Investment Terms Explained

John Maher talks investment terms with John Brennan, Senior Vice President, Trust & Financial Services and Rick Ciolino, Trust Investment Officer, at Cape Ann Savings Bank in Gloucester, Massachusetts. They cover the essentials about stocks, bonds, mutual funds, and portfolios. They explain the difference between quantitative and qualitative analysis, and they talk about how Cape Ann Savings uses different types of analysis to shape portfolios for investors.

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Transcription Disclosure: Below is a transcript of the conversation between John Maher, John T. Brennan and Rick Ciolino. Please note, this is an unedited "word for word" rendition of the actual conversation and is not intended to be grammatically correct.

John Maher: Hi, I'm John Maher. I'm here today with John Brennan, Senior Vice President of Trust & Financial Services and Rick Ciolino, Trust Investment Officer at Cape Ann Savings Bank in Gloucester, Massachusetts. Today our topic is investment terms explained. Welcome, John and Rick.

John Brennan: Hi, John.

Rick Ciolino: Hi, John.

What Are Stocks?

John Maher: So, Rick, we'll start with you today. What are stocks? Can you explain what those are and what that means?

Rick Ciolino: Certainly, John. Stocks are a type of investment that we use that provide growth for a client. And basically what a stock is is quite simple. It's ownership of a company. So when a corporation is growing and looking to raise money, what they do is they will issue shares which will actually represent ownership of the company. So as an investor, you're able to buy shares in companies that represent actual ownership. And with that, as the company grows it becomes worth more, because they're earning more money, your share of value will hopefully rise as well.

Large, Mid, and Small Cap Stocks

John Maher: Okay. And a term that I've heard in terms of stocks is large cap stocks, mid-cap stocks and small cap stocks. What does that mean and what are the differences?

Rick Ciolino: What you often hear us talk about when we're talking about investing is diversification. And we find many ways to break up the universe of what you can invest in for different types of strategies. So when we talk about a large cap, that's typically what we would consider a large company. And capitalization refers to the overall how much the company is worth, what its full capital is. So large capitalization stocks are the largest of all the companies that are available to invest in.

And these are typically the names that you mostly would've heard of. Some of the largest of the companies that have stock offerings out there might be Apple, Microsoft, Amazon, Tesla, names like that. So as we start breaking it up, and we do look for different ways to invest, and different ways to diversify a portfolio to get into a lot of different assets, we might decide for a particular strategy that, all right, it's good to have a core of large cap stocks in the portfolio. So large companies that basically are a little bit more stable than smaller companies, and they allow, hopefully, growth for our clients that invest in them.

But then as we break down as to how we're investing and what we want to invest in, we say, "Okay, we might be able to get a little bit more growth if we buy some smaller companies." Again, this capitalization is the size of the company, so we might buy something, and this is not considered large, this is considered mid-cap, which would be a company with a capitalization anywhere from 3 billion to 10 billion in total assets. Now that just shows the size of some of these companies that we're investing in, where the top companies are over a trillion dollars in assets.

So as we're looking for different categories to invest in, if we look in the mid-cap, yeah we might find companies that have the ability to grow into large caps. So we try to hit that mid-cap space and then we look for something with a little bit more diversification, a little bit different, we might go to the small cap market. And the small cap are companies that typically are under 3 billion in total capitalization.

So they issue shares just like the larger companies do, but they're smaller and it's a different type of investment. Interesting thing that we look at is we try to invest in all categories most of the time just to try to get a good diversification because they may act differently. For example, coming out of a recession, you'll see small companies are smaller, they have the ability to move quicker and to adjust to the market faster. So they may be the winners in certain times of the economic cycle. Whereas in a poor economic cycle, when things aren't going so well, we might lean more on large companies that are more stable and are more able to weather it through a poor economy. So there are a lot of different categories we look at.

What Are Bonds?

John Maher: Okay. And then our next investment term that we want to discuss is bonds. Tell me a little bit about bonds and what they are.

Rick Ciolino: Certainly. As stock is ownership in a company, a bond is the company borrowing from you. So often, in addition to giving out ownership of the company, sometimes the companies may want to retain their ownership, but they need to raise capital. And they might have a new project, they might just need more money for operations, they might be building a new plant somewhere.

What they may do is they could issue bonds. And by issuing these bonds, they're setting out and they're taking your money in and they're giving you this bond. And what you end up with is investment where the terms are set for how much you are going to return on it. So typically what they'll do is they'll issue a bond... I'll give you an example. They could issue a million dollars in bonds maturing in five years at 10%. So that means the investor gets back every year 10% of their investment until it hits that maturity in five years.

Now, honestly, I used a very high interest rate. I probably should've used a five-year, a 5% or a 4% bond, because that's more likely what we'll see in the market for bonds. But it allows for a very stable income for the investor and it's a way to invest your money with expecting the money to come back in. Now, just like stocks can be more aggressive and less aggressive based on the company you're purchasing it from, bonds can too. And there's more risky bonds and less risky bonds depending on who the actual issuer is that is borrowing money.

Best Stocks and Bonds for Investors

John Maher: Right. And do you have particular types of stocks and bonds that you recommend generally for investors?

Rick Ciolino: Well, I would say yes, but it's a very broad base. So typically what we'll do is we'll get to know the client and see what's most important and the best way to meet the client's goals. And we try to buy investments, and we're not always looking for the best investments, because we have to offset the risk and the return. So we don't want to take the riskiest assets all the time because there might be a consideration for not losing the money and having stability in your returns as well.

And typically what we do is we'll start with a core set of large cap companies and then we put different types of assets in. We might decide that you want half the money invested in bonds and half the money invested in stocks. And then on the stock side you might say, "Okay, we'll put three quarters of that money into large stable companies and then we want some exposure to small cap because we think there can be some more growth there, some mid-cap as well." And we might actually bring some international exposure into the portfolio at different levels of capitalization. Different levels of size as well.

So it is all in building a very diversified portfolio that can have less fluctuation over time. Because if you think of it, the large companies may not move the same way the small companies move. They might go up and down based on different economic cycles or different news within the economy. Same thing on bonds. They will react differently than stocks. And so what we try to do is we try to balance the return with the risk and get the highest return that we think we can get for projected risk.

What Is an Investment Portfolio?

John Maher: Okay. You brought up another term, which is your portfolio. What is an investment portfolio? What does that mean?

Rick Ciolino: Yeah, sure. An investment portfolio is simply your account. So if you have your savings account and you might just have nothing but cash in there, then your portfolio you'll have money that you invest into the portfolio account, and then what you do is you purchase different types of assets. So your portfolio may have a certain percentage of stocks, a certain percentage of bonds, you may have other assets in there as well. So the portfolio is the full account.

John Maher: So basically it's made up of all of your different investments. Like you said, you can have a certain amount in your large cap stocks and some mid-cap or small cap stocks, you have some bonds here and there and all of those things combined make up what your investment portfolio is.

Rick Ciolino: Exactly. And what we try to do is our goal is to develop a portfolio that's going to work for you. Instead of just buying one asset, for example, that we say, "Okay, we'll live or die by how well this does." This is a portfolio that has multiple assets with multiple different goals trying to reach an overall return at the lowest possible risk.

What Is a Mutual Fund?

John Maher: So you can invest in certain stocks of particular companies, but you can also invest in something called a mutual fund. What is a mutual fund?

Rick Ciolino: So a mutual fund is just a basket of investments. So as I've been talking about buying individual stocks, it makes sense when you're buying stocks you have to pay for the shares. And you have to buy multiple stocks. As I mentioned, we try to buy large cap, small cap, mid-cap. If we were to buy an individual portfolio, there could be 50 or more individual investments in that portfolio.

Now what are mutual funds are groups of investments. So that will allow you to buy into that group. So instead of buying, for example, a bunch of small cap companies because we don't want to take risk with just one, we can buy a mutual fund that invests only in small cap companies. So the interesting thing is there are actually more mutual funds on the market than there are individual companies because there are so many different types of funds out there that do different things.

You can buy large cap, you can buy small cap, you can buy mid-cap, you can buy international, you could buy commodities within the different categories. You could have more companies that are growing, you could look for companies that are lower priced, which we call penny stocks. You can look at companies that focus only on dividends. There are so many different aspects and so many different types of investments that you can look at. And by using combinations of mutual funds and individual stocks, we put together portfolios that make sense for the clients and can be well diversified and have a certain overall goal.

Assets in Mutual Funds

John Maher: Are mutual funds just groups of stocks that you're investing in or can they include bonds as well?

Rick Ciolino: They certainly can include bonds as well as commodities or they could be simply a bond fund. You could buy a fund of just treasury bonds. You could buy a fund of just high yield, which are high yield bonds, which are bonds that have very high interest rates because the companies are not as solvent in the way when they go to the market to issue bonds, they have to issue them at higher rates.

There's so many different categories of mutual funds on the bond side, on the stock side, like I mentioned, through commodities, through hedging strategies, there were just a lot of different choices.

What Is an Index?

John Maher: And then our final investment term is an indices or index. What is that?

Rick Ciolino: An Index is something that we lean on as a benchmark. And basically what it is is it's a way to categorize all these different investment categories. So most of your listeners I'm sure have heard of the S&P 500, and basically what that is, that's an index. That is the 500 most influential companies in the United States.

And this group, Standard and Poor's, is an investment firm that decides and will make changes from time to time. It's basically the biggest, but not necessarily the biggest, they try to find the leaders in every industry and they try to come up with the 500 companies that are considered the leaders, the most influential. So that's one index.

Then we have smaller cap indexes and mid-cap indexes that we have indices for all different categories. And, again, as an investment manager, it helps me because I can take a look and I can say, "Okay, what have the different benchmarks done and how do I want to invest this client's money by using different asset categories?" And using the benchmarks as ways to determine what expected return will be, and whether or not we're doing well for the client, or whether or not we need to do something different for the client.

Investing in an Index

John Maher: So can you invest in a particular index, like the S&P 500, just like you would a mutual fund?

Rick Ciolino: Certainly. And we will use them from time to time for simplicity. We certainly use them for smaller companies from time to time and these can be done through a few different ways, and mutual funds is certainly one of them. You could buy a mutual fund that only invests in the index. These tend to be lower cost, they tend to be more efficient in that sense and some clients or investors will like them because of their ability to just get you market exposure without doing the management and paying the cost.

So you can do this for mutual funds is also something called an exchange-traded fund, which is basically just like a mutual fund, it's a basket, but instead of having a group of investment managers that decide what goes into the fund, they're following nothing but an index. And they're traded on the stock market so you can buy and sell shares of the exchange-traded fund. And on a different aspect, it's right for certain investors and we use it in certain cases. We'll use exchange rated funds, we'll use mutual funds, depending on the situation.

Quantitative Vs. Qualitative Analysis

John Maher: And finally, John Brennan, can you talk a little bit about quantitative versus qualitative analysis in terms of investments?

John Brennan: Yeah, you can think about investing in two ways. One is from the balance sheet up. So I would call that the qualitative, the hard number side, where you look at the firm's balance sheet, how they're spending money, the results that you get from a bottom up analysis.

A qualitative analysis would be, it's not hard numbers, it's a little more softer in its focus. And that would be an analysis sort of saying, "Okay, the world is an economy," and then thinking of, "North America's economy and what are the needs? And housing and..." I'm probably not making the best case for qualitative analysis, but I think it's more of a softer science and it's really looking at the population's needs and interests. Something like a qualitative analysis would be some of the things that maybe came up around COVID. People are shut in their houses, so what do they need? They need Netflix, they need delivery services, they need Peloton, stuff like that. So qualitative is a little more subjective in its approach to economic analysis.

Rick Ciolino: And, John, I completely agree with the way you described that, where quantitative is numbers based, number crunching. Going through, like you said, going through the balance sheets, just really looking at how much money a company has the ability to earn and cash flows and so forth.

And I would look at quantitative, and you mentioned a top down approach, you talked about the bottom up of qualitative, and the top down of quantitative. And what you're doing is you're looking at management, you're looking at the overall economy, you're looking at other things, not just the numbers.

John Brennan: Yeah.

Rick Ciolino: So I think a good investment strategy is focused on both. I mean, we will look at research from both qualitative managers and quantitative managers and try to put the whole package together.

John Brennan: So in another way of phrasing it, John, would be bottom up, top down investing and then you get into that middle stripe and then that's what you want to invest in.

John Maher: Right. Companies that work well by the numbers, that quantitative analysis. And also quality companies that, like you said, from the bottom up, match with what the nation overall is looking for at that particular time. And you're trying to hit those companies or invest in those companies that match with both of those.

John Brennan: Yep. So a really good kombucha company would be something that could be in both provided... A few years ago, everybody's really into kale. So a really good kale company would be of the moment.

John Maher: And maybe it's not the absolute most money making company out there, it's not on the S&P 500 or something like that, but it does pretty well. But also, it's just matching the demand that's out there in the market today.

John Brennan: Yeah. And I can think of Crocs, that was a darling for a while. Rick, wasn't Chobani yogurt, that was right in the middle for a while. Peloton certainly was during the pandemic. Zoom was of the moment, reasonably well run, zoomed to the top and then came back down again.

Rick Ciolino: Yeah. That's when investors get excited about a possibility for the future and the company starts trading on potential as opposed to hard numbers. So that would certainly be a difference where if you're buying Procter & Gamble, which sell diapers, sell paper products and chargers, you're looking at how much money they're making as opposed to how much money they could make if things work out right.

Contact Cape Ann Savings to Talk About Your Investments

John Maher: All right. Well, that's really great information, John and Rick. Thanks again for speaking with me today.

John Brennan: Sure thing.

Rick Ciolino: See you.

John Maher: And for more information, you can contact Cape Ann Savings Trust & Financial Services at (978) 283-7079 or visit the website at capeannsavings.bank.

Investments purchased through the Cape Ann Savings Trust & Financial Services department are not FDIC insured, not FDIC guaranteed, not bank guaranteed and may lose principal value.