Personal Finance & Investing Terms and Definitions
It's easier than you think!

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If you are learning about personal finance from podcasts such as ChooseFI or reading books like the Simple Path to Wealth some of the acronyms or general language may seem foreign to you. Below we will provide definitions that are pertinent to understanding financial freedom a bit easier.

FI – This one will get tossed around many times and even recently in mainstream media. FI simply means “Financial Independence”. Most people agree this means you don’t have to directly work a day job in order to pay bills/provide for your family, that is taken care of by investments when an individual reaches “FI”.

 

FIRE – Another recently popular term with a highly debated actual meaning, it stands for “Financial Independence Retire Early”. It’s the true meaning of “Retire” that causes controversy but for ease of conversation let’s just say this means you can quit your day job when one “FIREs” (ironically close to being “fired” isn’t it?).

 

Compound interest - When you're investing or saving, this is the interest that you earn on the amount you deposit/invest, plus any interest you've accumulated over time. When you're borrowing, it's the interest that is charged on the original amount you are loaned, as well as the interest charges that are added to your outstanding balance over time. Think of it as “interest stacking on interest.” This will make your savings or debt grow at a faster rate than simple interest, which is calculated on the principal amount alone.

 

Net Worth - The difference between your assets and liabilities. You can calculate yours by adding up all of the money or investments you have, including the current market value of your home/car (this is subjective but in reality it counts), as well as the balances in any checking, savings, retirement, or investment accounts. Then subtract all of your debt, including your mortgage balance, credit card balances and any other loans. The results of this calculation is by definition your current “net worth”.

 

Asset Allocation - The process by which you determine what portion of your portfolio you'd like to dedicate to various asset classes such as stocks, bonds, and cash or cash equivalents (money market/CDs/Etc).

 

Effective Tax Rate – One major common misconception about the US tax system is that if you earn a higher amount all of your earnings will be taxed in a higher bracket. This is not true, thankfully the US system is progressive in nature. What that means is when you go “up a bracket” as people commonly refer to it that next amount of earnings (for example 75,000-125,000) would be taxed at the higher amount – but it would not effect the first 74,999 you had previously earned. What this progressive system does is create what is referred to as an “effective rate”, which in simple terms means the actual percentage you end up paying. Sample below:

 

Annual Percentage Rate (APR) - The cost of credit for one year expressed as a percentage.

 

Bear market - A market characterized by falling prices of 15 percent or more, characterized by/associated with pessimism.

 

Bull market - A rising stock market in volume and prices, which is characterized by/associated with optimism.

 

FICO - A “FICO” credit score is a credit score developed by FICO, a company that specializes in what’s known as “predictive analytics”. This basically means they take information and analyze it to predict what’s likely to happen – more specifically will an individual pay back a loan he/she takes. The number is meant to determine likelihood of repayment.

 

Mutual Fund - A company that pools the money of many investors to buy a large selection of securities (stocks generally) usually in hopes of beating the stock markets index average. Historically few have done so over a long period of time.

 

Index Fund – Index funds were created by Jack Bogle, the founder of Vanguard. In the financial independence world you will hear about the total stock market index (for Vanguard that is symbol VTSAX) and the S&P 500 index (which simply tracks the 500 largest companies). There are also many sector based index funds and several other companies than Vanguard that track the major index, they were just the first. Jack Bogle is pictured below:

 

Bonds - Bonds are commonly referred to as fixed income securities. Many corporate and government bonds are publicly traded on exchanges, while others are traded only over the counter. Put simply when a company/government/entity borrows money from an investor and agrees to pay for that privilege they form a “Bond” agreement to do so.

 

Travel Hacking – This is meant to describe traveling with credit card reward points/bonus points. Many people have found a way to travel at low/no cost to themselves by really monitoring deals/bonuses given by credit card companies.

 

House Hacking – There are several ways to accomplish this but the most simple form would be buying a residential dwelling and renting out the rooms you choose not to live in. It is possible to have essentially “free” housing or in certain cases generate positive cash flow.