GLOSSARY OF TERMS

This glossary of investment and retirement related terms provides simple definitions of terms that you may need to know.

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Accrued interest

The amount credited to a bond or other fixed-income security between the last payment and when the security is sold, or any intermediate date. The buyer usually pays the seller the security's price plus the accrued interest.

Active management

Where a person or team, often called the portfolio manager, actively makes investment decisions and initiates buying and selling of securities using analytical research, forecasts, and their own judgment and experience. The opposite of active management is called passive management, better known as "indexing."

Actual contribution percentage (ACP)

In a 401k plan, this is the result of the average of ratios of combined contributions to compensation for both highly compensated and non-highly compensated employees. Each employee's ratio is calculated and then averaged for the group.

Actual Deferral Percentage (ADP)

This is the proportion of a plan participant's compensation that is contributed to a 401k plan as an employee elective deferral.

Advisory letter

A written statement issued by the Internal Revenue Service to a volume submitter practitioner or volume submitter mass practitioner as to the acceptability of the form of a specimen plan and any related trust or custodial account under §401(a).

Annual defined contribution limit

The maximum 401k contribution limit that applies to all employee and employer 401k contributions in a calendar year. This limit is the lesser of 100% of the employee's total pre-tax compensation or a fixed amount that can change annually.

Annuity

A contract by which an insurance company agrees to make regular payments to someone for life or for a fixed period.

Appreciation

Increase in the value of an investment over time.

Ask price

The price a seller is willing to accept for the security; also called the offer price. This price is usually higher than the Bid price.

Asset allocation

Dividing your investment portfolio among the major asset categories. The most important decision you will make.

Asset allocation fund

A common trust fund or mutual fund that spreads its portfolio among a wide variety of investments, including domestic and foreign stocks and bonds, government securities, and real estate stocks. This gives small investors far more diversification than they could get allocating money on their own. Some of these funds keep the proportions allocated between different sectors relatively constant, while others alter the mix as market conditions change.

Asset

A resource that has economic value to its owner. Examples of an asset are cash, accounts receivable, inventory, real estate, and securities.

Automatic contribution arrangement

A feature in a plan whereby a covered employee's compensation is reduced by an amount specified in the plan and contributed to the plan on the employee's behalf unless the employee makes an affirmative election to have a different amount or no amount contributed to the plan. In the case of a 401k plan with an automatic contribution arrangement, the amounts withheld from employees' compensation are contributed to the plan as elective deferrals and the percentage of compensation contributed is called the default deferral rate.

Auto enrollment

The practice of enrolling all eligible employees in a plan and beginning participant deferrals without requiring the employees to submit a request to participate. Plan design specifies how these automatic deferrals will be invested. Employees who do not want to make deferrals to the plan must actively file a request to be excluded from the plan. Participants can generally change the amount of pay that is deferred and how it is invested.

Auto escalation

A plan which automatically increases the percentage of (retirement) funds saved from salary. this type of plan generally features a default or standard contribution escalation rate.

Balance sheet

The firm's financial statement that provides a picture of its assets, debts, and net worth at a specific point in time.

Balanced fund

A common trust fund or mutual fund that maintains a balanced portfolio, generally 50% bonds or preferred stocks and 50% common stocks, but this percentage can and does vary.

Beta

A measure of a stock's risk relative to the market, usually the Standard & Poor's 500 index. The market's beta is always 1.0; a beta higher than 1.0 indicates that, on average, when the market rises, the stock will rise to a greater extent and when the market falls, the stock will fall to a greater extent. A beta lower than 1.0 indicates that, on average, the stock will move to a lesser extent than the market. The higher the beta, the greater the risk.

Bid price

The price a buyer is willing to pay for a security. This price is usually lower than the Ask price.

Blackout period

When a plan sponsor decides to switch from one plan vendor to another, there is typically a period during which participants are not permitted to make changes in their investment selections. This is known as the blackout period. Once the blackout period commences and until it ends, participants can no longer direct the investments in their accounts. Blackout periods can last up to 60 days.

Bond

A certificate of debt issued by a company or the government. Bonds generally pay a specific rate of interest and pay back the original investment after a specified period of time.

Book value per share

The accounting value of a share of common stock. It is determined by dividing the net worth of the company (common stock plus retained earnings) by the number of shares outstanding.

Bundled plan

A 401k package which includes all investment, administration, education, and recordkeeping that is sold as one unit. This is in contrast to a basic 401k plan in which the plan sponsor can individually hire each component provider separately.

Business and industry risk

Uncertainty of an investment's return due to a fall-off in business that is firm-related or industry-wide.

Buy-and-hold

A strategy in which the stock portion of your portfolio is fully invested in the stock market at all times.

Call option

The right to purchase stock at a specified (exercise) price within a specified time period.

Callable bond

A bond that can be redeemed by the issuer prior to its maturity. Usually a premium is paid to the bond owner when the bond is called.

Cash Balance Plan

A defined benefit plan in which each participant has an account that is credited with a dollar amount that resembles an employer contribution, generally determined as a percentage of pay. Each participant's account is credited with earned interest. The plan provides the benefits in the form of a lump-sum distribution or annuity.

Cash or deferred arrangement (CODA)

See Salary Reduction Plan.

Capital gain

An increase in the value of a capital asset such as common stock. If the asset is sold, the gain is a "realized" capital gain. A capital gain may be short-term (one year or less) or long-term (more than one year).

Catch-up provision

A provision found in some 401k plans that allows an eligible employee who are at least age 50 to make higher annual contributions in the years prior to retirement.

Certificate of deposit

A bank deposit that pays a specified rate of interest for a certain period of time.

Churning

The unethical and excessive trading of a client account in order to generate commissions for a broker, but which may not in the best interests of the client. Not only does the client pay high commissions, they also gets stuck with a high tax bills due to the short-term holding of assets.

Cliff vesting

A 401k plan with "Cliff Vesting" vests 100% of employer contributions after a specified number of years of service. After three years of service, benefits must be fully vested.

Collective investment trust

Investments created by a bank or trust company for employee benefit plans, such as 401k plans, that pool the assets of retirement plans for investment purposes. They are governed by rules and regulations that apply to banks and trust companies instead of being registered with the SEC. These funds are also referred to as collective or commingled trusts.

Commission

Broker's fee for buying or selling securities.

Common stock

An investment representing ownership interest in a corporation.

Compliance testing

Testing required by the IRS to make sure that the 401k plan is fair to both highly compensated and ordinary employees.

Compounding

The ability of an asset to generate earnings that are then reinvested and generate their own earnings (earnings on earnings).

Contingent beneficiary

A contingent beneficiary stands second-in-line, behind the primary beneficiary, to inherit the assets of a retirement plan.

Controlled group

A group of trades or businesses (employers) that are related through ownership. A controlled group of employers is either (1) one or more chains of employers connected through ownership with a common parent employer where at least 80% of each employer, other than the common parent, is owned by one or more of the other employers and the common parent owns at least 80% of one or more of the other employers ("parent-subsidiary controlled group"); (2) two or more employers where five or fewer common owners satisfy an 80% common ownership test and a 50% identical ownership test ("brother-sister controlled group"); or (3) three or more employers where each employer is in either a parent-subsidiary controlled group or a brother-sister controlled group and at least one of the employers is the common parent employer in a parent-subsidiary controlled group and is also in a brother-sister controlled group ("combined group").

Conversion premium

The amount, expressed as a dollar value or as a percentage, by which the price of the convertible security exceeds the current market value of the common stock into which it may be converted.

Corrective distribution

A distribution of funds from the plan to correct a nondiscrimination test or to correct a contribution in excess of a statutory limitation.

Current ratio

Current assets, including cash, accounts receivable and inventory, divided by current liabilities, including all short-term debt. A rough measure of financial risk: the smaller current assets relative to current liabilities,the greater the risk of credit failure.

Current yield

Annual income (interest or dividends) divided by the current price of the security. For stocks, this is the same as the dividend yield.

Custodian

The bank or trust company that maintains a retirement plan's assets, including its portfolio of securities or some record of them. Provides safekeeping of securities, but has no role in portfolio management.

Cyclical industry

An industry, such as automobiles, whose performance is closely tied to the condition of the general economy. The company (and their stock) do well during good economic times, and not as well during poor economic times.

Debt-to-equity ratio

Long-term debt divided by stockholders' equity. The ratio identifies the relationship of debt to ownership interest in the firm's financial structure. A measure of financial risk.

Deemed IRA

The "Deemed IRA" (also called a "Sidecar IRA") was part of "The Economic Growth and Tax Reconciliation Act of 2001" (EGTRRA), although the concept has been around since the early 1980's. Basically, if your 401k plan adopts this provision of EGTRRA, for plan years beginning on or after January 1, 2003, a 401k plan may allow employees to make voluntary employee contributions to a "Deemed IRA" which is a separate account established under the plan.

Deep discount bond

A bond that has a coupon rate far below rates currently available on investments and whose value is at a significant discount from par value.

Default

A failure to repay a plan loan in accordance with the provisions specified in the plan document. The document must identify the events that constitute the failure and the parameters for any grace period.

Default deferral rate

In the case of an automatic contribution arrangement in a 401k plan, the percentage of compensation, specified in the plan, withheld automatically from a covered participant's compensation (unless the participant elects otherwise) and contributed to the plan as an elective deferral.

Default risk

The risk that a company will be unable to pay the contractual interest or principal on its debt obligations.

Defined benefit

A defined benefit plan is an employer maintained plan that pays out a specific, pre-determined amount to retirees. Defined benefit plans are guaranteed by PBGC.

Defined contribution

A defined contribution plan does not promise a specific benefit at retirement, but does provide regular, set contributions to a pension fund. Defined contribution plans tend to be less expensive than defined benefit plans.

Deflation

The increase of purchasing power due to a general decrease in the prices of goods and services.

Depreciation

Decrease in the value of an investment over time.

Direct rollover

A tax-deferred transfer of assets from one qualified retirement plan to another qualified retirement plan or IRA. Sometimes called a "trustee to trustee" transfer. The transfer is made without any funds being sent directly to the plan participant.

Discount bond

A bond that is valued at less than its face amount.

Discount broker

A stockbroker who charges a reduced commission and provides no investment advice.

Discount rate

The interest rate used in discounting future cash flows; also called the "capitalization rate."

Discrimination testing

All tax qualified retirement plans must be administered in compliance with several regulations to meet Internal Revenue Service guidelines, every tax qualified retirement plan (like a 401k) must pass a series of numerical measurements each year. These include the ADP Test (Actual Deferral Percentage), ACP Test (Actual Contribution Percentage), Multiple Use Test and Top-heavy Test. Typically, doing these tests is called discrimination testing.

Designated roth contribution

An elective deferral designated as a Roth contribution when contributed to the plan and which is not excludable from gross income.

Distributions and withdrawals

When money is withdrawn from a 401k plan, the withdrawal is referred to as a distribution. 401k plan assets can be withdrawn without penalty after age 59 1/2. Employees are required to begin taking distributions after age 70 1/2.

Diversification

The practice of spreading risk by investing in a number of securities that have different return patterns over time. When one investment is yielding a low or negative rate of return in a diversified portfolio, another investment may be enjoying positive or above-normal returns.

Dividend

Payments by a company to its stockholders. A dividend is usually a portion of profits. Payment of dividends on common stock is generally discretionary. Dividends to common-stock shareholders may be withheld if business is poor or if the corporation's directors decide to retain earnings to invest in business operations.

Dividend payout ratio

Annual dividends per share divided by annual earnings per share.

Dividend yield

Annual dividends per share divided by price per share. An indication of the income generated by a share of stock. The dividend yield plus capital gains percentage equals total return.

Dollar-cost averaging

A process of buying securities at regular intervals and at a fixed dollar amount. When prices are lower, the investor buys more shares or units; when prices are higher, the investor purchases fewer shares or units. Over time, this typically results in a better average price for all shares or units purchased.

Dow jones industrial average (DJIA)

Price-weighted average of 30 actively traded blue-chip stocks, traditionally of industrial companies.

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