Financial concepts



These are various concepts I’m picking up from various resources, mainly situations I’ve lived, heard multiple resources discuss, or, more often, both.

Saving isn’t investing

Section titled Saving isn’t investing

The biggest difference between saving and investing, as I’ve taken to using the terms, is saving involves currency while investing involves converting currency to a different asset; specifically an asset that generates income and is believed to increase or maintain its original value (cost basis) over time. Arguably, investing is a type of saving.

Cash is a liquid asset traded directly for goods and services.

In the case of the USD, the Federal Reserve is the only sanctioned entity that can create or destroy money. The USD is similar to many other currencies found around the world.

Because cash doesn’t typically rot (like foodstuffs), it affords (pun intended) the opportunity for hoarding; being taken out of circulation by private individuals. To combat hoarding, the creators and destroyers of the currency tend to print more of it. This creation and destruction may impact purchasing power. During times of inflation, how much you can purchase for a single unit of currency reduces; reduced purchasing power, which can be viewed as the money rotting. During times of deflation, increased purchasing power, how much you can purchase per unit of currency increases; yes, this can happen and can be seen as the food regenerating itself.

Currencies can be seen as a share in the entity who (or for whom) the currency is created; in the case of the USD, it’s a share in the United States. Therefore, printing more of the currency is similar to when companies dilute their stock by issuing more shares; this is different than splitting the stock.

A company may dilute its stock whenever it wants to, however, it’s often done when ownership becomes too concentrated with a single entity; hoarding.

So, people hoard cash, which effectively takes it out of circulation, the supply of cash in circulation decreases, if demand for the currency increases or even remains the same, those in charge of the currency print more of it; by issuing more or splitting what’s already out there. This may result in the value of the stock decreasing, at least in the short-term.

The money printers may also take money out of circulation. In corporate terms, this is a stock buyback; the company buys its stock and holds or destroys those shares.

The money printers (US Federal Reserve, for example) have a few ways to do it.

This is a very simplified explanation of currencies.

Having said that, the general rule of thumb goes like this:

  1. If supply is high and demand is the low, the perceived value of the thing goes down.
  2. If supply is high and demand is high, the perceived value remains the same.
  3. If supply is low and demand is low, the perceived value remains the same.
  4. If supply is low and demand is high, the perceived value increases.

When thinking in terms of price for goods and services (expenses not assets), you can switch the term “value” for “cost” in the list above.

Cash is considered a liquid asset as it can be traded directly for goods and services. This is in contrast to more illiquid assets, like a house. Typically we don’t trade houses for goods and services, they must be sold (liquidated to cash). The time it takes to convert a house to cash can be weeks, months, or, in some cases, years.

The only way to lose money from an investment is to sell the asset for less than you purchased it. (Beware the sunk cost fallacy.)

This bears repeating:

The only way to lose money from an investment is to sell the asset for less than you purchased it.

Another way of looking at it, the moment I purchase an asset (convert cash to something else), I’ve “lost” the money because it’s no longer cash. From that point forward, the questions are: What is the fair market value of the thing I purchased? And how much income has been generated?

If the fair market value is more than I paid, I haven’t made money; I have an unrealized gain. If I sell the thing at a higher value, I have a realized capital gain; made money.

If the fair market value is less than I paid for it, I haven’t lost money; I have an unrealized loss. If I sell it for a lower amount, I have a realized capital loss.

If the asset pays me (usually in the form of dividends), I’ve made money. These dividends are classified outside the fair market value; however, the two are related. So, it’s possible to sell an asset for an unrealized loss that has produced a profit for you.

At all other points, the asset is just increasing or decreasing in fair market value; I’m neither making nor losing money.

Finally, just because I use cash to purchase something doesn’t mean I’ve made an investment.

The three principles of investing

Section titled The three principles of investing

These three principles are attributed to Jack Bogle (founder of Vanguard) and Ray Dalio (from the hedge fund Bridgewater Associates). (I credit Frank Vasquez from Risk Parity Radio for introducing me to these.)

The macro-allocation principle says that portfolios made of similar asset classes in similar proportions will act over 90 percent the same. For example, all 100 percent stock portfolios will act over 90 percent the same. Changes to the proportions within the asset classes are somewhat moot regarding returns, gains, losses, and so on.

The Holy Grail of Investing says that asset classes have an environment where they perform best. Consider a quad chart. The first column is growth, and the second column is inflation. The top row is rising, and the bottom row is falling. The midpoint is the market expectation of what will happen next. According to this principle, we want to evenly distribute risk across the 4 quadrants by choosing different asset classes that perform well in each environment, setting proportions to our comfort and the risk of each asset type. We do this by looking at the historical performance of each asset type and the correlation between asset types. From historical performance analysis, we find equities do better when the expectation is rising growth. Further, we find intermediate- and long-term treasuries (at least in The United States) have the greatest negative correlation to equities and do better in falling growth and inflationary environments. Commodities also do better in rising growth and inflation environments; however, they tend to have a low correlation with equities and treasuries.

The simplicity principle says we want to minimize the number of securities and fees to balance preservation and return of capital; simple.

Investing, speculating, and gambling aren’t the same

Section titled Investing, speculating, and gambling aren’t the same

It’ll be easier and more direct to take these in reverse order compared to the heading.

I go to a casino (or a Chuck E. Cheese). I trade cash for tokens or chips; I’ve lost money. I use those tokens or chips to participate in various games. As I play I win and lose tokens. If I win more tokens than I started with, the value of the asset I purchased (my pool of tokens) has gone up. If I lose tokens, the value of the asset I purchased has gone down. At the end of my time playing, I can exchange the tokens for cash. The majority of people who go to the casino leave with less cash; that’s what makes it gambling.

In the case of carnival-like systems, such as Chuck E. Cheese, it’s pretty clever. I trade a dollar for 4 metal tokens that can only be spent at Chuck E. Cheese; metal feels more expensive than paper and I traded one paper thing for four metal things. I spend the tokens to play skee-ball. As I play, I earn paper tickets (feel less expensive than the tokens), however, I often receive a higher quantity of paper tickets compared to the number of tokens used to play the game (one token and I get eight tickets); I feel like I’m getting more for the exchange. I can trade those paper tickets in for a toy of some kind, which usually cost less than the amount of cash it took for me to play the game. Further, I’m often left with one or two tickets, tokens, or both that can’t be converted directly to cash and might cause me to purchase more tokens to zero out. The activity and contrast of the trades makes it feel like I’m winning though and the concept of sunk cost can entice me to continue playing and losing monetary value in the exchange; it’s gambling.

In the case of carnivals we’d likely call it spending money and not gambling because we’re usually not hoping for, nor expecting, a higher value return compared to the cash put in, which is different than how many of us feel going to the casino or playing the lottery.

Speculating is similar to gambling, only the probability of a positive return on the cash spent is higher though uncertain.

Cryptocurrencies, for example, as of this writing, could be considered speculative. The speculative nature comes in part because they are:

  1. highly volatile when it comes to fair market value,
  2. a newer technological implementation of the same old concepts (like community currencies, casino chips, Chuck E. Cheese, and, yes, government-backed currencies),
  3. the regulations for them and the service industry that’s emerged to support cryptocurrencies are also in flux, and
  4. the income generation is highly dependent on someone else being willing to pay more than you did (they don’t generate income as a result of the productive effort of others).

Investing is similar to speculating only the probability of a positive return on the cash spent is higher than either speculating or gambling and, at least in terms of stocks and bonds, income is generated regularly. It’s not guaranteed you’ll earn income or the value will increase, we just have a history demonstrating a positive return; in the case of the New York Stock Exchange in the US, that history starts in 1792, however, tracking data took a minute and many datasets go back to around 1900. If you own a home and do not charge rent, not an investment (most likely a use asset). If you do charge rent, the house could be seen as an investment because income is generated. Having cash in an interest-bearing savings account is not an investment because the value (purchasing power) of the currency (individual asset) tends to decrease.

The 10 questions

Section titled The 10 questions

These 10 questions represent a proposed method of determining if something is an investment, speculation, or gamble and are proposed by J. David Stein in his book Money for the Rest of Us.

  1. What is it?
  2. Is it investing, speculating, or gambling?
  3. What’s the upside?
  4. What’s the downside?
  5. Who’s on the other side of the trade?
  6. What’s the investment vehicle?
  7. What does it take to be successful?
  8. Who’s getting a cut?
  9. How does it impact your portfolio?
  10. Should you invest?

What I appreciate about this approach is it helps cover the age-old advice (another principle) of don’t buy into things you don’t understand.

Let’s take VTSAX in a 100 percent equities portfolio.

  1. First question: An index fund purchasing shares of every company registered with The New York Stock Exchange in proportion to the market capitalization of the company.
  2. Investing: it pays dividends and each share may increase or decrease in value over time.
  3. It invests in all stocks available in the New York Stock Exchange, therefore, the likelihood of going to 0 is minimal and, if it does, there are probably bigger concerns than the value of the portfolio. It pays dividends on a regular basis. Vanguard is owned by its investors. VTSAX is a long-running, well-known, and relatively liquid security. And so on.
  4. It could lose value compared to what I’ve put in and could take a long time to recover. And so on.
  5. It’s passively managed by Vanguard.
  6. Index mutual fund; I’m investing in Vanguard as much as the companies underlying the fund.
  7. Does better in growth environments and favors large-cap companies.
  8. Vanguard takes a percentage for passive management of the fund. The expense ratio as of this writing is 0.04 percent per year. This percent is converted to a daily percent and the gains and losses are adjusted by that percent daily.
  9. Because it’s 100 percent of the portfolio, it is the portfolio.
  10. I’m in accumulation mode with more than 10 years before needing to withdraw, have a high risk tolerance, and capacity, so, pretty easy to say yes here.

It’s important to note that the majority of responses are not based on emotion. With that said, adding in more emotional considerations aren’t inherently a problem.

For example, I tend to favor even distribution across small-, mid-, and large-cap companies when it comes to investing in the United States stock market. VTSAX favors large-cap companies; putting a higher proportion of each dollar spent toward companies that have already raised or earned a lot of money. Because I prefer equal distribution, I added other funds that afford me the opportunity to distribute my contributions more evenly across cap-weights. These additional funds increases expense ratios, volatility, and complexity slightly. Further, the macro allocation principle tells us the equities portion of the portfolio will perform roughly the same regardless, so, it’s not that this allocation will outperform or underperform.

In other words, the modifications aren’t because I think my mix will outperform anything; it makes me feel better and is better aligned to my financial character.

Net worth isn’t the same as cash on hand

Section titled Net worth isn’t the same as cash on hand

As of this writing, I’m part of the six-figure club, which is to say I have a net worth greater than 100,000 USD and less than 1 million USD; this doesn’t mean I have that in cash.

When we say someone is a millionaire or billionaire it’s because, if we liquidated their assets and paid off their liabilities, they would, in theory, have that much cash remaining. However, if we liquidated their assets, eventually the fair market value of the assets would likely drop (scarcity model and mindset).

The US Government can’t tax the same dollar twice. So, as of right now and my understanding, if I put 100 USD of after-tax money into a savings account and that 100 USD earns 10 USD in dividends, I could get taxed on the 10 USD but not the 100 USD which was already taxed. Only realized gains or losses have potential tax implications; not money that has already been taxed. (As of 2022, legislation is being considered that would tax unrealized gains for people with an income—or net worth—over a certain threshold. It seems like another way to combat hoarding and put money back into circulation; however, this would be done by the Government, not the US Federal Reserve.)

I’m still looking for non-partisan primary sources for the following and, given the rules of the tax game, this seems reasonable. The majority (over 80 percent) of taxes collected by the US Government are collected from individuals, not corporations (not speculating why). 97 percent of taxes paid come from 50 percent of tax payers. 40 percent of taxes are paid by the top 1 percent of earners (those earning over 500,000 USD per year in taxable income). (Again, haven’t found primary sources that didn’t include some form of slant or misrepresentation of those numbers.)

There are two ways to pay zero taxes:

(Taxes in the United States are weird; I think I understand how we got here from an infinite game perspective, but still.)

Gross income and taxable income aren’t the same thing.

Let’s say you work somewhere and earn less than or equal to 12,500 USD in 2021 and you are filing your taxes as a single person. Your taxable income is zero USD because of the standard deduction everyone gets to take.

Let’s say you earned 32,000 USD and you contributed the full amount of 20,500 USD to your 401k (in 2022), you’re taxable income should be zero USD; the 12,500 USD standard deduction and the 20,500 USD to a retirement plan that lowers your adjusted gross income.

Let’s say you earned 35,600 USD. You maxed out the 401k and maxed out a HSA contribution for the year; taxable income of roughly zero USD. (Check out this calculator.)

Now, let’s say you threw 100 USD of after-tax money into the aforementioned stock and sold it 10 months later for 110 USD. The 100 USD wouldn’t be taxed, but the 10 USD would count as regular, taxable income.

Federal long-term capital gains rules have their own progressive tax.

Let’s say you invested 60,000 after-tax USD, a few years later it’s now worth 100,000 USD. If you sell for the whole 100,000 USD the 60,000 USD doesn’t have any tax implications because it’s been taxed. The 40,000 USD in gains is not taxed because the long-term capital gains progressive tax is zero percent on up to 40,000 USD (in 2021). You now have 100,000 USD and have paid zero taxes on it. Granted, you had to have earned 60,000, been taxed on it, and invested it, then waited long enough for it to increase in value by 40,000 USD; you are paid for patience and investing in the redistribution of assets.

Basically, looking at it from an ethical social engineering perspective, the US Government is trying to incentivize long-term saving and investing through the tax code with tax deductions, tax-free growth, and in the case of HSAs and the Roth Individual Retirement Accounts, tax-free withdrawals. Further, if you’re living strictly on capital gains from various investments (retired), you can live a modest lifestyle without paying any more taxes; the moment you go over that 40,000 USD point though, you pay 15% tax on the amount you went over. So, also incentivizing modest living.

One more thing: Net worth has nothing to do with actual worth as a human. To be more accurate it’s financial net worth. If all assets were liquidated and all liabilities were paid off, the difference is financial net worth, which is arguably a small part of your actual worth as a human. Finally, some may say financial net worth has nothing to do with your worth as a human while others might say it’s a reflection of your contributions to society.

Accumulation, drawdown, and rebalancing

Section titled Accumulation, drawdown, and rebalancing

Finances can be divided into two primary modes:

  1. accumulation and
  2. drawdown.

When in accumulation mode, you receive most revenue from an outside source; employment, sales, and similar. (Someone else’s assets become yours.) When in drawdown, you’re giving your assets to someone else or otherwise liquidating them. It’s less a light-switch and more a spectrum.

In accumulation mode, you want to purchase assets that are less valuable per unit now. In drawdown, you want to sell assets that have increased in value compared to the overall portfolio and original cost basis (how much you spent to acquire the asset).

Being able to shift strategies between purchasing low and selling high is one reason for having more than one type of security; holding multiple types of securities is not the same as diversification.

For example, as of this writing, I’m operating a variation on what is sometimes called the VTSAX and chill approach. In short, this approach asks us to increase income while reducing expenses and investing the difference in a total stock market index fund (specifically VTSAX) and hold on for the ride. As the cost per share of the index fund goes up, we are constantly buying in at the higher price; thereby, increasing our average cost basis. When the cost per share goes down, we are buying low. In no case are we selling or divesting to something else. (For details on what I’m doing, check out the personal finances area.

Mutual funds are internally rebalanced on a regular basis. You should be able to see the rebalancing strategy by examining the prospectus for the index fund. When the index fund is rebalanced, it can impact your tax liability; this is why some people want to avoid investing directly in mutual funds (indexed or otherwise) and may, instead, invest in ETFs so they can have more control over the tax implications.

Rebalancing is resetting the allocations of a portfolio to a specific target amount (or close to it). Rebalancing can be accomplished by purchasing a specific asset to increase its allocation; often done when in accumulation mode. It can also be done by selling a specific asset to decrease its allocation; often during drawdown. Or you can do both by selling something with a high allocation and purchasing something with a low allocation; often done at a specific time or when a certain event has occurred.

Rebalancing requires establishing targets for more than one asset type. If you only have cash, no rebalancing is possible. If you have more than one security, on the other hand, rebalancing using either of the three methods becomes possible.

Owning equity shares versus funds

Section titled Owning equity shares versus funds

Index funds are a form of mutual fund. A mutual fund is a way for individuals to pool their resources and invest in various securities that they may not be able to afford alone; if the stock price for a company, for example, is beyond your ability to pay, you may be able to invest in that company using a mutual fund; or a broker that offers fractional shares and dollar-based investing. Index funds, like VTSAX, use a calculation to determine the asset allocation; this is referred to as passive management, because the person in charge of the mutual fund isn’t making decisions on individual investments, instead, they are following the allocations set by the index. In the case of VTSAX, the allocation of a given stock is based on the market capitalization of the company issuing the stock. In other words, the more money investors (index fund, mutual fund, or individual) put into a company, generally, the higher the market capitalization of the stock increases and the more future dollars put into the index fund will go to those companies. On the flip side, index funds are set up to be self-cleansing; as an underlying security in the fund no longer meets the criteria of the fund or its current allocation, the security is removed or reallocated.

There are also voting implications and differences.

When you buy stock in a company it typically grants you the right to vote on certain issues. Each share you hold gives you a weighted vote overall; this is where the term “controlling interest” comes into play. A person or group may hold so many shares in a company that, if they all agree, the result of votes performed by other shareholders doesn’t really matter; however, if those with controlling interest don’t agree, the votes from other shareholders can break the tie. In the United States this is similar to the Federal Government delegating a decision to the states and the states delegating the decision to the people.

If you own shares directly, you can vote on topics in-person or by proxy. When you own mutual funds, on the other hand, you typically forfeit voting rights for the entity issuing the underlying security. You are purchasing shares of the fund, not the underlying security, therefore, the company operating the fund has the voting rights as the owners of the underlying security. Granted there are around 4,000 companies in The New York Stock Exchange as of this writing and, if you were asked to possibly participate in a vote every time one came up for every company, that’d be your full-time job; instead fund investors delegate that responsibility to someone else.

This can sometimes create the aforementioned concentration in ownership. A broker issues an index fund. Loads of people invest in that fund. That broker has weighted voting rights for the underlying securities.

(This drive for decentralization that results in centralization is a motif in human existence; the former reduces risk and the latter lowers barriers to entry. The New York Stock Exchange is a centralized method of investing in individual, decentralized companies. Mutual funds are a centralized method for investing one or more exchanges while delegating certain risks and responsibilities.)

Cost basis, capital gains (or losses), and methods

Section titled Cost basis, capital gains (or losses), and methods

You buy 100 shares of an index fund for 1 USD each (lot 1); 100 USD on day one. On day two you buy another 100 shares of the same index fund for 2 USD each (lot 2); 200 USD. Your total cost basis is 300 USD and you have 200 shares valued at 2 USD each. On day three the fair market value of a single share is 3 USD, which means the value of your investment is 600 USD; 200 shares at 3 USD each.

300 USD is your cost basis and 300 USD is an unrealized capital gain, which is spread across two lots. (If the fair market value was 200 USD, the 100 USD difference between the value and your cost basis is an unrealized capital loss.)

Let’s say you want to sell 60 USD worth of shares at 3 USD each; 20 of your 200 shares (10 percent). The transaction can be performed using various methods (the link is for Vanguard; other brokerage firms should allow similar methods):

  1. average cost;
  2. first in, first out;
  3. highest in, first out; and
  4. lot ID (or specific ID).

I don’t understand average cost enough yet, so, we’ll skip it. Mainly, I’m not sure the implications when it comes to capital gains and losses except what is noted in the link; in limited circumstances, capital gains or losses may be converted to short-term instead of long-term.

First in, first out sells the oldest lots first. This increases the possibility that the sale will fall under long-term capital gain and loss rules. It also means, there’s a chance, there will be more capital gains compared to the cost basis of those shares compared to younger shares.

Highest in, first out sells the shares based on the price paid, not the date of purchase and will sell the more expensive ones first. As a result, this method should take better advantage of both capital gains and losses, however, (as stated in the link) in limited cases short-term capital gains or losses may be realized before long-term.

Lot ID means you get to look at each lot and shares you’ve purchased and choose which to sell. Selling by lot ID offers the most flexibility, requires the most work, and carries the most risk should undesired results occur.

That covers withdraw methods in brief, let’s talk earned income (dividends).

When it comes to dividends there are usually two options:

  1. automatically reinvest in the security that generated the income and
  2. don’t.

When it comes to taxable accounts, I’m a fan of not reinvesting automatically. I’d let earned income spit out of the security; into a cash account. Then I’d put aside a percent in an account for paying future taxes. (Note: Some types of accounts don’t have cash accounts and dividends must be reinvested in the security that generated them—one of my 401k retirement accounts, for example.)

So, if a security spits out 100 USD in dividends, part of that could be taxed at ordinary income (or capital gains). Let’s say my marginal tax rate was 10 percent, I’d take 10 USD and put it aside just in case I owe taxes, then I’d do something with the other 90 USD; most likely invest it either in the security that generated it or something that was down from an allocation perspective.

For tax-advantaged accounts you don’t pay taxes on the earned income. Further, exchanges (selling something to by something else) within the account typically aren’t classified as taxable events; even capital losses—no tax loss harvesting available. If there’s only one security in the account, reinvesting dividends is fine for the sake of simplicity and taking advantage of compounding. When there’s more than one security it can get a little trickier, but defaulting to reinvesting is probably fine because you always rebalance by buying and selling.

Bulls, bears, and corrections

Section titled Bulls, bears, and corrections

Most days, The New York Stock Exchange (the largest, most well known exchange in the US) is, well, just the stock market. With that said, there are certain events that have been given names. It’s important to note that, from what I understand, there’s a difference between events happening in or to “the market” and events happening to folks in general, however, the two may experience good and bad at the same time.

A bull market means fair market values of things are tending to increase roughly 20 percent in a two month stretch; a bear market is the opposite. A correction is a decrease of 10 percent in a short period of time. A crash is a decrease of 40 percent or more.

So, from highest to lowest the market goes like this:

  1. bull (20 percent up),
  2. stable,
  3. correction (10 percent down),
  4. bear (20 percent down),
  5. crash (40 percent or more).

Since 1900, corrections have occurred about once a year and last about 4 months. Bear markets have happened roughly every 3.5 years and last roughly one year. Crashes have happened roughly once every 12 years, not sure how long they last because there seems to be some debate on how many have occurred (at least in the US). When I talk about how long they each last, what I’m referring to is the time it took before the market was considered to have returned to its previous highest point; this is different than when values start to rise again in general.

Corrections tend to be short-term events, as the name implies, once the market has corrected we should be in a roughly stable state; I think of corrections as the market rebalancing its portfolio (systems thinkers of the world unite, or something). Historically the stable state for The New York Stock Exchange is roughly an 8 percent increase year over year.

I’ll try to be explicit in saying The New York Stock Exchange because “the stock market” is a misnomer, because not all stocks available for purchase are in The New York Stock Exchange. There are roughly 4,000 companies listed on The New York Stock Exchange, as of this writing, and there are literally millions of businesses registered in the United States, all of which have at least one stock or share. This is why I try to avoid using the term “the market,” because “the market” is vast and The New York Stock Exchange represents a fraction; diverse as it might be, you have to be a certain type of business to even be listed there (no judgment on the businesses that are or are not listed).

A recession and depression are not necessarily related to the stock market in general. Instead these are terms for how employment, businesses, and consumption are functioning. A recession occurs when a reduction in GDP is seen for two or more consecutive quarters and (very important “and” here) the NBER says it’s a recession. A depression is a recession on steroids; the financial impact is often more severe, the effects can be felt for years, and increased unemployment may be included.

Even though “the market” and whether a region is experiencing a recession or depression aren’t mutually inclusive they aren’t mutually exclusive either. Exchanges can be in a bull phase while the rest of the economy is in recession. With that said, if people have less disposable income and fear for the stability of their income, chances are they’re not putting extra into exchanges.

With that said, the potential for any of these events are factors when considering risk tolerance and risk capacity.

Risk tolerance and risk capacity

Section titled Risk tolerance and risk capacity

Risk tolerance is your ability to “hold the line” during good and bad times. Risk capacity is your ability to recover from (or at least weather) the bad times.

If your financial net worth dropped by 20 percent and stayed that way for a year or more, could you be okay? Could you survive? Could you maintain contentment, if not happiness and joy?

This is one of the reasons investment policies and budgets can be so powerful; they help you determine your risk tolerance and capacity.

Being rich and looking rich aren’t the same

Section titled Being rich and looking rich aren’t the same

A couple more interesting sets of figures I plan to consider further regarding sources and accuracy.

The first set has to do with those with a net worth of a million USD or more. Roughly 80 percent of millionaires are considered first generation, which is to say they didn’t inherit a million USD. Further, 60 percent of them didn’t inherit more than 100,000 USD. Finally, a majority (over 50 percent) didn’t reach a net worth of a million USD until after age 50 and most of their net worth was inside an employer-sponsored retirement plan (like a 401k) and their home.

The second set of figures has to do with generational wealth; what I’ve heard called the wealth wash cycle. 50 percent of inherited wealth will be lost by the second generation and 90 percent will be lost by the third generation. I’m not sure if this includes inheritance to multiple parties. What if 10 million USD is divided amongst 10 siblings; one million each? Does this dataset mean 5 million USD will be lost by the second generation, that 5 of the siblings will lose all of their inheritance, or does it include both. (It’s worth noting that this isn’t to say generational wealth doesn’t exist or that something like trickle down economics works at a scale large enough to matter; just that the data indicates a redistribution of wealth happens and we don’t necessarily know where it goes.)

There’s a sort of template phrasing that goes like this:

X rich, Y poor.

Life rich, cash (or retirement) poor: Is the most generic and sometimes used as shorthand to describe someone whose lifestyle gives the appearance of having a lot of money, however, when viewed from a per paycheck basis (or accounting for liabilities), they don’t have a lot of cash flow or discretionary funds. This could be traveling, owning expensive assets like cars, something else, or a combination. “They must be rich,” might be a response made by onlookers.

House (or car) rich, cash (or retirement) poor: Similar to the previous only this time it’s a particular type of asset. Having a one million USD home or car that accounts for the majority (or all) of their financial net worth.

There are plenty more of these turns of phrase, the point being that in one aspect the person looks rich, while in another aspect the person appears poor.

Another item of note is how somewhat common being a millionaire is in the United States. Yahoo! Finance references research from Phoenix Marketing International stating there are over 8 million households who can claim millionaire status. With that said, most of them are unknown to us. We usually only hear about those who are more lavish or loud about “being rich.” While 8 million is only a little over 2 percent of the US population, the population of the US includes all individuals, including children, not households or groups, which is what the study was looking at.

Double-entry bookkeeping

Section titled Double-entry bookkeeping

Double-entry bookkeeping is a method of record keeping where each transaction has two entries in two, different accounts in a chart of accounts. One entry will remove money from the account, while the second entry will add money to the account.

The balances of income and expense accounts typically won’t be tracked by you as that money comes in from or goes to third-parties. Asset and liability accounts, however, will usually have the balances tracked.

You get paid. This money comes from an income account (maybe named for the employer or type of employment); a negative number (expense) on the employer’s ledger.

This income gets deposited to your checking account at a financial institution (an asset account); a positive number.

You pay a bill with a credit card. This money is transferred from the credit card ledger to the service provider; a negative number (expense account) and the service provider receives the money as a positive number (income).

You pay the credit card from your checking account. This money is subtracted from the checking account (one entry) and added to the credit card account (second entry).

Timing and types

Section titled Timing and types


Section titled Glossary
Asset allocation
The proportion of each asset class within a portfolio.
Basis point
One-hundredth of one percent. Increasing or decreasing by one basis point is a 0.01 percent change in either direction.
A loan issued by a company or government whereby you purchase the bond with a promise of repayment by the company or government with interest. Bonds differ from shares because shares imply some form of ownership, while bonds do not.
Capital gain
An increase in the value of an asset compared to the cost basis.
Capital loss
A decrease in the value of an asset compared to the cost basis.
Char of accounts
A categorized list of all accounts used in bookkeeping.
Cost basis
The amount of money it took to acquire an asset.
Holding multiple assets wherein some assets may increase in value while others decrease at different degrees or directions. One asset may increase while the other decreases or vice versa, or one asset will rise or fall in fair market value faster or slower than another.
Dollar-cost averaging
Spending an amount regularly on investments regardless of the current fair market value of the security.
Expense ratio
The ongoing cost of managing a mutual fund. The percent is a per-year number. However, the percent is usually divided by roughly 365 to generate a Daily percent, which is charged daily.
Fair market value
The amount you can reasonably expect to receive when converting an asset into cash through the sale of that asset, usually based on recent sales of similar assets.
Associated to accounts with contribution limits (ex. 6,000 USD per year) and refers to contributing as much as possible as early as possible.
You trade currency to participate in an activity or for an asset with a high probability of losing money. In some cases, this may feel like purchasing a product, like a car, which we don’t tend to view as gambling in the way we would purchasing a lottery ticket. (Compare to saving, investing, and speculating.)
Hedge fund
A privately available mutual fund.
A method of tracking the performance of a group of assets in a standardized way.
Index fund
A mutual fund intended to follow a benchmark index of assets. The Dow Jones Industrial Average is an index and there are mutual funds that try and match its performance; those mutual funds are index funds.
Purchasing a security that produces some form of income and historically increases in fair market value. A home you live in would not necessarily qualify, however, a house where you collect rent would. (Compare to saving, speculating, and gambling.)
How easily a given security can be traded for products and services in a given context.
A pool of assets (ex. Stocks) purchased at the same time and at the same fair market value.
Management (active)
A style of asset management whereby an individual or team of individuals actively choose assets to buy and sell and when; often with the intent of beating the returns of a benchmark index.
Management (passive)
A style of asset management whereby an individual or team of individuals choose assets to buy and sell based on a standardized methodology; often an index.
Market (capitalization)
The estimated value of a company based on multiplying shares outstanding and price per share.
Market (correction)
A correction occurs when the overall value of assets in a broad-based collection of assets drops by 10 percent or more; typically for a short period of time.
Market (bear)
A bear market occurs when the overall value of assets in a broad-based collection of assets drops by 20 percent or more.
Market (bull)
A bull market is when the overall value of assets in a broad-based collection of assets increases by 20 percent or more; usually in a two month period.
Mutual fund
A collection of assets held in trust; usually represented as shares using pooled resources of the shareholders and available to the public. Mutual fund shareholders are not direct owners of the assets being purchased and do not have voting privileges.
Net worth
The amount remaining after adding together the fair market value of all assets and subtracting the fair market value of all liabilities.
Asset portfolio
All assets owned by one or more legal entities; typically the assets are grouped by types.
Portfolios may be made up of one or more sub-portfolios. You may have a portfolio made of cash, bonds, and equities. The “equity portfolio” may be broken up by sector, market capitalization, region, or some combination.
Whether or not a capital gain or loss has occurred. The point at which we can say money has been earned or lost.
Buying assets with low allocation compared to its target within the portfolio.
Selling assets with a high allocation compared to its target within the portfolio.
Selling assets with a high allocation compared to its target in order to buy assets with a low allocation compared to its target.
Risk capacity
How much risk you “must” take on to reach your financial goals.
How long you’re able to continue on when things go pear-shaped. You may have a high risk tolerance but not be able to survive if things go pear-shaped.
Risk tolerance
How much uncertainty you’re willing to take on.
You receive income in the form of currency and hold it.
You spend less on an item than you normally would. The “normally would” being the operative phrase. Purchasing something on sale that you would not have purchased is a bit different. (Compare to investing, speculating, and gambling.)
See stock
You participate in an activity or purchase a product that does not generate income on its own, however, you believe it will increase in value in the future and you can sell it for a profit compared to its cost basis. Buying a home you do not collect rent from would most likely fall under this heading. Most collectibles land hear as well. (Compare to saving, investing, and gambling.)
An asset held to represent partial ownership of an enterprise. All private and public companies have stocks; regardless of participation in a stock exchange. Further, stock ownership often comes with the responsibility and privilege of voting on certain decisions made by the company.
Sunk cost fallacy
The idea that a company or organization is more likely to continue with a project if they have already invested a lot of money, time, or effort in it, even when continuing is not the best thing to do. Throwing good money after bad.
The desire to avoid selling something at a loss.
Tax location
The type of account in which various securities are held and how they are treated for tax purposes.
True-up provision
Often related to retirement accounts where a third party conyributes as well (ex. 401k with employer match), which allows front-loading of contributions by the employee while the employer dollar cost averages up to the full match throughout the year.
Whether or not a capital gain or loss would occur. The point at which we can have an idea of the fair market value of an asset; an appraisal on a house, for example, establishes the unrealized gain or loss in value.