habit of giving early on rarely become charitable."
12. Give back
Yes, your eyes may glaze over when you’re reading the fine print. But really understanding what’s offered to you can help you take advantage of any "free money," like a 401(k) matching program, health savings account, gym discount or a pretax commuter benefit, says Gilmour. "Also, if you donate to charity," he says, "many large companies are willing to match your gift, which helps your dollar go even further."
13. Review your employer's benefits
Planners say they are shocked by how few people have a budget. Blaylock says that you should start by asking yourself these key questions: How much are your monthly fixed expenses? How much are your variable or flex expenses each month? How much is your net income? Armed with the answers, you can then sit down to map out a monthly budget that can help keep you on track for your financial goals.
14. Create a budget
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