Glossary

The vocabulary, defined once

75 terms. The writing on this site uses the real names for things rather than simplified substitutes, on the view that a reader who learns "sequence risk" can then read anyone else's work on it. These are the definitions behind every underlined word.

Active management: Choosing which securities to hold in the hope of beating a benchmark. In aggregate active investors hold the market, so before costs they earn the market return and after costs they must earn less. Most active funds underperform, and past winners rarely repeat →
All-in cost: Everything the arrangement costs in a year, not just the headline expense ratio: platform fees, advice fees, trading spreads, and the fund's own dealing costs. It is the only cost figure worth comparing. Fees are the most reliable predictor of returns you control →
Annuity: A contract that exchanges a lump sum for income guaranteed until death. It transfers the risk of living a long time to an insurer, which is exactly the risk a portfolio handles worst. Mortality pooling raises safe income, and almost nobody buys it →
Anomaly: A pattern in returns that a standard asset-pricing model does not explain. Publication requires that it looked real in the sample it was found in, which is a weaker claim than it sounds. Factor premia are real in the sample and fragile out of it →
Asset allocation: The split of a portfolio between broad asset classes — shares, bonds, cash. It explains most of the variation in a portfolio's returns over time, far more than the choice of individual holdings within each class.
Asset location: Which account each holding sits in, as distinct from what you hold. Placing tax-inefficient assets inside sheltered accounts and tax-efficient ones outside can add return without changing risk at all. Which account holds which asset changes your return without changing your risk →
Automatic enrolment: Enrolling employees in a plan by default and requiring an action to leave, rather than an action to join. It raises participation dramatically while changing no economic incentive whatsoever. Defaults beat intentions, so remove the decision →
Backtest: Running a strategy over past data to see how it would have done. The results are only as trustworthy as the discipline of whoever chose the rules, since the rules were chosen knowing the data. Factor premia are real in the sample and fragile out of it →
Basis point: One hundredth of a percentage point. A fund charging 20 basis points charges 0.20% a year. The unit exists because the differences that matter are small in absolute terms and large in compounded ones.
Benchmark: The index a fund is measured against. Choosing a flattering one is the oldest way to make an unremarkable record look good, which is why the comparison is only meaningful when the benchmark matches the fund's actual mandate.
Bequest motive: A wish to leave money behind. It is the main respectable economic reason not to annuitise, and it weakens rather than overturns the case for annuitising part of a portfolio. Mortality pooling raises safe income, and almost nobody buys it →
Book-to-market: A company's accounting net worth divided by its market value. High book-to-market shares are the cheap ones, and their historical excess return is the value premium. Factor premia are real in the sample and fragile out of it →
Buy and hold: Staying invested through everything rather than moving in and out. It is the baseline any timing strategy has to beat, and it beats most of them after costs and taxes. Market timing requires being right twice, and the good days cluster in the bad times →
Capital gain: The profit on selling an asset for more than you paid. It is taxed only when realised, which makes not selling a genuine tax strategy rather than merely inertia. Which account holds which asset changes your return without changing your risk →
Catch-up contribution: An extra allowance above the normal deferral limit, available from age 50 and larger between 60 and 63. It exists to let people who saved late compress contributions into their final working years.
Compounding: Returns earning returns. It is why a percentage point of annual cost is worth far more than a percentage point of a single year's return, and why time in the market matters more than the amount invested at the start.
Cost basis: What you paid for a holding, in the eyes of the tax authority. The gap between it and today's price is the gain you would owe tax on, so it decides what selling actually costs.
CPI: The Consumer Price Index, the standard US measure of inflation. It tracks a fixed basket of goods, which is why your own inflation rate can differ from it substantially and persistently. Stocks are a bad short-run inflation hedge and the best long-run one →
Discount rate: The rate at which future cash is converted to a value today. A higher discount rate lowers the present value of the same future earnings, which is how rising rates cut share prices without anything changing at the company.
Diversification: Owning enough different things that no single outcome decides your result. It is the one adjustment that reduces risk without a matching reduction in expected return. Most individual stocks lose money; a few pay for everything →
Dollar-cost averaging: Investing a sum in instalments over time rather than at once. It lowers expected return, because cash waiting to be invested earns cash returns, and buys a smaller worst case in exchange. Investing a windfall at once usually wins, but averaging in buys something real →
Drawdown: The fall from a portfolio's high point to its subsequent low. It matters more than volatility for people who might sell, because it is the number they are looking at when they decide.
Elective deferral: The money you choose to divert from your paycheck into a workplace plan. It is capped per person per year across all plans, at $24,500 in 2026, separately from anything the employer contributes. Unclaimed employer matches are the clearest mistake in personal finance →
Employer match: Money your employer adds to your plan in proportion to what you contribute, typically up to a few percent of salary. Declining it is declining part of your stated compensation. Unclaimed employer matches are the clearest mistake in personal finance →
Equity premium: The extra return shares have delivered over safe assets, as compensation for the risk of holding them. Historically large, theoretically hard to justify at that size, and not guaranteed to persist.
Expected return: The probability-weighted average of what could happen — not a prediction of what will. A strategy can have the higher expected return and still be the wrong choice for someone who cannot survive its bad tail.
Expense ratio: The percentage of your money a fund charges every year, deducted from the fund's assets rather than billed to you. A 0.5% expense ratio on $100,000 is $500 a year, taken quietly. Fees are the most reliable predictor of returns you control →
Factor: A shared characteristic — small size, cheapness, recent strength — claimed to explain differences in return across shares. Hundreds have been published; how many survive honest correction for the search itself is contested. Factor premia are real in the sample and fragile out of it →
Full retirement age: The age at which Social Security pays your unreduced benefit — 67 for anyone born in 1960 or later. Claiming earlier permanently reduces it; claiming later permanently increases it. Delaying Social Security is the cheapest longevity insurance available →
Home bias: The tendency to hold far more of your own country's market than its share of world markets would suggest. For a US investor it has paid handsomely for a century, which is not the same as it being free of risk. Building a plan on US returns is a bet, not a neutral assumption →
Illiquidity: Being hard to sell quickly at a fair price. A house takes months and several percent in costs to convert to cash, which is why it is a poor answer to an emergency. A cash buffer is what makes every other decision survivable →
Imputed rent: The rent an owner-occupier implicitly pays themselves by not renting. It is a real part of housing's return and it never appears as cash, which is why owners consistently underestimate what their house has earned. A house is a good asset for reasons that have little to do with price growth →
Index fund: A fund that holds whatever a published index holds, in the same proportions, without a manager choosing. Its selling point is not clever construction but low cost and no dependence on a manager's continued skill. Most active funds underperform, and past winners rarely repeat →
Leverage: Investing with borrowed money, which multiplies both the gain and the loss on the money that is actually yours. A mortgaged house is the most leveraged position most households will ever hold. A house is a good asset for reasons that have little to do with price growth →
Life expectancy: The age by which half of a group will have died. It is a median for a population, not a forecast for a person, and funding a retirement exactly to it means running out roughly half the time. Planning to life expectancy is planning to run out half the time →
Longevity risk: The risk of outliving your money. Planning to life expectancy addresses it exactly half the time, since life expectancy is the age by which half the cohort has died. Planning to life expectancy is planning to run out half the time →
Loss aversion: Losses feeling roughly twice as bad as equivalent gains feel good. It explains why investors sell at the bottom, hold losers too long, and take less risk than their own time horizon warrants. Losses hurt about twice as much as equivalent gains feel good →
Marginal tax rate: The rate applied to your next dollar of income, as opposed to the average across all of it. It is the rate that decides whether a deduction is worth taking and whether traditional beats Roth. Traditional versus Roth is one comparison of two tax rates →
Median: The middle value, with half of the sample above and half below. It differs sharply from the average whenever a few extreme results pull the average away, which is exactly what stock returns do.
Microcap: The smallest listed companies, often too thinly traded to absorb real money. Many published anomalies live almost entirely inside them, which is why they shrink when a study weights stocks by size. Factor premia are real in the sample and fragile out of it →
Monte Carlo simulation: Running a plan through thousands of randomly generated futures instead of one assumed average. It replaces a single answer with a distribution, which is a more honest shape for a forecast.
Mortality credit: The extra income an annuity can pay because it is funded partly by the contributions of buyers who die earlier. No portfolio can replicate it, because the money comes from other people. Mortality pooling raises safe income, and almost nobody buys it →
Nominal bond: A bond promising fixed cash amounts, with no inflation adjustment. Unexpected inflation transfers wealth from its holder to the borrower directly, which is why bonds are the clearest casualty of an inflation surprise. Stocks are a bad short-run inflation hedge and the best long-run one →
Nominal return: Return before adjusting for inflation — the headline number. Useful for comparing against a stated interest rate, misleading for comparing across decades. Stocks are a bad short-run inflation hedge and the best long-run one →
Opportunity cost: What you give up by choosing one option over the next best one. Paying down a 4% mortgage has an opportunity cost equal to whatever the money would have earned invested instead. Clearing debt is a guaranteed return; investing is not →
Percentile: The value below which a given share of outcomes falls. A 10th-percentile result is one that nine simulations in ten beat — which is the number worth planning around, rather than the median.
Quartile: One quarter of a ranked group. Fund league tables report top-quartile performance because it sounds selective; over consecutive periods, membership of it turns out to be close to random.
Real return: Return after inflation has been removed: what your money can actually buy afterwards, not what the number on the statement says. A 7% return in a 3% inflation year is a real return of about 3.9%. Stocks are a bad short-run inflation hedge and the best long-run one →
Rebalancing: Selling what has grown and buying what has not, to return a portfolio to its intended mix. Its main effect is risk control rather than extra return: without it, a portfolio drifts towards whatever recently rose. Rebalancing controls risk; it is not a source of return →
Required minimum distribution: The amount the IRS obliges you to withdraw from a tax-deferred account each year from age 73. It is the mechanism by which deferral eventually ends, and it can push a retiree into a higher bracket than they planned for. Traditional versus Roth is one comparison of two tax rates →
Risk-free rate: The return available with no credit risk, usually taken as short-dated government debt. Every risky asset's return is judged as a premium over it, so the level of the risk-free rate moves what counts as a good return.
Roth: An account funded with money you have already paid tax on, where qualified withdrawals are then untaxed. The mirror image of a traditional account: you pay today's rate instead of the rate you will face in retirement. Traditional versus Roth is one comparison of two tax rates →
Sequence risk: The risk that returns arrive in an unlucky order. Two retirements with identical average returns can end very differently if one meets its bad years while withdrawals are shrinking the balance. The order of returns decides retirements that averages cannot explain →
Skew: An asymmetric spread of outcomes. Stock returns are right-skewed: a loss stops at 100% while a gain has no ceiling, so a handful of enormous winners drag the average far above the typical result. Most individual stocks lose money; a few pay for everything →
SPIVA: S&P's twice-yearly scorecard comparing active funds against their benchmarks, corrected for funds that closed or merged mid-period. It is the closest thing the industry has to a scoreboard it cannot pick. Most active funds underperform, and past winners rarely repeat →
Standard deduction: The amount of income that is untaxed by default, without itemising. It is why the first slice of retirement withdrawals is often taxed at nothing at all, which favours the traditional account more than headline rates suggest. Traditional versus Roth is one comparison of two tax rates →
Success rate: The share of simulated or historical retirements in which the money lasted. A 95% success rate is a one-in-twenty chance of running out, which is a different sentence describing the same number. The 4% rule is a historical result with three heavy assumptions →
Survivorship bias: Measuring only what is left. Fund league tables that exclude closed and merged funds flatter the survivors, and the funds that disappear are disproportionately the ones that did badly.
t-statistic: How many standard errors an estimate sits from zero. The conventional threshold of 2 assumes one test; when thousands of ideas are tried against the same data, it guarantees a stream of false findings. Factor premia are real in the sample and fragile out of it →
Tax bracket: A band of income taxed at a given rate. Only the income inside a band is taxed at that band's rate, so moving into a higher bracket never reduces your take-home pay. Traditional versus Roth is one comparison of two tax rates →
Tax drag: The return lost each year to tax on dividends, interest and realised gains along the way, rather than at the end. Like a fee, it compounds against you for as long as your returns compound for you. Tax drag is a fee you can often remove entirely →
Tax-advantaged account: An account whose growth is sheltered from annual taxation — a 401(k), an IRA, an HSA. The shelter is the product; the investments inside it can be identical to the ones in a taxable account. Tax drag is a fee you can often remove entirely →
Tax-deferred: Taxed on the way out rather than the way in. Contributions reduce this year's taxable income and withdrawals are taxed as ordinary income, which makes the comparison against Roth a comparison of two tax rates. Traditional versus Roth is one comparison of two tax rates →
Time horizon: How long until the money is needed. It governs how much volatility is tolerable, and it is the assumption most often left unstated in a rule of thumb quoted without one.
TIPS: Treasury Inflation-Protected Securities: US government bonds whose principal rises with CPI. They pay a lower headline yield than ordinary Treasuries because the inflation protection is the compensation. Stocks are a bad short-run inflation hedge and the best long-run one →
Total return: Price change plus income — dividends for shares, coupons for bonds — with the income assumed reinvested. Quoting price change alone understates long-run equity returns by roughly the dividend yield each year.
Treasury bill: Short-dated US government debt, the conventional stand-in for a risk-free asset. When a study says a stock underperformed T-bills, it means holding it was worse than holding the safest thing available.
True-up: A year-end payment some plans make to top up a match that was calculated per paycheck. Without one, hitting the annual contribution limit early stops the match for the rest of the year.
Turnover: How much of a fund's portfolio it buys and sells in a year. High turnover means trading costs the expense ratio does not show, and in a taxable account it means realised gains you did not choose to take.
Value weighting: Whether each stock counts in proportion to its market value or counts the same as every other. Equal-weighting hands tiny companies the same influence as the largest, which is not a portfolio anyone could actually hold. Factor premia are real in the sample and fragile out of it →
Variance: The squared spread of returns around their mean, and the raw material of volatility. Higher variance around the same expected return is worse for anyone who must sell on a fixed date.
Vesting: The point at which employer contributions become irrevocably yours. Before it, leaving the job can forfeit them, which is why a match schedule and a notice period are worth reading together.
Volatility: How much returns scatter around their average, usually measured as a standard deviation. It is a proxy for risk rather than risk itself: it treats an unexpected gain and an unexpected loss identically.
Withdrawal rate: The percentage of the starting portfolio taken in the first year of retirement, then usually raised with inflation each year after. The 4% figure is a historical result for one country and one portfolio, not a law. The 4% rule is a historical result with three heavy assumptions →
Yield: Income as a percentage of price. For shares it is dividends over price, for a rental property it is rent over value, and for a bond it is the return implied by today's price if held to maturity.