30-Day Wash Rule: IRS law forbidding the sale of a security in December and repurchase the following January for the purpose of declaring a year-end loss to offset capital gains.
72t: A plan that allows an IRA account holder to take distributions earlier than age 59 1/2 without incurring a 10% penalty. The account holder must take ‘substantially equal distributions’ from the account for at least 5 years or until age 59 1/2, whichever comes last.
401(k) Plan: An employer-sponsored defined contribution plan for retirement. Employees make contributions to a separate account and choose from a list of investments, usually a relatively small number of mutual funds. Employers may match a portion of employees’ contributions. For tax purposes, 401(k) assets are treated similar to a regular IRA account – contributions reduce taxable income, and earnings in the account are not taxable until distributions are made. Distributions taken before age 59 1/2 are subject to income tax and a 10% early withdrawal penalty. Upon separation from an employer, an individual may elect to take a full distribution and ’roll over’ the assets to an IRA account. If the rollover is completed within 60 days of distribution, there is no tax or penalty due.
403(b) Plan: Similar to a 401(k) plan, a 403(b) is a retirement plan for public education employees, ministers and some employees of non-profit organizations.
457 Plan: A deferred compensation program available to state and federal government and agency employees. Similar to a 401(k) plan, except there are no matching contributions from the employer and it isn’t considered a qualified retirement plan under IRS rules. Participants can defer some of their annual income, and contributions and earnings are tax-deferred until withdrawal. Participants can choose to take distributions at retirement as a lump sum, annual installments or as an annuity. Distributions are taxed as ordinary income. 457 plan assets cannot be rolled over into an IRA.
Abnormal Returns: Returns in excess of overall market returns for a given period. Much of the investment advice given to the public, especially through the financial media, is focused on telling investors how to achieve abnormal returns on their investments. As a believer in efficient markets and the random walk theory, Northstar believes that higher returns are a function of accepting higher risk, not stock picking, trend analysis or market timing.
Active Portfolio Management: Practice of attempting to achieve higher investment returns by timing the purchase and sale of assets. Active managers search for undervalued assets to buy, and look to sell overvalued assets. Kenneth French, Professor of Finance at Dartmouth College, published a study titled ‘The Cost of Active Investing’ in 2008. That study looked at all costs associated with active investing (searching for superior returns) between 1980 and 2006, and concluded that the active investor’s returns lagged a passively managed portfolio by an average of 67 basis points (2/3 of 1 percent)per year. Active management is the opposite of passive management or buy and hold strategy.
Adjusted Cost Basis (or Basis): Total cost of an asset, to subtract from the proceeds upon sale of the asset, to determine the capital gain or loss. Adjusted cost basis should reflect trading commissions, and actions such as stock splits which have occurred while the asset was owned.
ADV: See Disclosure
Aggressive Growth Portfolio: As defined by Northstar, a portfolio with more than 70% of its assets held in equities and less than 30% in cash and fixed income investments.
Alpha: Measure of risk-adjusted performance, usually calculated by comparison of the asset’s excess return to the S&P 500 return.
Alternative Minimum Tax (AMT): A federal tax which eliminates many regular deductions, to ensure that wealthy taxpayers pay a minimal level of income tax. Taxpayers subject to the AMT calculate their taxes using the standard guidelines and the AMT rules, and must pay the higher of the two amounts.
Annuity: A periodic payment from an insurance company to an annuitant (or policyholder) for a specified period of time. Often used as a retirement plan, the policy holder pays into an account during earning years (the accumulation period) and then receives a regular payment during retirement. The payment amount can be fixed (constant) or variable (depending on the performance of the fund in which the payments are invested or an index). Earnings on annuities are generally not taxed until money is distributed from the account.
Appreciation: Increase in an asset’s value.
Ask: An offer by the owner of an asset to sell the asset in a public exchange at a specific price. Opposite of bid.
Asset Class Allocation: How an investor distributes his or her assets among different asset classes. Decades’ worth of academic and empirical studies from Eugene Fama at the University of Chicago, Gary Brinson et al and Roger Ibbotson et al support Northstar’s strategy of investing our clients’ assets in a diversified portfolio, divided by asset classes with low correlation.
Asset Classes: Different categories of investments, divided by geography (U.S., international, emerging market), company size (large-cap, small-cap, etc.), security type (stocks, bonds, cash) and sometimes sector or industry (such as real estate).
Assets Under Management: The value of all assets managed by Northstar on behalf of a client. The contract signed by the client and the Investment Advisor Representative will stipulate the management fee to be charged, which will be expressed as a percentage. This percentage is multiplied by the total Assets Under Management to determine the dollar value of the management fee.
Automated Customer Account Transfer (ACAT): A process used by Northstar’s Client Concierge to transfer a client’s assets into a separate account with an institutional broker.
Back-End Load Fund: A mutual fund that charges investors a fee to sell (redeem) shares. Those fees can be significant, 5% or more. See also contingent deferred sales charge.
Back-Testing: Reviewing the historical performance of the assets within a newly created portfolio in order to create a hypothetical performance history.
Balance Sheet: While most often considered part of a business’ financial statements, can also be used to assess the financial health of individuals and households. A balance sheet provides a simple way to determine an individual or household’s net financial worth, by subtracting the total debt owed from the total value of all assets owned.
Basis: See Adjusted Cost Basis.
Bear Market: A broad decline of prices within a market, usually prolonged and characterized by prices falling by 20% or more. Opposite of bull market.
Benchmark: A predetermined measure, usually an index, to compare portfolio performance. For example, common benchmarks to measure equity returns are the S&P 500 or the Wilshire 1000.
Beneficiary: The person who receives the assets of a trust or the proceeds of a life insurance policy upon the death of the grantor or insured.
Best Execution: As required by the SEC, Registered Investment Advisors periodically review the trades made by their custodians on their clients’ behalf to ensure that the trade was executed in a timely manner and at the best price available at the time.
Beta: The measure of an asset’s risk in relation to the market. For example, a stock with a beta of 2.0 would be expected to increase in value by 20% if the broader market increased by 10%. Assets with a negative beta would be expected to move in the opposite direction of the market. A beta of 0 suggests the asset is not correlated to the market at all.
Bid: An offer by an investor wishing to purchase an asset to buy the asset in a public exchange at a specific price. Opposite of ask.
Bid-Ask Spread: The difference between the highest bid and the lowest asked price. The bid-ask spread for large, liquid securities (like Toyota or Microsoft) is usually one or two cents, while spreads for small illiquid securities can be much larger.
Blue Sky Laws: State laws covering the issuance and trading of securities, and regulation of broker-dealers.
Bond: A means for a business or government entity to raise capital through the issuance of debt. Investors who buy bonds are creditors of the bond issuer. The issuer agrees to repay the principal amount of the loan at a specified time. Interest is also paid, generally at a fixed rate for the life of the bond.
Broker-Dealer: A person or business that buys and sells securities for others, and is willing to act as the principal in one side of the deal (either buy or sell the security for its own account). Merrill Lynch and UBS are large brokerage firms. TD Ameritrade and E-trade are online discount brokers.
Bull Market: A broad upward trend in prices within a market. Opposite of bear market.
Bulletin Board: See Over-The-Counter.
Business Cycle: Repetitive trend of economic expansion and contraction. Expansion is characterized by rapid economic growth, full employment and widely available credit. Contraction is characterized by slower or negative growth, higher unemployment, and higher cost of borrowing for businesses and individuals.
Business Risk: The risk that a stockholder will lose his or her entire investment in a company if the company goes bankrupt. If bankruptcy leads to liquidation of the company’s assets, creditors (including bondholders) will be paid back before stockholders, often resulting in the complete loss of the stockholder’s investment. Business risk can be eliminated through diversification.
Buy and Hold: A passive investment strategy in which investments are purchased and held with no further trading activity. Northstar favors a modified Buy-And-Hold strategy, in which the initial purchase of assets is designed to achieve a certain percentage of assets by asset class, and as assets move up and down in value within the portfolio, trades are made to maintain the original balance.
Call Risk: risk that an issuer will call a callable bond if interest rates decline.
Capital: Money invested in a company.
Capital Asset Pricing Model (CAPM): A model for determining the price of risky securities, developed by William Sharpe and John Lintner in the 1960s. CAPM states that the expected return of a security is the risk-free rate plus a risk premium based on the asset’s market risk.
Capital Gain/Loss: The difference, calculated at the time an asset is sold, between the proceeds from the sale, and the cost basis. Income tax is paid on capital gains, while capital losses can be used to lower taxable income.
Capital Gains Tax: Capital gains resulting from the sale of an asset held less than a year are usually taxable at the investor’s marginal tax rate, while long term gains (sales after one year) may qualify for a lower capital gain tax rate.
Cash (or Cash Equivalents): The financial definition includes more than currency. Cash equivalents include assets that can be converted into cash immediately, such as bank checking and savings accounts, money market funds and marketable securities that mature within 90 days (e.g., notes). Similar to liquid assets.
Certified Financial Planner (CFP): A person who has met the education, experience, examination and ethics requirements of the Certified Financial Planner Board of Standards, and has been approved to use the Board’s certification marks. CFP candidates must demonstrate proficiency in many areas of financial planning, including investments, risk management, insurance, estate planning and tax management.
Certified Public Accountant (CPA): A licensed accountant who has met state standards, including education, experience, and examinations.
CFP Board of Standards: A professional regulatory agency that fosters professional standards in personal financial planning so that the public has confidence in the financial planning profession.
Charitable Remainder Trust: A trust through which the grantor can receive income and tax benefits for a specified period of time, and then leave the remaining assets to a charity.
Chartered Financial Consultant (ChFC): A financial planning title awarded by the American College of Bryn Mawr. ChFCs must meet experience and education requirements and pass exams covering finance and investing.
Churning: The practice of trading excessively in a client’s account to generate added income to the broker through commissions. Fee-only advisors, like Northstar, do not receive any compensation for executing trades, and therefore have no incentive to make any more or less trades than are required to achieve the client’s financial objectives.
Closed-End Fund: An investment company that sells shares of its funds but does not redeem shares. Investors wishing to divest fund shares must trade them on a public market, like an individual stock or bond. Not the same as a Closed Fund.
Closed Fund: A mutual fund that is not selling shares to new investors (usually because it has grown too large in size). Not the same as a Closed-End Fund.
Commission: The fee paid to a broker to execute a trade. In recent years, technology and deregulation have led to the establishment of discount brokers, who charge significantly lower commissions than full service brokers, often $10 or less for an equity trade, regardless of the size of the trade. Full service brokers usually have a staff of stock and industry analysts and offer clients recommendations, while discount brokers execute a client’s order without offering advice or an opinion on a stock.
Compounding: Earnings on earnings, or interest on interest. Over a long time horizon, the effect of compounding on a portfolio is significant. For example, if $100,000 is invested for 30 years at 8% in an investment that does not offer compounded interest, the investor would receive $8,000 each year for 30 years, for a total ending balance of $340,000. However, if the interest compounds annually, the ending balance would be just over $1 million. If interest is compounded monthly, the ending total would be almost $1.1 million, which is more than three times the amount you would have without compounding.
Conflict of Interest: A situation which could result in a fiduciary having to choose between the best interest of a client and his or her own interest. Investment advisors who are registered with the SEC or state-registered (like Northstar) have a strict duty to deal with conflicts in a manner that never conflicts with the best interest of the client. All conflicts or potential conflicts of interest must be disclosed to the client. Where disclosure is not adequate to ensure that the advisor will always act in the client’s best interest, the advisor must abstain from the action. Northstar’s Form ADV Part II discloses conflicts of interest, as required by the Investment Advisers Act of 1940.
Conservative Growth Portfolio: As defined by Northstar, a portfolio with less than 30% of its assets held in equities and more than 70% in cash and fixed income investments.
Contingent Beneficiary:The person who receives the assets of a trust or the proceeds of a life insurance policy if the named primary beneficiary is deceased at the time of the death of the grantor or insured.
Contingent Deferred Sales Charge: A back-end load mutual fund fee that decreases over time. The full commission is charged if shares are redeemed within a short period of time (such as less than one year). If the investor retains the shares for many years, the back-end load may be eliminated entirely.
Contraction: A short period of slower or negative economic growth, higher unemployment, and higher cost of borrowing for businesses and individuals.
Contrarian: An investor or trader who follows a style of buying assets that have declined in value, and selling assets that have risen. The contrarian argument states that securities tend to trade within a range and if a security moves out of that range, it should return to its usual level. When a price movement is seen, the contrarian trader must assess whether the movement is the result of normal supply and demand factors or is the result of overreaction, trading error, automated selling or buying, a short squeeze, market manipulation or other abnormal factors. Even when a price movement is abnormal, there is no guarantee it will return to a normal range quickly or ever.
Correction: A reverse (usually rapid and short-term) in the price of an asset or a market following a long trend in movement a single direction.
Correlation: The degree to which the movements of the prices of two or more investments are related. Values close to 1 suggest a high degree of correlation, while a value of -1 suggests an inverse relationship (when one price rises, the other falls). A value of 0 suggests there is no correlation between the price movements of the investments.
Coupon: Periodic (usually semi-annual) interest payment made to a bondholder. The term stems from the largely outdated practice of issuing bonds with coupons physically attached. The coupons each had a stated maturity date, at which time they would be detached from the bond and redeemed for the stated cash value. Today, coupon interest is automatically credited to the brokerage account of the bondholder on the scheduled payment date.
Coverdell Education Savings Account: Formerly known as an Education IRA. An account created to pay for a beneficiary’s higher education expenses. Contributions are limited, and are not tax deductible. Accumulated earnings are not taxed if distributions are used to pay for qualified education expenses. Contributions are not allowed after the beneficiary reaches age 18.
Credit Risk: The risk that a debt issuer might default on its repayment obligations.
Currency Risk: See Exchange Rate Risk.
Custodian: A qualified third party broker-dealer who maintains separate accounts in the name of the client or the client’s trustee.
Custody: A financial advisor has custody of assets in his/her possession or if he/she has the ability to appropriate them.
Cyclical Stock: A stock that tends to follow the business cycle, rising when the economy is in a boom and falling during economic contractions. Housing and durable goods are two examples.
Debt Service: The amount of money spent repaying principal and interest owed to creditors.
Defensive Stock: A stock that does not decline in value with the rest of the market during a contraction or recession, usually because demand does not decline. Food, utility and tobacco stocks are considered defensive stocks.
Defined Benefit Plan: An employer sponsored plan that promises a pension benefit upon retirement, with no contribution necessary by the employee, and no separate account created for the employee.
Defined Contribution Plan: An employer sponsored savings plan in which the employee, the employer or both make contributions to a separate account for the benefit of the employee. Examples include 401(k) and 403(b) plans, profit sharing plans, employee stock ownership plans, Simplified Employee Pensions (SEP) and SIMPLE IRA plans.
Disability Insurance: An insurance policy that insures an individual in the event of an accident or illness resulting in disability that prevents the individual from working and earning income. Many employers offer employees both short-term and long-term disability plans. Short term plans generally cover the employee who is out of work for 6 months or less, while a long-term disability policy will pay the insured after 6 months, until the individual can return to work, normal retirement age, or death, whichever comes first.
Disclosure: For a financial advisor, Form ADV Part II, an SEC-required document that discloses all conflicts of interest and other pertinent information to clients and potential clients. This form is provided to all potential clients prior to entering into a written Advisor-Client Agreement, and is offered to all clients at least annually. Click here to view Northstar’s current Form ADV Part II.
Discount Broker: A broker that conducts its clients’ trades online and offers little or no opinions or advice on trades. Commission rates are usually much lower than those of a full-service broker.
Discretionary Authority: Permission to perform various functions, at the client’s expense, without further approval from the client. Such functions include the determination of securities to be purchased or sold, the amount of securities to be purchased or sold, and the broker-dealer to be used.
Diversification: The process of reducing risk by spreading assets across many different investments, preferably in different asset classes.
Divestiture: Selling or disposing of an asset or investment.
Dividend: A percentage of a company’s profits paid to its stockholders. Note that stockholders are part owners of the company, and therefore receive a share of the company’s profits. Bondholders are creditors, not owners, and receive interest, not dividends. Bondholders receive interest due before stockholders receive dividends. The amount of interest a bondholder receives is stated in the bond agreement and cannot be changed, while the dividend amount paid to stockholders is determined by the Company’s directors.
Dividend Reinvestment: Automatically using dividends paid by a stock or a mutual fund to buy more shares of the stock or fund. Usually there is no transaction or trading cost to reinvest dividends.
Dollar Cost Averaging: The widely accepted practice of investing a fixed amount of money at regular intervals in a mutual fund, thus enabling the investor to buy more shares when the price of the fund goes down. As a result, the investor’s average cost per share will be lower than the average of the prices at which shares were purchased.
Double Taxation: Government taxation of the same money twice. Corporate earnings are taxed at the corporate tax rate. Net profits after tax that are distributed to stockholders as dividends are then subject to income tax.
Downgrade: A negative change in ratings for a stock, or other rated security. A downgrade by a major analyst or brokerage house can have a negative impact (at least short term) on the price of the company’s security. Opposite of an upgrade.
Duration: A measure, expressed in years, of the price sensitivity of a bond to small changes in interest rates. Bonds with higher durations are generally more sensitive to interest rate changes.
EAFE: See European Australian and Far East index.
Education IRA: See Coverdell Education Savings Account.
Efficient Markets: Proponents of Efficient Market Theory believe that financial markets are efficient – stock, bond and other asset prices reflect all known information and therefore are unbiased about future prices. Therefore it is not possible to consistently outperform the market by using any information that the market already knows, except through luck. Professor Eugene Fama of the University of Chicago developed the theory in the early 1960s.
Emergency Fund: A cash reserve readily available (in a bank savings or money market account) to meet the costs of unexpected financial emergencies. As a general rule, it is recommended that households maintain three months’ income in an emergency fund.
Emerging Markets: Financial markets in countries that do not have fully developed economies. Emerging markets are considered riskier than developed international markets (such as Japan and the EU) and are characterized by low per capita income, primitive or non-existent securities markets and/or low industrialization.
Employee Retirement Income Security Act: See ERISA.
Equilibrium Price: The price at which supply equals demand. In an efficient market, securities prices will naturally and quickly settle at an equilibrium price following any news or event.
Equity: Ownership interest in a company, more commonly referred to as stock. In real estate, the difference between the market value and the debts claimed against the property.
ERISA: A federal law establishing minimum standards for company-sponsored pension plans, to protect the interest of employees participating in such plans. Among the key provisions are disclosure of financial information and standards for plan trustees.
Estate Planning: Preparing while an estate owner is still alive for the orderly administration, management and distribution of a person’s assets and liabilities upon death. The most basic component of estate planning is a will. Trusts, insurance, and powers of attorney are other important components to carry out the wishes of the estate owner and reduce the tax burden and other liabilities on the beneficiaries of the estate.
Estate Tax: Often referred to as the ’Death Tax’, estate tax is levied by the federal and state governments on the transfer of property at death. ‘Property’ includes any tangible personal property, real estate, jointly owned property, life insurance, employee benefits, certain gifts, and other assets. Proper estate planning can help to reduce the potential impact of estate taxes.
ETF: See Exchange Traded Fund.
Ethics: Standards of conduct or judgment. The CFP Board of Standards publishes and enforces a code of ethics for all Certified Financial Planners in order to promote the reputation of the financial planning profession. The CFP Boards ethics standards are fully incorporated into Northstar’s business standards.
Europe, Australia, and Far East index (EAFE): One of the most commonly used international stock indexes, created by Morgan Stanley.
Event Risk: The possibility that an event will negatively impact a company’s credit rating and/or its ability to pay interest and principle to bondholders.
Exchange Rate Risk: The risk that an international investment may decrease in value because of changes in the currency exchange rate. Also called currency risk.
Exchange Traded Fund: A collection of assets similar to a mutual fund, but which trades on a live exchange. Many ETFs are index funds. Because they do not recalculate their net asset value during the day, ETFs can trade higher or lower than their net asset value.
Execution: The process of completing the purchase or sale of securities. Although the brokerage account usually reflects the trade as soon as it is executed, actual settlement (payment and transfer of ownership) occurs between one and five days after execution. (Mutual fund settlement typically takes one day.) International settlements can take significantly longer.
Expected Return: What an investor expects to receive for investing in a given asset, given a probability distribution for the possible rates of return. Expected return equals the risk-free rate (usually the U.S. Treasury rate) plus a risk premium (an added expected benefit for taking on added risk) multiplied by the asset’s beta. EXPECTED RETURN IS NOT THE SAME AS ACTUAL RETURN. Any investment carries the possibility of returns lower than the expected return or even loss of invested capital.
Fallen Angel: A bond that has fallen from investment grade to a ‘junk’ rating. See also high yield bonds.
FDIC: See Federal Deposit Insurance Corporation.
Federal Deposit Insurance Corporation (FDIC): The U.S. government agency that insures bank deposits. Generally, each named account holder is insured for up to $100,000 in the event the bank cannot repay principle due to insolvency. Note that neither federal insurance nor any other insurance can protect the investor against principal losses due to falling securities prices.
Fee-Only Advisor: An investment advisor (like Northstar) that does not receive commissions, incentives or any other form of direct or indirect compensation for the selling of a specific investment product. Revenue comes solely from the fees charged (usually quarterly) directly to clients for portfolio management and other financial services.
Fiduciary: Someone who acts on behalf of and for the benefit of another. In a financial relationship it is characterized by control over assets, finances or actions. Investment advisors have a stronger fiduciary duty than broker-dealers.
Financial Planning: The process of evaluating the financial condition of an individual or household and developing a plan to help them achieve their financial objectives. Steps in the process typically include 1) establishing a relationship with the client, 2) doing a background analysis, 3) establishing the financial objectives, 4) developing a plan, 5) implementing the plan, and 6) measuring performance.
Fixed Annuity: See Annuity.
Fixed Costs: In viewing personal or business expenses, it is helpful to divide fixed costs from variable costs. Fixed costs generally do not change based on usage or other factors, and include mortgage payments, car payments and life insurance. Variable costs include the electric bill, vacation expenses and occasional gifts to relatives or friends.
Fixed Income Investment: An investment that pays a fixed dollar amount, usually expressed as an interest rate. U.S. Treasuries, municipal and corporate bonds are the most common fixed income investments.
Form ADV: See Disclosure. Click here to view Northstar’s current Form ADV Part II.
Front-End Load: A sales fee paid at the time of purchase of a mutual fund.
Front Running: The practice of a broker executing a trade for his or her own benefit with advance knowledge of a block transaction that will influence the price of the security. The SEC prohibits this practice.
Full-Service Broker: A broker who provides clients advice and opinions on security selection, as well as financial planning services. Full-service brokers managing a client’s brokerage account do not have the same fiduciary responsibility as independent Registered Investment Advisors, and often select investments from a relatively small list of commissionable products or broker-recommended products.
Fund of Funds: A mutual fund or hedge fund that invests in other mutual funds.
Fundamental Analysis: Security analysis that focuses on a company’s financial statements and all other public information. By contrast, see Technical Analysis.