A 401(k) plan is an employer sponsored retirement savings plan. 401(k)s are largely self-directed: You decide how much you would like to contribute, and which investments from among those offered by the plan you would like to invest in. Traditional 401(k)s are funded with money deducted from your pre-tax salary. Your earnings are tax deferred until you withdraw your money from your account. Roth 401(k)s are funded with after-tax income, but withdrawals are tax free if you follow the rules.
A 403(b) plan, sometimes known as a tax-sheltered annuity (TSA) or a tax-deferred annuity (TDA), is an employer sponsored retirement savings plan for employees of not-for-profit organizations, such as colleges, hospitals, foundations and cultural institutions. Some employers offer 403(b) plans as a supplement to—rather than a replacement for—defined benefit pensions.
Debt security issued or guaranteed by an agency of the federal government or by a government-sponsored enterprise (GSE). These securities include bonds and other debt instruments. Agency securities are only backed by the "full faith and credit" of the U.S. government if they are issued or guaranteed by an agency of the federal government, such as Ginnie Mae. Although GSEs such as Fannie Mae and Freddie Mac are government-sponsored, they are not government agencies.
A strategy for maximizing gains while minimizing risks in your investment portfolio. Specifically, asset allocation means dividing your assets on a percentage basis among different broad categories of investments, including stocks, bonds and cash.
Different categories of investments that provide returns in different ways are sometimes described as asset classes. Stocks, bonds, cash and cash equivalents, real estate, collectibles and precious metals are among the primary asset classes.
The average time that a mutual fund's bond holdings will take to be fully payable. Interest rate fluctuations have a greater impact on the price per share of funds holding bonds with longer average lives.
A bear market is one in which stock and/or bond prices decline over an extended period of time, at times accompanied by an economic recession, rising inflation or rising interest rates.
A benchmark is a standard against which investment performance is measured. For example, the S&P (Standard & Poor's) 500 Index, which tracks 500 major U.S. companies, is the standard benchmark for large-company U.S. stocks and large-company mutual funds. The Barclays Capital Aggregate Bond Index is a common benchmark for bond funds.
A debt instrument, also considered a loan, that an investor makes to a corporation, government, federal agency or other organization (known as an issuer) in which the issuer typically agrees to pay the owner the amount of the face value of the bond on a future date, and to pay interest at a specified rate at regular intervals.
Owner of a bond; may be an individual or institution such as a corporation, bank, insurance company or mutual fund. A bondholder is typically entitled to regular interest payments as due and return of principal when the bond matures.
A method of evaluating the quality and safety of a bond. This rating is based on an examination of the issuer's financial strength and the likelihood that it will be able to meet scheduled repayments. Ratings range from AAA (best) to D (worst). Bonds receiving a rating of BB or below are not considered investment grade because of the relative potential for issuer default.
A bull market is one in which prices rise during a prolonged period of time.
The issuer's right to redeem outstanding bonds before the stated maturity.
A feature of some callable bonds that protects the investor from calls for some initial period of time.
The risk that a bond will be called prior to its maturity date, causing the bond's principal to be returned sooner than expected. If the bondholder wishes to reinvest the principal, it usually must be done at a lower rate than when the bond was originally purchased.
Capital gains tax
Tax assessed on profits you realize from the sale of a capital asset, such as stock, bonds or real estate.
Collateralized Mortgage Obligation (CMO)
A bond backed by multiple pools (also called tranches) of mortgage securities or loans.
A fee paid to a broker, as an agent of the customer, for executing a trade based on the number of bonds traded or the dollar amount of the trade.
A bond issued by a corporation to raise money for capital expenditures, operations and acquisitions.
A bond with the option to convert into shares of common stock of the same issuer at a pre-established price.
The interest payment made on a bond, usually paid twice a year. A $1,000 bond paying $65 per year has a $65 coupon, or a coupon rate of 6.5 percent. Bonds that pay no interest are said to have a "zero coupon." Also called the coupon rate.
The annual interest rate established when the bond is issued. The same as the coupon rate, it is the amount of income you collect on a bond, expressed as a percentage of your original investment.
The possibility that the bond's issuer may default on interest payments or not be able to repay the bond's face value at maturity.
The yearly coupon payment divided by the bond's price, stated as a percent. A newly issued $1,000 bond paying $65 has a current yield of .065, or 6.5 percent. Current yield can fluctuate: If the price of the bond dropped to $950, the current yield would rise to 6.84 percent.
An unsecured bond backed solely by the general credit of the borrower.
Any security that represents loaned money that must be repaid to the lender.
The amount by which a bond's market price is lower than its issuing price (par value). A $1,000 bond selling at $970 carries a $30 discount.
Diversification is an investment strategy for allocating your assets available for investment among different markets, sectors, industries and securities. The goal is to protect the value of your overall portfolio by diversifying your investment risk among these different markets, sectors, industries and securities.
The risk that an event will have a negative impact on a bond issuer's ability to pay its creditors.
The amount the issuer must pay to the bondholder at maturity, also known as par.
Full faith and credit of the U.S. government
A promise by the U.S. government to pay all interest when due and redeem bonds at maturity. Treasuries, savings bonds and debt securities issued by federal agencies are backed by the "full faith and credit" of the U.S. government.
A bond with an interest rate that remains constant or fixed during the life of the bond.
A bond with an interest rate that fluctuates (floats), usually in tandem with a benchmark interest rate during the life of the bond.
General Obligation bond (GO)
A municipal bond secured by a governmental issuer's "full faith and credit," usually based on taxing power.
Government-Sponsored Enterprise (GSE)
Enterprises that are chartered by Congress to fulfill a public purpose, but are privately owned and operated, such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Unlike bonds guaranteed by a government agency such as Ginnie Mae, those issued by a GSE are not backed by the "full faith and credit" of the U.S. government.
A bond issued by an issuer that is considered a credit risk by a Nationally Recognized Statistical Rating Organization, as indicated by a low bond rating (e.g., "Ba" or lower by Moody's Investors Services, or "BB" or below by Standard & Poor's Corporation). Because of this risk, a high-yield bond generally pays a higher return (yield) than a bond with an issuer that carries lower default risk. Also known as a "junk" bond.
Holding period risk
The risk, while you are waiting for your bond to mature (holding it), that a better opportunity will come around that you may be unable to act upon. The longer the term of your bond, the greater the chance a more attractive investment opportunity will become available, or that any number of other factors may occur that negatively impact your investment.
A legal document between a bond issuer and a trustee appointed on behalf of all bondholders that describes all of the features of the bond, the rights of bondholders, and the duties of the issuer and the trustee. Much of this information is also disclosed in the prospectus or offering statement.
The risk that a bond's returns may not keep pace with inflation, eroding purchasing power.
Interest rate risk
The risk that a bond's price will fall when interest rates rise.
A bond whose issuer's prompt payment of interest and principal (at maturity) is considered relatively safe by a nationally recognized statistical rating agency as indicated by a high bond rating (e.g., "Baa" or better by Moody's Investors Service, or "BBB" or better by Standard & Poor's Corporation).
Another name for a high-yield bond.
The risk of not being able to execute a trade at the time you desire, or being forced to accept a significantly discounted price of a bond at the time you desire to sell.
If you sell a bond, your brokerage firm, when acting as a principal, may offer you a price that includes a "mark-down" from the price that it believes it can sell the bond to another dealer or another buyer. The mark-down is the firm's compensation in the transaction.
When a brokerage firm sells you a bond in a principal capacity, it may increase or "mark-up" the price you pay over the price the firm paid to acquire the bond. The mark-up is the firm's compensation in the transaction.
A maturity date is the date when the principal amount of a bond, note or other debt instrument is typically repaid to the investor along with the final interest payment.
A security that is secured by home and other real estate loans.
A bond issued by states, cities, counties and towns to fund public capital projects like roads and schools, as well as operating budgets. These bonds are typically exempt from federal taxation and, for investors who reside in the state where the bond is issued, from state and local taxes, too.
A feature of some bonds that stipulates the bond cannot be redeemed (called) before its maturity date. Also called a "bullet."
Non investment-grade bond
A bond whose issuer's prompt payment of interest and principal (at maturity) is considered risky by a nationally recognized statistical rating agency, as indicated by a lower bond rating (e.g., "Ba" or lower by Moody's Investors Service, or "BB" or lower by Standard & Poor's Corporation).
A short- to medium-term loan that represents a promise to pay a specific amount of money. A note may be secured by future revenues, such as taxes. Treasury notes are issued in maturities of two, three, five and 10 years.
The risk that a better investment opportunity will come around that you may be unable to act upon because of a current investment. Generally, the longer the holding period of a bond, the greater the opportunity risk.
Over-the-counter (OTC) securities
Securities that are not traded on a national exchange. For such securities, broker-dealers negotiate directly with one another over computer networks and by phone.
An amount equal to the nominal or face value of a security. A bond selling at par, for instance, is worth the same dollar amount at which it was issued, or at which it will be redeemed at maturity—typically $1,000 per bond.
Interest reportable to the IRS that does not generate income, such as interest from a zero-coupon bond.
The possibility that the issuer will call a bond and repay the principal investment to the bondholder prior to the bond's maturity date.
The amount by which a bond's market value exceeds its issuing price (par value). A $1,000 bond selling at $1,063 carries a $63 premium.
The market in which new issues of stock or bonds are priced and sold, with proceeds going to the entity issuing the security. From there, the security begins trading publicly in the secondary market.
- For investments, principal is the original amount of money invested, separate from any associated interest, dividends or capital gains. For example, the price you paid for a bond with a $1,000 face value the time of purchase is your principal. Once purchased, the value of your bond holdings can fluctuate, meaning you can see an increase or decrease to your principal.
- A brokerage firm that executes trades for its own accounts at net prices (prices that include either a mark-up or mark-down).
A formal written offer to sell securities that sets forth the plan for a proposed business enterprise, or the facts concerning an existing business enterprise that an investor needs to make an informed decision.
Real rate of return
The rate of return minus the rate of inflation. For example, if you are earning 6 percent interest on a bond in a period when inflation is running at 2 percent, your real rate of return is 4 percent.
A type of municipal security backed solely by fees or other revenue generated or collected by a facility, such as tolls from a bridge or road, or leasing fees. The creditworthiness of revenue bonds tends to rest on the bond's debt service coverage ratio—the relationship between revenue coming in and the cost of paying interest on the debt.
The possibility that an investment will lose, or not gain, value.
A person's capacity to endure market price swings in an investment.
U.S. government bond issued in face denominations ranging from $25 to $10,000.
Markets where securities are bought and sold subsequent to their original issuance.
Short for "Separate Trading of Registered Interest and Principal of Securities." STRIPS are Treasury Department-sanctioned bonds in which a broker-dealer is allowed to strip out the coupon, leaving a zero-coupon security.
U.S. government securities designed to protect investors and the future value of their fixed-income investments from the adverse effects of inflation. Using the Consumer Price Index (CPI) as a guide, the value of the bond's principal is adjusted upward to keep pace with inflation.
Negotiable debt obligations that include notes, bonds and bills issued by the U.S. government at various schedules and maturities. Treasuries are backed by the "full faith and credit" of the U.S. government.
Non-interest bearing (zero-coupon) debt security issued by the U.S. government with a maturity of four, 13 or 26 weeks. Also called a T-bill.
Long-term debt security issued by the U.S. government with a maturity of 10 to 30 years, paying a fixed interest rate semiannually.
Medium-term debt security issued by the U.S. government that has a maturity of two to 10 years.
All money earned on a bond or bond fund from annual interest and market gain or loss, if any, including the deduction of sales charges and/or commissions.
The return earned on a bond, expressed as an annual percentage rate.
A yield curve is a graph showing the relationship between yield (on the y- or vertical axis) and maturity (on the x- or horizontal axis) among bonds of different maturities and of the same credit quality.
Yield to call (YTC)
The rate of return you receive if you hold the bond to its call date and the security is redeemed at its call price. YTC assumes interest payments are reinvested at the yield-to-call date.
Yield to maturity (YTM)
The overall interest rate earned by an investor who buys a bond at the market price and holds it until maturity. Mathematically, it is the discount rate at which the sum of all future cash flows (from coupons and principal repayment) equals the price of the bond.
Yield to worst (YTW)
The lower yield of yield-to-call and yield-to-maturity. Investors of callable bonds should always do the comparison to determine a bond's most conservative potential return.
Yield reflecting broker compensation
Yield adjusted for the amount of the mark-up or commission (when you purchase) or mark-down or commission (when you sell) and other fees or charges that you are charged by your broker for its services.
Short for zero-coupon bond.
A type of bond that does not pay a coupon. Zero-coupon bonds are purchased by the investor at a discount to the bond's face value (e.g., less than $1,000), and redeemed for the face value when the bond matures.