Glossary of FIRE Terminology

These are high-level definitions of intricate concepts written with the intent of giving you a general understanding of each one throughout Build Your FIRE’s articles and videos. Entire books can and have been written on some of these terms, but for the beginners, this can be a good place to start.  

 

Financial Independence (FI):

Those who are financially independent have saved up (or received) enough money to put them in a position where money is not a major determinant in some of their life decisions. Those who are financially independent are able to leverage money to make their life better.

Financial Independence is a spectrum: For example, someone who has paid off their loans is financially independent from debt, someone who has saved up a year’s worth of living might be financially independent enough to quit a job they hate, and someone who has saved up 25-28 times their spending is financially independent enough to not require income from a job again.

 

Retire Early (RE):

While pop culture has set our first definition of retirement as spending your twilight years lounging by the beach, here at BYF we think of it as quitting your job early to do what you are passionate about regardless of whether or not that pursuit generates income. This could be becoming a stay at home dad/mom, becoming a full-time artist, starting a passion project, or starting your dream job that pays considerably less than what you need to make. Money becomes merely a tool you leverage to assist you in reaching self-actualization.

While early retirement can mean plenty of beach lounging, one can only do that for so long before they hunger for purpose.

 

Financial Independence Retire Early (FIRE):

FIRE is the two terms FI & RE (see above) put together.  

 

Safe Withdrawal Rate (SWR):

This is the rate at which you can withdraw money from your invested assets and have a good chance of never depleting your portfolio. This is based on the Trinity Study, which you can read here.

Essentially, since we can expect the market to grow more than 4 percent each year, withdrawing annually at this rate is likely to sustain your spending forever.

The general rule of thumb is a safe withdrawal rate of 4 percent plus inflation each year, but for those of you who are more conservative, you can withdraw 3-3.5 percent to have a higher success rate.

For example: Say you have a $1,000,000 portfolio. At a SWR of 4 percent, you can withdraw $40,000 the first year and then adjust for inflation each year after that.

A 4 percent SWR on a $1,000,000 balance would look like this:

Year one: $40,000.

Year two: $40,000 plus last year's inflation. So if inflation was 1% your full withdraw for year two would be $40,400.

Year three, if inflation was again 1%  the withdrawal would be $40,808.

...and so on...

 

Savings Rate (SR):

Savings Rate is an equation that we use to see how fast we are moving toward FIRE. Essentially, it is a percentage of how much of your take home pay you are saving.

See #3 in my article 10 Steps to Retire Early by Finding Financial Independence for the calculation and full definition.

You can use BYF’s Simple Savings Rate Calculator to find out your Savings Rate after you understand the concept.

 

Stocks

Also known as “equities,” stocks are shares of a company. When you purchase stock in a company, you are buying shares of that company. When you buy a single share, the value of that share will fluctuate, but you still own one share no matter the valuation, unless that company goes out of business.

Owning shares gives you a number of benefits, the biggest of which is dividends (see below).

 

Dividends

A portion of a company’s profits that are divided, or think of it as “divied” up, among the shareholders (you) based on the number of shares they own. The more shares you own, the larger your dividend amount. You don’t even have to work for the company to get paid by them! All you have to do is purchase shares, sit back, and watch your “green employees” make money (dividends) for you.

Dividends can get reinvested in your portfolio after you earn them, slowly turning your assets into a runaway train that gains momentum on its own.

 

Bonds

Bonds are, at a very basic level, money that entities such as corporations or governments borrow to grow their business. Borrowers pay back the money borrowed plus interest, generating net positive value for the investor.

To put it another way: Bonds are mortgages for entities but instead of borrowing money from a bank to buy a house, they borrow money from you to fund a venture and pay you back the principal and interest.

Bonds are generally less volatile than stocks. But because they are less volatile, they also typically grow less in value.

 

Low-cost broad-based index funds:

You will read about these investments a lot here because it is our favorite way to build wealth over the long term.

Stocks in only one company can put your portfolio at risk since your money is in one single company. Rather than investing in the stock of one or just a few companies, index funds allow you to invest in whole economies and markets by purchasing fractions of shares across a whole lot of companies. Every time you buy shares of an index fund, you are essentially investing in all the hard workers in that economy.

The genius behind index funds is that they help you mitigate risk and make your portfolio less volatile. For every company you own shares of inside an index fund that does poorly, there could be four others growing like crazy that essentially wipe out any losses you might have incurred over time.

Typically when we talk about low-cost broad-based index funds we will be referring to the VTSAX, VTIAX, and VBTLX index funds due to their broad exposure and incredibly low fees.

 

 

For example, if a company in the American total stock market index fund (VTSAX) goes out of business and their shares have no value, that company is no longer included in that fund. HOWEVER, since you own a small share in many companies, and not just one, the companies that do well stay in the fund, making your portfolio stronger and stronger each day. As you continue to buy shares of VTSAX you also benefit from the new companies entering the fund, while the failing companies work their way out. This means new companies continue to enter the fund while the losers leave, strengthening the fund over time. The beauty of it these funds is in their simplicity - they manage themselves.

 

 

Exchange-Traded Fund (ETF)

 

Like an Index Fund, an ETF is not actively managed, and also usually has lower expenses/fees than many other mutual funds.  A difference between an ETF and an Index Fund is that, unlike an Index Fund, the price of an ETF will fluctuate throughout the trading day. An ETF distributes dividends to shareholders quarterly, which, in general, can have tax consequences.  However, if the ETF is held in a “Tax Advantaged” account like a 401k, IRA, etc, this may not have an impact on you. You can trade an ETF at any time during the day, at the market set (fluctuating) price. Basically, an ETF is traded similarly to a stock.

 

Asset Allocation:

Let's break this one down further:

Asset = Any property you own that has value. In this space, most of the time we will be referring to property such as stocks, bonds, and index funds.

Allocation = The percentage of value assets have in proportion to one another in your portfolio.

For instance, if you hold $9,000 in VTSAX (stocks) and $1,000 in VBTLX (bonds) then your asset allocation would look be 90 percent stocks and 10 percent bonds.

Your asset allocation is important. Historically 100 percent stocks have performed best over time but can be volatile. If you cannot handle swings in the market and would be tempted to sell your assets every time the market hiccups, consider adding bonds which are more stable. I talk more about this in my article 10 Steps to Retire Early by Finding Financial Independence (see #4)

 

Beating the Market:

A common argument against passive index fund investing is from people who try to beat the market by investing in specific companies that will have higher returns than the returns from the S&P 500 index every year. Some people think that they have the ability to pick specific stocks that will go up in value in the future.

However, these actively managed portfolios are actually proven to do just the same, or worse than the market over time. Typically these also have much higher fees as well. While you can get lucky, even the most successful single stock pickers in the world eventually revert back to the mean.

 

Tax-advantaged accounts:

Accounts that help you keep more money in your pocket through special tax rules. Leveraging your tax-advantaged accounts is a key tool that you use in getting to financial independence since they keep more money on your side of the ledger rather than the governments. There are different rules for getting your money out of each of these accounts. Make sure you understand them all before taking advantage. Some of the popular tax-advantaged accounts are:

 

Health Savings Account (HSA):

HSAs are great because the money you put in goes in pre-tax and it also comes out without getting taxed when you use the money to pay for medical expenses. You can typically invest these funds while the are in the account as well. While the standard use for HSAs is to pay for medical expenses year to year, you can essentially hack this account by using it as a retirement account.

These are only available to those of us with high deductible health care plans. If you get your health care through your employer, check with your HR department to learn more about this type of plan.

You can get this money out by:

 

    1. Paying out of pocket for medical expenses, saving the receipt, and getting reimbursed down the road
    2. Paying for qualified medical expenses
    3. Withdrawing once you are 65 years old (at this age, HSAs essentially turn into an IRA which is taxed at withdrawal).

 

401k/403b:

 

 

This is the standard retirement plan offered by employers. In 2018, you could invest up to $18,500 per year straight from your paycheck into these accounts.

Through this plan, you can invest in index funds. Typically these are restricted to specific vehicles that your employer has brokered with the plan provider.

There are penalties for withdrawing money from these funds before you turn 59 ½, but there are ways around paying those penalties which you can read about here.

While this might seem like a pain, leveraging this account to its full potential can shave years off your path to FIRE.

 

Traditional IRA (tIRA) and Roth IRA (rIRA):

 

 

These are accounts that you can sign up for on your own through a brokerage account. In 2018 the maximum contribution one can make to either of these accounts is $5,500 annually.

The main difference between these two accounts is when the funds are taxed. Contributions to Traditional IRAs are typically taxed when you withdraw the funds as contributions are made pre-tax. Contributions to Roth IRAs are made post-tax, but the funds grow tax-free and come out tax-free since you essentially paid taxes on that money before you contributed it initially.

 

Brokerage Firm/Brokerage Account

A brokerage firm is a company (like Vanguard) that facilitates the buying and selling of an investor’s assets. In return for their services, they charge a fee to the investor.

The accounts you hold within a brokerage firm are called brokerage accounts.

 

Do you have any terms you would like to see defined here? Add them to the comment section below!