Financial Terms Glossary

The world of financial terms can be a confusing one to navigate. In this blog, you’ll find a list of commonly used financial industry terms. At Schmitt Wealth Advisers, we don’t expect you to know all of these. Let us help you get the most out of your investments so you can focus on what matters to you most.

401(k) Retirement Savings Plan

• A 401(k) plan is an employer-sponsored qualified retirement benefit plan. The plan enables participants to defer a portion of their salary into their retirement plan account inside the company sponsored program (plan). In addition to an employee’s salary deferral contributions, the employer may also make matching contributions or profit sharing contributions depending upon the design of a particular company’s plan.

Base Salary

• The regular amount of income or compensation an employee is paid prior to any compensation bonus, awards, or other incentive income.

Common Stock

• Common stock(s), as defined by Charles Rolo and George Nelson in The Anatomy of Wallstreet, are securities which represent an ownership interest in a corporation. Both common stock and preferred stock are included in a corporation’s capital stock, which is all of the outstanding ownership shares of a company. In the event of liquidation of a company (usually a chapter 7 bankruptcy), common stockholders have a claim on company assets. However, a common stockholder’s claim falls below claims by preferred stockholders which falls below claims of bondholders. This is the primary reason why common stockholders assume more risk than preferred stockholders and corporate bondholders.

Convertible Class “A” Preferred Stock Series “A” (specific to Procter & Gamble)

• Procter & Gamble’s convertible class “A” preferred stock series “A” is used to fund a portion of the PST plan contribution annually. Each share of P&G’s preferred stock series “A” is convertible into one share of P&G’s common stock and has voting privileges (see here, pg 2). As of the firm’s 2019 annual report, the preferred stock series “A” pays a dividend equal to the dividend paid on the firm’s common stock and has a liquidation value of $6.82 per share (click here and see pages 56-57). 

Core Investment

• A core investment is typically a diversified mutual fund or ETF that a retirement plan sponsor offers as a primary investment choice. For instance, a core mutual fund or ETF may own a diversified selection of large, high quality, more established, and stable companies across a broad spectrum of industries and sectors.

Cusip

• Securities available for trade are issued a unique nine-character identifier called a cusip. For more detail, visit the SEC here. 

Diversification

• Diversification is a method of spreading risk or minimizing risk. For example, a company that makes only one product is not diversified and would benefit by buying or developing additional product lines. Likewise, investors owning only one investment vehicle, especially only one stock, take the risk that their particular investment does not perform well or loses significant value due to market changes, increased competition, financial issues, regulatory issues, product issues, or other issues. Diversification among many different companies whether directly or indirectly through mutual funds or ETF helps to minimize company-specific investment risk. Another important method of investment diversification is called asset allocation and involves owning a cross section of different types of investments (assets) like stocks, bonds, alternatives, and cash.

Dividend

• A dividend is the pro-rata distribution (usually quarterly) of a portion of a company’s profits to common stockholders and preferred stockholders. The board of directors for a corporation decide if, when, and how much dividend should be distributed. Preferred dividends are usually distributed as a fixed amount based on the prospectus details of a particular preferred stock issue; common stock dividends may vary each quarter. A corporation may choose to pay a dividend from the profits of past quarters even when the company has no profit in the current quarter.

Employee Stock Ownership Plan

• An employee stock ownership plan, or ESOP, as defined by the IRS (here), is a qualified defined contribution plan that is a stock bonus plan or a stock bonus/money purchase plan. In short, an ESOP plan enables the employees of a company to own shares of the company they are employed by, inside of a retirement plan.

Employment Separation Date

• The date of the last day of a person’s employment at a particular company.

Exchange Traded Fund

• An exchange traded fund, or ETF, is a package of investment products that are then traded on an exchange like a stock. An ETF is often a low-cost, passively managed index fund that offers investors a way to gain investment exposure to a particular stock index or bond index. The first ETF in US markets was created to track the S&P 500 index and launched by State Street Bank in 1993.

Fiduciary

• Generally, a fiduciary is a person or entity that has a fiduciary duty to another person, a plan, or a trust over which it makes certain decisions. The fiduciary duty is a standard of care requiring loyalty to the person or entity being cared for. This duty of care obligates a fiduciary to place the interests of the person(s) or entity(s) over which he/she has certain decision making authority above or ahead of his/her own interests. Persons in certain roles or functions involving a high level of trust or the exercise of control may be deemed a fiduciary. For example, a trustee has a fiduciary duty over a trust in his/her care. The trustee is a fiduciary. An investment adviser representative acting in their capacity as an investment adviser for a registered investment adviser (RIA), is a fiduciary for his/her clients (here). Conversely, a broker/financial advisor/wealth manager/managing director, acting in their capacity as a broker for a broker/dealer (e.g. Morgan Stanley, Merrill Lynch, UBS, Wells Fargo, etc.) has a different standard of care requirement called suitability (here).

Incentive Stock Option

• Incentive stock option, or ISO, is a statutory incentive stock option. It can also be referred to as a qualified stock option, or QSO. Public corporations may grant qualified stock options as a form of incentive compensation to certain key employees.  When a grant is made, there is a grant date, a grant price (sometimes referred to as a strike price or bargain element), a specified number of shares of company stock granted, a vesting date, and an expiration date. The IRS identifies two types of employee stock options, statutory (an ISO/QSO) and non-statutory (an NSO/NQSO). The IRS tax treatment for employee stock options differs depending upon whether the grant is statutory or non-statutory. For more details, visit the IRS website and consult your tax professional.

Index Fund

• An index fund is a packaged investment product passively managed by an investment company under the Investment Company Act of 1940. Understanding the term ‘index’ provides an accessible way to understand the concept of an index fund. According to Merriam-Webster dictionary, an index is a list of items such as topics or names in a book, or, in the case of investments, a list of publicly traded companies. An index fund seeks to own all of the companies on the list of a particular index. An index fund is required to issue a prospectus that describes the investment objective, investment methods, and risks of a particular index fund. An index fund can be invested in stocks or in bonds, and some cash depending upon the fund’s objective. An index fund is passively managed, meaning, changes in holdings are only made due to a change in the composition of the list or index. Index funds may be packaged as an exchange traded fund or a continuously offered open-ended fund.

Individual Retirement Account

• An individual retirement account, or IRA, is a type of account that allows individuals below certain income thresholds to make pre-tax contributions to save for retirement. Investment earnings inside of an IRA account grow tax-deferred until a distribution is made after the age of 59 ½. After the age of 72 is attained by the IRA owner, required minimum distributions are required annually. Normal distributions (after age 59 ½) are taxable as ordinary income to the individual making the distribution. Early or premature distributions (generally distributions made prior to attaining age 59 ½) are subject to ordinary income tax and may also be subject to a 10% premature withdrawal penalty unless the distribution meets certain exceptions. Please visit the IRS website for more details and consult your tax adviser for details regarding the taxability of IRA distributions.

Investment Adviser

• An investment adviser, or IAR, is a firm or professional in the business of providing investment related advice. IARs are compensated by advisory fees paid for advice and are fiduciaries who must put the interests of the client ahead of their own interests. Typically, because an investment adviser is compensated by fees for advice, they may not also collect commissions, mark-ups, or sales charges for selling products. There are exceptions to this rule, however, any additional compensation must be clearly disclosed in a Form ADV document. An IAR is typically affiliated with a registered investment advisor (RIA) firm. See the SEC’s definition here. An IAR should not to be confused with an employee of a broker/dealer with titles such as; broker, stockbroker, financial advisor, wealth advisor, wealth manager, or managing director at a broker/dealer (e.g. Merrill Lynch, Morgan Stanley, UBS, Wells Fargo, etc.). Employees at a broker/dealer firm may be dually licensed as both a stockbroker and as an investment adviser representative and may act in either or both capacities. This may create confusion when doing business with a dually registered representative as they may charge advisory fees at certain times and collect commissions at other times. It is advisable to ask questions, do your due diligence, and read all disclosures carefully.

Long-term Incentive Program

• Long-Term Incentive Program, or LTIP, is a form of compensation awarded by Procter & Gamble to certain employees. Employees eligible for the award may choose whether to receive the award in Non Statutory Stock Options (NSOs) or in Restricted Stock units (RSUs).

Mutual Fund

• A mutual fund is a packaged investment product actively managed by an investment company under the Investment Company Act of 1940. Understanding the term ‘mutual’ provides an accessible way to understand the concept of a mutual fund. In 1736, Benjamin Franklin organized a mutual fire company called the Union Fire Company. This was an early example of a group of people (homeowners in Philadelphia) with a common interest (saving their home from fire) joining a “mutual” organization to protect members’ homes from fire. By extension, a mutual fund is a group of people (investors) joining a “mutual” organization with a common interest (the prospectus objective of a particular mutual fund) to invest and manage some of the members’ (fund owners’) money. The prospectus is a required document issued by every mutual fund that describes the investment objective, investment methods, and risks of a particular mutual fund. A mutual fund can be invested in stocks, in bonds, and cash or any combination depending upon the fund’s objective. A mutual fund is often actively managed, meaning, a portfolio manager or management team makes changes in the fund’s investment holdings based on the team’s fundamental research, analysis, and forecasts about certain holdings. Changes may also be required to generate cash when shareholders sell shares in excess of the cash on hand in the fund. Mutual funds are usually packaged as a continuously offered open ended fund. According to Morningstar, there are over 8,000 distinct institutional funds available as of the writing of this glossary.

Net Unrealized Appreciation

• Net unrealized appreciation, or NUA, is a method of distribution from pensions, retirement, or profit sharing plans (visit the IRS here). NUA distributions take advantage of the cost basis of company shares owned inside of a retirement plan. Generally, when a lump sum distribution is made from a tax-deferred retirement plan, the value of the distribution is taxable as ordinary income in the tax year the distribution is made.  However, when certain company shares are taken in a prescribed method as a lump-sum distribution, the distributed shares may qualify for net unrealized appreciation tax treatment. Please visit the IRS website and consult your tax professional.

Non-core Investment

• A non-core investment is deemed outside of the core, a peripheral, or a secondary choice inside a retirement plan. A non-core investment may have a higher risk profile. For instance, a non-core investment may be non-diversified, with a specific focus on a particular sector, style, country, or region. It may hold companies in higher risk developing nations, regions, industries, or technologies. It may also hold smaller, less established companies.

Non-qualified Dividend

• See definition for Qualified Dividend.

Non-qualified Stock Option

• Non-qualified stock option, or NSO/NQSO is a non-statutory employee stock option. Public corporations may grant non-qualified employee stock options as a form of compensation. When a grant is made, there is a grant date, a grant price (sometimes referred to as a strike price or bargain element), a specified number of shares of company stock granted, a vesting date, and an expiration date. The IRS identifies two types of employee stock options, statutory (an ISO/QSO) and non-statutory (an NSO/NQSO). The IRS tax treatment for employee stock options differs depending upon whether the grant is statutory or non-statutory.  For more details, visit the IRS website and consult your tax professional.

Net Unrealized Appreciation Distribution

• See definition for Net Unrealized Appreciation.

Qualified Dividend

• The Jobs and Tax Relief Reconciliation Act of 2003 (JGTRRA) changed how certain corporate dividends are taxed. Prior to JGTRRA, essentially all dividends where taxed as ordinary income at ordinary income tax rates. The JGTRRA legislation created two classes of dividends, qualified and non-qualified. After December 31, 2002 qualified dividends where subject to a lower tax rate, similar to the capital gains tax rates. Non-qualified dividends, however, continue to be taxed as ordinary income. For example, common stock dividends are typically classified as qualified and certain REIT or preferred stock dividends are non-qualified. Tax laws are subject to change and the most recent changes may or may not be reflected here, always consult with your CPA or tax preparer with tax specific questions and for details about your particular tax situation.

Qualified Stock Option

• Qualified stock option (QSO) (see definition for ISO). According to the IRS “if your employer grants you a statutory stock option, you generally don’t include any amount in your gross income when you receive or exercise the option. However, you may be subject to alternative minimum tax in the year you exercise an ISO”. For more details, consult your tax professional. 

Preferred Stock

• Preferred stock is generally used by U.S. corporations and is publicly traded capital stock issued by a corporation. Although preferred stock is listed and traded on stock exchanges, it is priced or valued more similarly to an unsecured debt instrument or bond. A preferred stock issue has no voting rights and pays a fixed dividend typically stated as a percentage of par. In the event of a bankruptcy, preferred stock owners have a claim on the firm’s assets and cash flows ahead of common stock owners but behind unsecured bonds in liquidation order. Because of its bond-like characteristics, preferred stock is often evaluated for its fixed income distributions and its ability to pay future obligations. Credit rating agencies such as Moody’s, Fitch, and Standard & Poor’s may evaluate a preferred security and assign a credit rating.

Profit Sharing Trust Plan

• The profit sharing trust plan is Procter & Gamble’s primary retirement benefit. It is a defined contribution plan called the Procter & Gamble Profit Sharing Trust (PST) and Employee Stock Ownership Plan. 

Required Minimum Distribution (RMD)

• The IRS mandates that annual distributions must be made by individuals owning an IRA, rollover IRA, and certain other tax-deferred retirement accounts after the age of 72 is attained by the account owner.  More details may be found by visiting the IRS website and always consult your tax adviser for details regarding the taxability of IRA and other tax-deferred account distributions.

Restricted Stock Unit

• Restricted stock unit, or RSU, is sometimes granted to an employee as a form of compensation by public corporations. When a grant is made, there is a grant date, a grant price (sometimes referred to as a strike price), a specified number of shares of company stock granted, and a vesting date. As the term ‘restricted’ suggests, shares granted to an employee are not available until the vest date. When RSU shares vest, the holder receives the specified number of shares of the company stock (plus dividend re-investment shares if applicable) at the current market price.  Generally speaking, RSU’s are taxed as ordinary income calculated by multiplying the number of shares by the price per share upon vesting. For more details, consult your tax professional.

Retirement Eligible

• Retirement eligible, or retirement eligibility, is a phrase used when an employee is eligible to retire based on their particular plan in which the employee participates. The description is used by companies, by the Social Security Administration, and by federal, state, and local governments to describe when full retirement benefits become available to participants in their particular plan. Organizations may use a stated attained age, or a formula, or some combination of both. For instance, Procter & Gamble confers retirement eligible status to an employee whose attained age + length of service at the firm adds to the sum of 70 (The Rule of 70). Retirement plans and eligibility rules may change, so, always consult with your benefits department for current eligibility and rules whether for Procter & Gamble or any other employer. 

Roth IRA

• The Roth IRA is a type of individual retirement account established by the Taxpayer Relief Act of 1997 and named for the bill’s initial sponsor Delaware Senator William Roth. The Roth IRA is a retirement savings vehicle similar to a traditional IRA or rollover IRA but with some notable exceptions. The Roth IRA must be always funded with after-tax contributions (subject to annual income limits) and qualified distributions are tax-free as long as certain requirements are met. Also, Roth IRAs are not currently subject to required minimum distributions. For more details on the taxability of Roth IRA’s visit the IRS website or consult your financial adviser.

Rule of 70

• See definition for Retirement Eligible.

Salary Deferral

• Employees who participate in certain company sponsored retirement plans may direct or defer a portion of their regular income into their retirement plan account. For example, a 401(k) retirement savings plan and a 403(b) retirement savings plan both enable employees to save for retirement by deferring a percentage of their salary to their account in the plan.

Separation From Service

• The date on which an employee left an employer due to retirement, a job change, a lay-off, or for some other reason.

Share Class (Mutual Fund)

• Continuously offered mutual funds may offer several different share classes. Each share class may have different internal expenses, and some may carry an upfront sales charge or load, and some may carry a back-end sales charge or CDSC (contingent deferred sales charge). Some classes are considered “no-load”, meaning they carry no upfront or back-end sales charge. Investors should always review the fund’s prospectus to learn the particular cost structure of each share class for a given mutual fund. A simple mutual fund share class example is; A, C, and I. In this example, Class “A” shares may carry a front-end sales charge (load) that gradually declines based on “break-points” (the amount of the investment made). This class might also have an internal 12b-1 expense of 0.25% annually to compensate the broker/dealer for selling and holding the fund. Class “C” shares may have no upfront load but may have a back-end CDSC and an internal 12b-1 expense of 1.00% annually to compensate the broker/dealer for selling and holding the fund since there is no upfront charge. Class “I” shares in this example are an institutional share class that have no upfront charge, no back-end (CDSC) charge, and have no internal 12b-1 expense. Institutional shares typically have the lowest internal expense and are often only available directly or through an RIA. Low cost Institutional shares are typically not available through a traditional broker/dealer (e.g.; Merrill Lynch, UBS, Morgan Stanley, Wells Fargo, etc.).

Short-Term Achievement Reward Program

• Short-term achievement reward program, or STAR program, is a form of compensation awarded by Procter & Gamble to certain employees. Employees eligible for the award may choose whether to receive the award as a cash bonus or in restricted stock units (RSUs).

Tax Withholding

• Tax withholding is a familiar concept for anyone earning a paycheck and getting a W-2 report each year. The W-2 report details compensation for the previous tax year and any taxes withheld by the employer for your federal, state, or local income taxes. Investors who make a taxable distribution from an IRA or certain qualified retirement plans may request to have a portion of the distribution withheld for federal or state taxes due as a consequence of the distribution. For example, individuals taking regular distributions out of their IRA or IRA rollover account to supplement income in retirement will typically have at least a portion of the distribution withheld to satisfy federal and sometimes state income taxes that will be due.

The Stock Rule

• An employee stock ownership plan, or ESOP, is required to own a minimum of 30% company stock. As of the writing of this glossary, the Procter & Gamble Profit Sharing Trust (PST) and ESOP has set its minimum company stock holding requirement at 40%. Vested PST participants over age 50, may elect to diversify as much as 60% of their holdings into non-P&G stock investments available inside the plan. Importantly, since the preferred shares may have certain cost basis advantages over the common shares, it is typically best not to sell any of the preferred shares when considering diversification inside the plan.

Vesting Date

• The vesting date is the date at which a particular deferred benefit becomes ‘vested’ or fully available to the person or employee to which the benefit was given or awarded. For example, a typical 401(k) retirement plan is set up to enable salary deferral contributions by employees and matching or profit-sharing contributions by the employer (the sponsor company). In this example, salary deferral contributions are vested immediately, whereas, company matching contributions may be unavailable to the employee until a stated vesting date.

Disclaimer:

This material is provided by Schmitt Wealth Advisers for informational purposes only. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. Opinions expressed by Schmitt Wealth Advisers are based on economic or market conditions at the time this material was written. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from sources believed to be reliable. Schmitt Wealth Advisers, however, cannot guarantee the accuracy or completeness of such information. Past performance may not be indicative of future results.