13 Essential Investing Terms All Beginners Need to Know

Learning to invest is like learning to speak new language. Many people find investing and personal finance confusing because of the confusing investing terms.

No need to panic, it won’t be this way for long. You can learn to speak this language of investing fluently in no time. That’s why I’m going to break down some of the essential financial terms every investor needs to know to invest money wisely. So breathe, relax, listen up, and watch these videos on investing terms.

1. Margin of Safety

You’re going to hear Margin of Safety a lot. So what is it?

Margin of Safety is how we provide room for error when we invest. There is the sticker price that a business is going for in the market. Let’s say this business is going for twenty dollars.

Then there’s the price it’s actually worth. Let’s say that’s fourteen dollars. Then there’s how much we want to buy it for. The difference between the sticker price and how much we want to buy a business for is the Margin of Safety.

The concept of Margin of Safety is crucial in value investing. By purchasing securities at a significant discount to their intrinsic value, investors can protect themselves against errors in judgment or unforeseen market downturns. This approach not only minimizes potential losses but also provides opportunities for substantial gains when the market corrects its undervaluation.

For Rule #1 investing, we use a fifty percent margin. That means whatever a business is worth, we want of buy it for half of that price. So in this example, we want to buy this business for seven dollars. We never make purchases at the sticker price.

2. Return on Invested Capital

Another term you’ll always hear is Return on Invested Capital or ROIC.

ROIC is the percentage return you get back from the cash you’ve plowed into your business.

One way to calculate this is to subtract dividends from net income. Then divide that number by total capital.

For example, let’s say your kids finance a lemonade stand for two-hundred dollars to get it up and running. That is their “investment capital.”

After a week, they’ve made three-hundred dollars. Subtract the invested capital of two-hundred dollars, they made a hundred dollar profit.

You divide the dividend, one-hundred dollars, by the total capital, two-hundred dollars. That gets us a fifty-percent ROIC, which is a pretty amazing capital gain return!

ROIC is a key indicator of a company's efficiency in allocating capital to profitable investments. A consistently high ROIC suggests that the company has a sustainable competitive advantage and is likely to generate value for its shareholders over the long term. Investors should compare a company's ROIC to its cost of capital to assess whether it is creating or destroying value.​

As Rule #1 investors, we want to see at least ten percent ROIC per year and we don’t want to see it on a downward trend.

3. Dollar Cost Averaging

It’s the practice of buying a certain number of shares with the same amount of money in a given stock periodically, regardless of the price per share.

Investors do this because it allegedly helps reduce their risk of investing a large amount in a single stock at the wrong time.

For example, you buy one-hundred dollars worth of shares in a business every year, no matter what the price is.

So when the price is down, you end up buying more shares with your allotted money. And when the price goes up, you end up buying fewer shares.

The idea is you’re making the average cost per share of stock smaller, minimizing your investment risk.

While DCA can mitigate the risk of investing a large amount at an inopportune time, it's important to note that this strategy does not guarantee a profit or protect against loss in declining markets. Investors should consider their individual financial situation and investment goals when deciding whether DCA aligns with their overall strategy.

Instead of trusting DCA, Rule #1 investors already know the value of a wonderful business and buy it when it’s undervalued. We buy one dollar for fifty cents and repeat. We never buy when the price is up.

4. Payback Time

Payback Time is the amount of time it takes before you get the return on your invested capital.

Calculating Payback Time involves dividing the initial investment by the annual cash inflow. For example, if an investment of $10,000 generates $2,000 annually, the Payback Time would be 5 years. This metric helps investors assess the risk and liquidity of an investment, with shorter payback periods generally being more desirable.​

In Rule#1 investing, our payback time goal is eight years or less.

If a business makes a million dollars a year, you want to know how long it would take you to get your money back in eight years or less at whatever price you were to buy it for.

Once you earn all that money back, you have no risk. You’re just playing with house money.

If you want to play around and calculate Payback Time for a company you are interested in currently, I have a calculator you can use. But essentially you divide your investment by the amount of money the business makes a year.

Now let’s see how Payback Time and Rule #1 investing all tie together to earn you more money.

Assume that you find a business you really understand with a great Moat and Management you can get behind. Assume it has a conservative value of twenty dollars a share, it’s selling for a Margin of Safety price of ten dollars, and it has a Payback Time of eight years.

You have ten thousand dollars to invest and you buy one thousand shares.

Six months later you’ve managed to save another ten thousand dollars and are looking for something to invest in, so you reconsider this business you love.

But now it’s priced at twenty dollars, with a Payback Time of thirteen years. Nothing has fundamentally changed in its long-term value, but it no longer has the Margin of Safety or Payback Time we’re looking for.

That means that you can’t buy any more shares with your ten thousand dollars because we don’t use Dollar Cost Averaging to buy it at any price. At the end of five years, the stock price is still at twenty dollars, and if you decide to sell, you’ve doubled your money and made a fifteen percent annual return on your one thousand shares. Nice!

5. Assets

Assets are items that have value in the market. Resources controlled by a company from which future economic benefits are expected to be generated. In a business, an asset is something the business owns that has a dollar value. (An asset in general, is anything of value that can be traded.)

Assets are categorized into current and non-current assets. Current assets, such as cash and inventory, are expected to be converted into cash within a year, while non-current assets, like property and equipment, are long-term resources used in the company's operations. Understanding the composition of a company's assets can provide insights into its operational efficiency and financial stability.​

An intangible asset is an asset that has a dollar value but may not be worth anything unless the business is successful. Typically this is an asset that was acquired through buying another business. The price paid in excess of that business’s net worth is often called “goodwill” and is treated as an asset for GAAP purposes.

6. Sticker Price

The sticker price is the intrinsic value of a business. The value of a business, despite the selling price on the market. Rule #1 investors seek to buy businesses at 50 percent of their Sticker Price, when they are undervalued. Sticker Price is determined by performing calculations on the Four Growth Rates (see definition).

Determining the Sticker Price requires a thorough analysis of the company's financial statements, growth prospects, and industry position. Various valuation methods can be employed to estimate intrinsic value. Investors should seek to buy stocks trading below their Sticker Price to maximize potential returns.​

7. The Stock Market

Stock is ownership in companies that are public - meaning they have sold off chunks of their company.

Together as a group, this collection of companies is known as the stock market. The key to success in the stock market is buying a good business that will survive for 10-15 more years. And buy it on sale! Make sure the business is durable and has a CEO with integrity.

The stock market's performance is influenced by numerous factors, including economic indicators, corporate earnings, and geopolitical events. While historical data shows an average annual return of approximately 10% for the S&P 500, actual returns can vary significantly in the short term. Therefore, a long-term investment horizon is essential for weathering market volatility.​

8. The S&P 500

The S&P 500 is an index compiled of the 500 best stocks currently in the market.

The S&P 500 is a market-capitalization-weighted index, meaning that companies with higher market capitalizations have a greater impact on the index's performance. As of 2024, the index has become increasingly concentrated, with the top 10 stocks accounting for over 33% of its value. This concentration can introduce additional risk, as the index's performance may be disproportionately influenced by a few large companies.

In general, the S&P is a measure of how the stock market is doing. I want you to disregard the S&P 500 when it comes to making money.

Focus on your absolute return - how much money are YOU making every year? Don’t compare yourself to any index.

9. Index Funds & Mutual Funds

An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the S&P 500.

Index funds typically have lower expense ratios compared to actively managed mutual funds. For instance, Vanguard has recently announced significant fee reductions across many of its funds, enhancing the cost-effectiveness of index investing.  Lower fees can have a substantial impact on net returns over the long term, making index funds an attractive option for cost-conscious investors

Mutual funds are doing the same thing that index funds are doing, except they charge higher fees. Both diversify your portfolio across hundreds of stocks.

Index funds are just very specific to the index that it’s tracking.

10. Earnings Per Share

Earnings per share are the net earnings of the company divided by the number of shares in the company.

EPS, also known as profit per share, is used to calculate the value of a business. EPS can be influenced by factors such as changes in net income, share buybacks, or issuance of new shares. It's important to analyze the components affecting EPS to understand whether changes are due to operational performance or financial engineering. Additionally, comparing a company's EPS growth to its industry peers can provide context regarding its competitive position.​

Make sure the cash flow of the company is as good as its earnings per share.

11. 401(k) Plans

The 401(k) is a retirement account created by taking a portion of your salary pre-tax each month. This is also known as a defined contribution plan.

For 2025, the IRS has increased the contribution limit for 401(k) plans to $23,500, up from $23,000 in 2024. Individuals aged 50 and over can make additional catch-up contributions.  Maximizing contributions to employer-sponsored retirement plans can enhance retirement readiness and provide tax advantages.

As noted, with a 401K plan, there is a defined amount of money that you can put in your account each month. Once you retire, you pay taxes to the federal government. Today, however, if the stock market goes down, your retirement fund decreases. I recommend getting a self-directed 401(k) plan from management so you can invest the money where you want to.

12. 10-K Reports

A 10-k is a financial report. Every public company has to file a 10-k annually. In it, you'll find a full explanation of the company. It includes things such as risks, numbers, and anything else about the business. The CEO and CFO have to fill it out properly and sign it, risking jail time if the information is false or inaccurate.

The 10-K report is divided into several sections, including the business overview, risk factors, financial data, and management's discussion and analysis. Reviewing the 10-K provides a comprehensive understanding of the company's financial health, strategic direction, and potential challenges. Investors should pay particular attention to the risk factors and management's discussion to gauge future prospects.​

Use 10-k’s to your advantage when investing. Read them and gain knowledge about companies and their competitors.

13. Roth IRA

It is a wonder the federal government has not discontinued the Roth IRA yet. It produces a phenomenal retirement fund!

The beauty of it lies in the fact that you put money into a Roth IRA after you pay taxes. Once you put the money in, it never gets taxed again. This also includes all of the money that grows on top of it. I recommend all new investors get one NOW.

In 2024, the contribution limit for IRAs, including Roth IRAs, has increased to $7,000, with an additional $1,000 catch-up contribution for individuals aged 50 and over.  Moreover, the income limits for Roth IRA eligibility have been adjusted, allowing single filers with a modified adjusted gross income (MAGI) of less than $146,000 to make full contributions. These updates provide greater opportunities for individuals to take advantage of the tax-free growth and withdrawal benefits offered by Roth IRAs.

Are there any other investing terms you'd like me to go over? Let me know in the comments. Learn how to invest like the best investors in the world from my free Transformational Investing webinar.