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Glossary

Financial glossary

Plain definitions of the terms used across the blog, the calculators and the simulators. One term per page, in the language you are reading.

Investing and markets 14 terms

  • Asset allocation

    How a portfolio is divided between asset types (equities, bonds, cash), and the decision that explains most of its behavior.

  • Compound interest

    The effect by which the returns on your money begin generating their own returns, so capital grows exponentially rather than linearly.

  • Diversification

    Spreading money across enough different assets that no single one of them can ruin you.

  • Dollar cost averaging (DCA)

    Investing a fixed amount at regular intervals instead of trying to time your entry.

  • Drawdown

    The cumulative loss from a portfolio’s highest point to its lowest point afterwards.

  • ETF

    A fund that trades on an exchange like a share, and in practice the most common and cheapest way to buy a whole index.

  • Index fund

    A fund that does not try to pick the best companies but instead replicates an entire index at the lowest possible cost.

  • Monte Carlo simulation

    A method that projects thousands of possible futures with randomized returns, to estimate the probability of an outcome rather than a single figure.

  • Real return

    The return left after subtracting inflation: what your purchasing power actually gained, rather than what your balance did.

  • Rebalancing

    Returning a portfolio to its target weights by selling what has risen and buying what has fallen.

  • Sequence of returns risk

    The risk that poor returns arrive early in your withdrawal phase, while there is still a large balance to lose.

  • TER (total expense ratio)

    The annual percentage a fund charges on the money you have invested, deducted in good years and bad alike.

  • Time in the market

    The idea that staying invested over time matters more than trying to get the timing of entries and exits right.

  • Volatility

    How much an asset’s price swings up and down; a measure of movement, not necessarily of danger.

Personal finance 11 terms

  • 4% rule

    The rough rule that you can withdraw 4% of your portfolio in year one, adjust that amount for inflation, and expect it to last thirty years.

  • Compounding debt

    The same mechanism that grows an investment, running against you when unpaid interest is added to the principal.

  • Emergency fund

    Liquid, boring money set aside for the unexpected, whose job is not to grow but to stop you having to sell investments or borrow.

  • FIRE (financial independence)

    The point at which your assets generate enough to cover your expenses, so that working becomes a choice rather than an obligation.

  • Inflation

    The general, sustained rise in prices, which reduces what the same amount of money can buy over time.

  • Net worth

    Everything you own minus everything you owe: the one figure that summarizes your financial position in a single number.

  • Passive income

    Income that does not need your continuous active work (dividends, interest, rent), and that almost always needs capital or prior work instead.

  • Pay yourself first

    Treating saving as the first bill of the month rather than whatever is left at the end, usually via an automatic transfer.

  • Personal cash flow

    The money coming in and going out each month, and the gap between them: the real mechanism that grows or shrinks your net worth.

  • Safe withdrawal rate

    The percentage of a portfolio you can spend each year with a high probability that the money does not run out before you do.

  • Savings rate

    The share of your income you do not spend, and the variable that most determines how long it takes to become financially independent.

Psychology of money 8 terms

  • Hedonic adaptation

    The human tendency to return to a habitual level of satisfaction shortly after a material improvement.

  • Life cost (cost in hours)

    The price of a purchase expressed in the hours of work needed to pay for it, rather than in money.

  • Lifestyle creep

    The process by which spending rises automatically with every pay increase, leaving the savings rate exactly where it was.

  • Loss aversion

    The tendency to feel a loss roughly twice as intensely as a gain of the same size.

  • Mental accounting

    The tendency to treat money differently depending on where it came from or what label we gave it, even though it is perfectly interchangeable.

  • Opportunity cost

    The value of the best alternative you give up when you choose one option: what every decision costs on top of its price.

  • Present bias

    The tendency to overvalue an immediate reward against a larger future one, even when the second is clearly better.

  • Recency bias

    The tendency to give too much weight to what happened recently and project it forward as if it were the norm.