More Definitions
Continuing our theme from last week, let's review three more of the finance terms folks report having little knowledge of: asset allocation, bull and bear market, and endowment. You may know these terms already and, if so, that's great. But since about 50-60% of Americans are either unaware of or aren't confident about the terms, let's dive in.
Asset Allocation – Asset allocation is a foundational component of financial planning and investment management, so it pays to know at least something about it. Weighty scholarly works have been written about the topic and it's hard to condense a definition down to a few paragraphs, but I'll try.
Asset allocation is a strategy that helps determine your investment return and the downside risk you'll have to endure to get it. Since more risk equals more return (and vice versa), the asset allocation process mixes riskier investments, such as stocks, with less risky investments like bonds and cash, to find the optimal blend for an investor.
Mixing different categories of investments together turns asset allocation into a series of tradeoffs. Do you want more growth over time? If yes, this means you'll need more stocks and will have to endure more downside risk in the short-term. Want more stability? If so, your allocation will require more bonds, cash, as well as lower expectations for growth.
Ideally, your asset allocation is based on your tolerance for risk and how hard you need your money to work for you. If created appropriately, your allocation should stay the same for a very long time and would only be altered if something fundamental changes in your life (not just because the market is down, political concerns, etc).
Bull & Bear Market – While the history on this is unclear, these terms have interesting beginnings.
Market lore says that a rising stock market is known as a "bull market" because bulls thrust their horns upward when attacking, so prices moving higher became known as being "bullish". A "bear market", on the other hand, was named after a bear's downward swipe during an attack and became associated with prices moving lower.
Perhaps ironically, there isn't a specific technical definition of what constitutes a bull market, but there is for a bear market. Stocks, for example, are said to be in a bear market after prices have fallen at least 20% from a recent high.
Bull markets and bear markets are best used as descriptors for longer-term sentiment. The terms can describe stocks, bonds, real estate, just about anything where buyers and sellers can be said to be optimistic (bullish) or pessimistic (bearish) about their prospects.
We're currently within an almost ten-year long bull market for stocks that began in March of 2009 during the Great Recession. Investors have been bullish since then and investment returns have been solid. At some point in the future sentiment will experience a meaningful shift, investors will become bearish, and we'll enter a bear market, continuing a normal cycle that plays out over time.
Endowment – An endowment is a chunk of money set aside to benefit an organization, such as a university, hospital, or charity. Money or other property is gifted by one donor or by many, and the gifts form the principal of the endowment. The principal (another word on the YouGov survey – meaning the original amount given) is then managed to generate income the university spends on financial aid grants, for example.
With endowments, the principal is often left untouched and having more principal means having more income to spend. The government has rules about this but, in general, endowments try to hoard money as much as possible. The reason is that unlike you or me, endowments often have infinite time horizons, meaning they think about financial health over multiple generations, not just the current one, so it's always better to have more money.
In a twist on the theme, another way to think about endowments is like a retired couple wanting to preserve all their assets for their children while just living on the income the assets generate in the meantime. When the couple passes away, it could be said that they left an endowment for their kids who would then, hopefully, do the same for the grandkids, and so on for generations. In practice, the government tries to limit this activity, but the example makes understanding endowments a little easier.
A takeaway for investors could be that it's helpful to think long-term about your investments, much like an endowment would, and not get too caught up in the news of the day. Endowment managers focus on process, asset allocation, and not overspending, all helpful things for us to remember.
Hopefully this helps you understand these fundamental finance terms a little better. If you have questions, please don't hesitate to ask.
Here's a link to a summary of the YouGov report...
Have questions? Ask me. I can help.
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