Gnomes are small creatures who live underground and guard treasure chests. You may think of them as existing only in fables.
They’re alive and well, and thriving in the investing world. They’re known as Vocabulary, Goals and Risk. And together they’re a powerful trio that can keep you from reaching for wealth.
Fortunately, gnomes have a vulnerability—one ray of light can render them harmless by turning them to stone. Here are tips for turning that vulnerability to your advantage:
Vocabulary. This particular gnome is also called “Jargon.” Jargon thrives in the investment world. In fact, Jargon is so prevalent you may be fairly fluent in investment-ese. For instance, you’re no doubt familiar with the difference between a forward-charging bull market and a ready-to-hibernate bear market. And part of your portfolio is probably already invested in dividend reinvestment plans (DRIPs) and mutual funds.
But terms like ex-dividend, reverse splits, and P/E ratios may still sound like the vernacular of tiny beings who live underground. Worse, those words are only the top coins in the treasure chest—there are plenty more buried underneath.
There are several techniques for casting light onto the gnome of Jargon:
- Web sites like http://www.investopedia.com/dictionary/ are useful translators. They can tell you things like the meaning of ex-dividend, which is the date a stock is sold without the most recently declared dividend as part of the price.
- Books from the financial shelf of your library can define reverse splits, among other things. A company that declares a reverse split reduces the amount of outstanding stock in the market by replacing the number of shares you own with a lesser amount.
- Investment classes at your local college can teach you financial calculations such as the price to earnings (P/E) ratio, and their uses. The P/E ratio is the price of a stock divided by the earnings per share. When compared to similar stocks, a P/E ratio can be a useful initial indicator of whether a stock is properly valued in the marketplace.
- Financial magazines, radio and television news programs and newspapers can also illuminate investing jargon.
Goals. This gnome may seem innocuous, but is, in reality, fairly sneaky. How? Vague, unwritten goals with no set time frame can be impossible to get started on or meet.
Suppose your goal is to save money. That’s a fine aspiration. But save money for what? An emergency fund? A car? A new house? A college education? Retirement income? Each has a different time frame, funding requirement and investing approach.
Getting past the Goals gnome means focusing your light directly on the path to your financial future. Stepping stone luminaries include:
- A brainstorming session that involves family members in the discussion and clarification of future financial needs.
- The use of free on-line financial calculators to determine the amount to save on a regular basis.
- A written plan of your goals and your commitment to reaching them.
Risk. The Risk gnome may be the most frightening of the three investment world gnomes. Risk means uncertainty, and uncertainty can never be fully eliminated.
You can, however, turn the Risk gnome to stone with the laser-light of assessment. Risk assessment means focusing on whether the return you’re getting is worth the risk you’re taking. The assessment laser has three beams:
- Your personal risk aversion level
- Your financial objectives
- The type and amount of risk presented by specific investments
If you want to eliminate the gnomes that are keeping you from reaching your financial future, shine the light of knowledge on them. Learn the vocabulary, establish financial goals, assess and understand the risks. Once the gnomes are nothing more than harmless stone, you’ll be free to lift the lid of the treasure chest called investing.