FIRE Archives - Page 2 of 4 - Where's the FI/RE?

Use a 401(k) and Roth IRA for Maximum Efficiency

Posted on July 1, 2021 by David

There are a ridiculous amount of different retirement accounts. To name a few: the Traditional IRA, 401(k), 403(b), and 457(b). There are also Roth variants of each of them. Another that is fairly common is the taxable brokerage account. Which ones should you use as your investment vehicle? And in what order should you contribute your savings into each one? If you need a refresher on financial terms, I have a glossary here. Image source: History.com

For tax purposes the three main types of investment accounts are the Traditional IRA and 401(k), the Roth IRA and 401(k), and the taxable brokerage account. The question is, “What is the best way to use these three accounts to minimize the amount you owe in taxes?”

Three Different Retirement Accounts

Taxable Brokerage Account

Traditional IRA/401(k)

With a traditional IRA you only pay taxes on withdrawals

Roth IRA/401(k)

With a Roth IRA you only pay taxes on contributions

The red parts are taxed and the green parts are tax-free. It’s obvious from this graphic that both kinds of IRA/401(k) are better than a brokerage account when it comes to taxes because you are not taxed on gains.

The first thing we have to discuss is availability. The 401(k), 403(b), and 457(b) are all basically the same thing, but only government workers have access to a 403(b) or 457(b). In order to simplify things I’ll only discuss the 401(k), since all of the principles that apply to a 401(k) also apply to a 403(b) and 457(b).

Everyone has access to a taxable brokerage account. There are two different kinds of accounts you can open, an individual account and a joint account. You can have any number of either (although I can’t see any reason why you would need to). You can open one up at any brokerage firm.

Everyone also has access to an IRA as long as they have earned income. As the name implies, you can only open an individual IRA, but a non-working spouse can also open up an IRA and fund it with their joint money (as long as they file taxes jointly). There are age limits for a Traditional IRA and income limits for a Roth IRA.

Traditional IRA:	Roth IRA
Pre-Tax	After Tax
Must be under age 72	No age limit
No income limit	$198,000 (married filing jointly)

A 401(k) is like an employer-sponsored IRA

Like an IRA there are also traditional and Roth variants of the 401(k). The difference (other than the contribution limits) is that there is no income limit for the Roth 401(k). The real question is whether or not your employer offers a traditional 401(k), or Roth 401(k), or both. Most large employers offer a traditional 401(k). Roths are less common, but they are gaining traction. Also smaller employers are less likely to offer a 401(k).

Traditional 401(k):	Roth 401(k)
Pre-Tax	After Tax
Must be under age 72	Must be under age 72
No income limit	No income limit

According to the Bureau of Labor Statistics 56% of companies offer a 401(k). Of those companies, 70% offer a Roth 401(k), and half (51%) match a certain percent of your 401(k) contributions. The average 401(k) match is 3.5%.

If you happen to be one of the lucky people whose company sponsors a 401(k) and offers a 401(k) match, the first thing you should do is contribute enough to get your full 401(k) match. If they match everything you contribute up to 4% of your salary, then you need to contribute 4% to get your full match. That’s free money! Don’t just leave it on the table. If you contribute $3000 and your company matches that $3000, that’s a 100% return on investment. There is no other investment that will give you a 100% return in a year!

Example – Use a 401(k) and a Roth IRA

Let’s pretend you’re a typical Midwestern family with a single income earner that makes $60,000/year. Your company offers a traditional 401(k) and will match your contributions up to 3.5% of your salary. If you want to save 15% of your income that would be $9,000/year. My first suggestion after setting up your 401(k) would be to open up a Roth IRA for both you and your spouse.

First 3.5% goes in your Traditional 401(k)
The next $6,000 goes into your Roth IRA
Any leftover savings go into your spouse’s Roth IRA
* (If you are really saving a lot or make a higher salary, after maxing out both of your Roth IRAs, the next step is to put any leftover savings into your 401(k) again.)
** (If you still have more savings after maxing out your 401(k), put the rest into a joint taxable brokerage account. This is probably not applicable since you would have to be saving more than $31,500.)

I believe this is the most efficient way to save for retirement. For the first step you get to claim your full company match in your 401(k) and you get to decrease your taxes by 3.5%. In the second and third steps you max out your Roth IRA and put the leftovers into your spouse’s IRA. This doesn’t decrease your taxes this year, but allows you to take out all your money (including gains) tax free at 59½.

But that’s not all. Before you’re 59½ you can take out any money you’ve contributed to a Roth IRA. (You can’t withdraw the gains without paying a 10% penalty, but you can withdraw contributions because you’ve already paid the taxes on that money.) This makes the Roth IRA the perfect tool not only for retirement, but also for an emergency fund or college fund etc. You get the interest of the stock market, but you can withdraw the money you’ve contributed whenever you need it.

What if your company offers a Roth 401(k)?

If your company offers a Roth 401(k) I would pick that over the traditional 401(k), but I would keep the steps the same:

First 3.5% goes in your Roth 401(k)
The next $6,000 goes into your Roth IRA
Any leftover savings go into your spouse’s Roth IRA

The advantage of a Roth 401(k) is that you can roll it over into your Roth IRA and not have to pay any taxes in retirement.

The other advantage of maxing out your IRA before your 401(k) is that you have more control over what funds you can invest in. With a 401(k) you only have the investment options that your company provides. Sometimes these options aren’t great, or have high management expense ratios. There was a bit of a scandal a few years ago when it was exposed that many 401(k) providers charged unnecessarily high fees. Since that scandal broke and the lawsuits followed, most 401(k) providers now offer a regular S&P 500 Index Fund with lower fees so they are much better than they were before.

So that’s my recommendation. I have read a few articles that claim a Traditional IRA/401(k) is better for tax purposes but most of those are Silicon Valley types making the assumption of high salaries. For a typical Midwest family I believe a Roth IRA/401(k) is the better option. I go into detail about the math of that claim in Roth or Traditional IRA, Which is Better?

What do you think? Do you agree with my analysis? Do you contribute to a 401(k), IRA, or both? Let us know in the comments below!

Ten Lessons I Learned Growing Up With Little

Posted on June 28, 2021 by Courtney

I suppose an introduction is required. My name is Courtney, and I’m David’s wife. We’ve been married for almost 7 years, and we have a little boy who was just born this year. Quarantine babies, am I right? We make a pretty good living right now, but when we were newlyweds we lived off of David’s graduate student salary. It put us below the poverty line, technically, but I felt richer than I ever had before. My parents were missionaries for most of my early childhood, and then they just had my dad’s pastoral salary with all three of us kids. We had very little.

Living off of that small amount is what taught me the following ten lessons, which I think could be valuable for you too.

Learn to do it yourself if you can

I learned this very early from my dad. When we first moved overseas, the house my parents were given by the mission had a lot of work that needed done. Subfloors were rotten, closets needed built, kitchen cabinets needed installed, and the house needed a water heater–to name a few things. We lived way out in the absolute middle of nowhere, so hiring professionals would have been incredibly difficult and incredibly expensive. So instead my dad buckled down and learned to do everything he could. He had help when it came to the technical aspects from people who came down from the States, but he soaked up everything he could and was never merely a bystander in the process. Even now, when he and my mom have far more disposable income than they had ever had in their lives, my dad still does most of the work on projects around the house. For example last year he and my brother put a new engine in an old Miata my dad had bought off of Craigslist!

My dad learned how to do these things out of necessity, but I also know that a job well done brings him a great sense of pride and fulfillment. That’s the lesson I’m currently taking from learning to do things myself. I can afford nice store-bought bread, but the sense of accomplishment I get from making a loaf of bread, and having it come out of the oven perfect and fluffy, can’t be bought. I’m not advocating that you have to be able to fully build, wire, and plumb your own house (unless that’s what you really want to do), but I am saying that you should learn all you can. It can save you a lot of money, give you a great sense of accomplishment, and be a fun talking point.

Things taste better when you’ve worked hard for them

I will be honest, gardening is not my favorite thing. Every year as a teen I would dread the days mom would send us outside to pick green beans. The plants are itchy on bare legs, hide a million bugs that are just waiting to jump on you, and seem to have a never-ending supply of beans that you have to search and search for. Seriously, no matter how many times you turn the plant to a different side, there’s always some you missed. It was always worth it though, because eating something you worked for is so satisfying. I find the same thing to be true with home cooking. Homemade cheesecake tastes better than store-bought because of all the effort that went into it. The fortunate thing here is that not only does it taste better, it’s usually cheaper too. Also, if you’re making it yourself you can add more sugar to ensure it tastes better!

Second hand does not mean subpar

When I was young shopping at thrift stores was embarrassing. I know thrifting is less embarrassing now than it was 20 years ago, but I can’t tell you how much I wished that I could own anything new. Finally, for my 16th birthday my aunt gave me a gift card for Old Navy. I was thrilled, and immediately bought myself a new pair of jeans (which basically used up the whole gift card). Then the next week when we were at the thrift store I found the exact same pair of jeans–for one dollar. I learned my lesson right there. Even now I hardly ever buy anything new, because I know Craigslist, Facebook Marketplace, or the thrift store will likely have what I need. Buying used doesn’t mean having to buy old or broken and just “making it work”. The furniture in my son’s bedroom is in great shape and cost less than $150 for a solid wood dresser with a hutch, a bedframe, and a nightstand. That’s less than if I had bought cheap particle board furniture from Walmart and if I didn’t know it was 20 years old I’d never have guessed!

You’re not saving money by buying something on sale if you wouldn’t have bought it otherwise

This is pretty straightforward. If you buy something just because it’s on sale, but don’t actually need it, then you’re not saving anything at all. This isn’t to say it isn’t a good idea to occasionally buy toilet paper or other necessities when they are on sale. But if you buy the cute dress you find on sale even though you have plenty of other dresses that you’ve never worn hanging in your closet, you’re wasting money.

A lot of the things that we “can’t live without” we could not only could live without, but genuinely don’t need

I, like many housewives, have watched my fair share of HGTV. I really enjoy seeing a house transformed, and also seeing all the cool new gadgets and interesting features that can be added to a home. What always bugs me though, is when people call things like heated floors “must haves”. It’s OK for these kinds of things to be goals, but I think as a society we need to get away from the thought of gadgets and accessories being things we need to have rather than what they are–luxuries. We don’t need these things to survive, and not only that but we don’t need them at all! I really enjoyed the car we had when we were first married that had heated seats. But when we were looking for another car and found a reasonably priced one without heated seats, I was fine with that. Because heated seats are a luxury, and I don’t need them.

Anything can be a luxury if you consider it so

And yet luxuries are nice! I don’t think anybody wants to live in the absolute most Spartan fashion. We all like a little something that makes us feel like we are living “the good life”. Unfortunately a lot of people take this desire too far, and end up with maxed out credit cards and luxury vehicles they can’t afford. Instead of spending a crazy amount of money in order to feel like you’ve made it, I would recommend that you reframe your thinking.

While we lived overseas, my parents made it explicitly clear that we were not to drink the tap water. I think it had something to do with bacteria in the water that our guts were unable to tolerate, but honestly I was pretty little and all I took from their lesson was that tap water was off-limits. When we moved back to the United States, my dad made a big show of pouring himself a glass of water from the sink. My siblings and I were amazed! What a luxury to be able to drink the tap water without boiling it. In fact, I thought it was so much of a luxury that I was later found washing my hand in the tub so as not to waste the drinking water.

What a simple thing, but it made me feel like we were living large. This kind of attitude is something we should try to cultivate. Make your morning cup of homemade coffee special by having it in a comfy seat at a time where you won’t be bothered so you can really enjoy it. Make a regular night at home fancy by popping popcorn, turning down the lights, and enjoying a movie. Little things can be luxuries if you allow yourself to luxuriate in them.

Things are nice, but don’t make your happiness contingent on them

We moved a lot. Like, a lot a lot. By the time I was 12 we had moved 15 times. When you move that often, you have to condense your belongings drastically. My parents couldn’t afford to ship heavy furniture overseas, and weren’t willing to waste valuable space on a giant stuffed animal collection. I got really used to getting rid of toys and clothes, even ones I still liked, because it wouldn’t fit in our new home or we didn’t have space to bring it in the first place.

When my great-grandmother passed away, my grandma decided to move to my home town to be closer to my parents. We went down to help her downsize, as she was going to be moving from a 2 story, 5 bedroom house (plus full walk-in attic and basement) to a ranch with 2 small bedrooms. My mother went through the house with her systematically, trying to find things she could part with, but it was like pulling teeth! She’d ask if she could get rid of a dutch oven that was full of dust on a shelf my grandmother couldn’t even reach, but grandma would say, “Oh I can’t get rid of that, so and so gave it to me at my wedding.”

I was fortunate to learn that things don’t bring you happiness at a young age. My grandma, while not having fully attached her happiness to these things, was definitely emotionally attached to them. She had a very hard time parting with them, because she had a sentimental attachment to everything she’d ever owned, even if she’d never used it! Being emotionally attached to things is a big problem, but attaching your happiness to them is even worse for you. Having a hard time getting rid of things can be overcome, but if you attach your happiness to having those things it becomes almost impossible. After all, how can you stand to get rid of it if it will make you unhappy? You not only are unhappy about losing it, but you can easily allow that unhappiness to sour whatever caused you to lose it–even if it was a happy thing that caused it! Even if you really want a baby, you can easily become angry towards them if you have to sell a sports car you had attached your happiness to just to afford the child. Or maybe you get a great new job opportunity, but you have to downsize from your beautifully decorated house and get rid of many of your favorite furnishings. It would be easy to begin to resent the job if you had elevated those things in your life so much that they dictated your happiness.

The thing is, at the end of the day these are all just things. You are allowed to like things, and you are allowed to be made happy by things. But you can’t allow those things to dictate whether or not you are happy.

Living on less can make your relationships stronger

This one is counterintuitive, I know. Money is the number one reason for divorce, so I recognize that things can go the other way. But when you don’t have much, all you have is each other. If you allow having little to teach you to work together instead of allowing it to tear you apart, the bond you build is going to be incredibly strong. David and I had very little when we were first married, and we were immensely happy with each other. I think our relationship was built on a very solid foundation because it was founded on our love for each other, not the things we had. It was a lot of hard work, but in the end it paid off with a relationship that can weather just about anything.

Being generous does not require a big income

One of the biggest impressions my parents made on me has to do with donating. My dad is a pastor, and for most of my childhood my mom didn’t work. But every first Sunday of the month my mom would write a check and put it in the offering plate, same as everyone else. They also supported ministries in the area, including nonprofits that helped out single mothers. Even though they didn’t have much, they still made sure that they were donating where they could. This made a big impression on me. Even when you don’t feel like you have a lot, helping your fellow man is important! There are a lot of ways you can be generous, even if you don’t donate to charity in the traditional way, and you don’t even have to have a dime to do some of them.

A grateful attitude makes much of little

And conversely, an envious attitude makes even much feel little. Desiring what others have instead of being grateful for what you already have sours you to anything that isn’t the thing you want. Let’s look at a Bible story for this one. How about King David and Bathsheba? We know from the Bible that David had at least 7 wives before he met Bathsheba, but it wasn’t enough. He couldn’t just be happy with what he had, he wanted more! And in the end, it ended up costing him greatly. He became a murderer, and lost the son he and Bathsheba had. This envious attitude only leads to hurt and loss. On the other hand, when you are grateful for what you have, it doesn’t feel so small. I was grateful for the clothes, toys, and games I had, and I never felt like I had too little. But an honest recollection makes it clear to me that I didn’t really have all that much. I knew plenty of kids that had more, and were unhappy with what they had. There can be joy even in little; find it!

David’s Note:
Courtney and I have been married for 7 years and it’s still crazy how much we think alike. Even though we grew up on different continents, we have the same philosophy of life. Our foundation for all of life is the belief that the Bible is the Word of God. Because God created both mankind and money, if you take these ten lessons to heart it will help make life so much easier. But it’s not just money, God has provided wisdom for all manner of life: first of which is how to know Him personally.

Hopefully you are able to get something out of these ten lessons. Let us know which ones you liked most in the comments below!

What Investments to Actually Buy

Posted on June 24, 2021 by David

When you read about investing you hear a lot of jargon, most of which we hopefully explained in the last post. You hear a lot of about asset allocation and risk tolerance and financial planning, but you’re rarely told what is a wise investment. The closest you get is someone telling you what to invest in, and when that happens you’re probably better off not following their advice because it’s some speculative stock or startup company. So what is a wise investment? What investments should you actually buy? Source: xkcd.com

One of the simplest and most efficient ways to invest is what’s called the Three Fund Portfolio, so named because it only invests in three different funds. It’s also called the Lazy Portfolio. A Three Fund Portfolio consists of an American total stock market index fund (which we recommended in our post What is Financial Independence), an international total stock market index fund and a total bond market index fund.

With just these three funds an investor can invest in over 10,000 different assets and securities all over the world!

The idea of this simple set of index funds is that you’ll get exposure to the American stock market, the international market, and the bond market. The American stock market is probably the greatest wealth-creation tool ever created. Most other countries have their own stock exchanges as well so with the international market you can invest in companies from those countries. The third fund covers bonds, which are basically government and corporate money-raising programs. So with just these three funds an investor can invest in over 10,000 different assets and securities all over the world!

What investments should you buy? Advantages of a three fund portfolio — Source : https://www.bogleheads.org/wiki/Three-fund_portfolio

So why these three funds?

According to our definition from the last article, index funds just try to replicate an index (basically a really fancy Excel spreadsheet). These three funds are replicating the Total Stock Index, the Total International Index, and the Total Bond Index. That means they will never under-perform the market as a whole, since they represent the entire market. Also being index funds, they have low expense ratios. Remember, the expense ratio (MER) is the percent of your invested money that is charged in management fees. Index funds can have a very low MER because there is no need for a manager to pick stocks – it just follows the index. While actively managed funds can have expense ratios of 1-2%, Charles Schwab’s S&P 500 fund charges just 0.02%. 1/100^th of the cost!

These funds also have several advantages: diversification (lots of different companies and asset classes), low turnover (less in taxes), and being easy to rebalance (since you only need to keep track of three funds).

Asset Allocation

Remember, asset allocation is the ratio of assets that you choose to hold. Since we are only talking about three funds, the ratio stays pretty simple. This is the ratio of American stocks to international stocks to bonds. What asset allocation should you have? A good starting point is 30% US Total Stock Market, 30% International Stock Market, and 40% total Bond Market. This follows the traditional 60/40 split between stocks and bonds. And it also splits US and international markets by weight since the US claims half of the entire world’s economy.

An advantage of deciding on a set asset allocation is that these three funds are not necessarily correlated. When stocks do well, bonds do not. If international stocks fall, US stocks could also fall or they could rise. When US stocks crater, US bonds go up. For example in March of 2020 when the stock market lost 30%, bonds went up 5%. This not only helps you weather storms, it also gives you a chance to make money. If in March of 2020 when your bonds are up 5%, you sold that extra 5% and used it to buy US stocks. Then in April when the stock market started to go back up you would have had that extra 5% increase in your investments.

Rebalancing

This is what is known as rebalancing. Rebalancing is when you sell some of your winners to purchase the funds that aren’t doing so hot. This may seem counterintuitive, but it allows you sell when asset prices are high and buy when they are on sale. This way you keep your desired asset allocation and survive through market crashes.

(As a note: I have very little in bonds right now as bond yields are so low. When they increase in a year or two I will start buying more bonds to get back to that 60/40 split. Also, if you are more than about 10 years away from retirement, I wouldn’t have 40% of my investment in bonds. I would focus more on pre-paying my mortgage or getting out of debt.)

So what funds should I actually invest in?

It depends on who you are investing with. While the funds are all basically the same since they replicate the same indexes, the actual ticker names are different.

For Vanguard the three funds are:

VTSAX – Vanguard Total Stock Market Index Fund
VTIAX – Vanguard Total International Stock Index Fund
VBTLX – Vanguard Total Bond Market Fund

For Schwab they are:

SWTSX – Schwab Total Stock Market Index Fund
SWISX – Schwab International Index Fund
SWAGX – Schwab U.S. Aggregate Bond Index Fund

For Fidelity you have options so that could be better or worse depending on how simple you want it:

FZROX – Fidelity ZERO Total Market Index Fund, or FSKAX – Fidelity Total Market Index Fund
FZILX – Fidelity ZERO International Index Fund, or FTIHX – Fidelity Total International Index Fund
FXNAX – Fidelity U. S. Bond Index Fund

These are just three examples. I personally invest using Schwab and I have SWTSX, SWISX, and SWAGX. For Schwab’s Total Stock Market Index Fund (SWTSX) the expense ratio is 0.03%, their International Index Fund (SWISX) has an expense ratio of 0.06%, and their U.S. Aggregate Bond Index Fund (SWAGX) has an expense ratio of 0.04%. This means at a 30/30/40 split asset allocation, the average expense ratio is 0.043% meaning for every $1,000 invested I would pay $0.43 per year. This is why the Three Fund Portfolio out-performs nearly every professional investment portfolio, It’s simple enough that anyone can do it and it costs almost nothing in fees.

What do you think? Which funds are you invested in? Let us know in the comments below!

Common Financial Terms

Posted on June 21, 2021 by David

So you’re ready to start your FIRE journey. You start looking at articles and videos about finances and investing, but you run into so much jargon! Finance articles all use the same jargon: Equities vs fixed income, securities, asset allocation, risk, but these words don’t mean much to the common investor. Honestly, you don’t even need to understand most of it. Here’s a list of the important common financial terms and their definitions. (Picture source: Attyca)

Common terms you need to know

Equities vs Fixed Income: Equities are another name for stocks because by owning a share of stock, you own a share of the equity in a company. Fixed income is just a fancy term for bonds because when you own a bond, the bond issuer pays you a fixed amount based on the contract of the bond when you bought it. The income is fixed even if the price/value of the bond changes.

Securities or Assets: An asset is anything that increases in value. This means that a house is an asset. Securities are publicly traded assets like stocks and bonds. There are other securities like gold or real estate investment trusts, but for the sake of simplicity the two most important securities are stocks and bonds.

Mutual Funds: a bundle of many different securities. There are mutual funds that hold healthcare company stocks, or utilities, or pretty much anything you can think of. There’s even a video game mutual fund. Mutual funds are safer than buying individual stocks because it’s harder for all of the stocks in a fund to go down at the same time. Unlike stock you don’t have to buy a whole share of a mutual fund. For example you purchase $100 worth of a mutual fund even if that is 1.23 shares.

ETF: Exchange Traded Fund, very similar to a mutual fund but you have to buy it in whole units. The price per share is usually less than a mutual fund. Sometimes they have lower expense ratios than their equivalent mutual funds.

Index: A marker of a segment of the stock market. This is not a fund in an of itself, its more like a spreadsheet of assets. An example of an index is the S&P 500 Index which tracks the 500 largest US companies, weighted by market cap (how much the entire company is worth). This index is widely regarded as the best gauge of the overall stock market. The Dow Jones Industrial Index (DJIA) tracks 30 large multinational companies that have been in existence for many years, weighted by stock price. The Nasdaq Composite Index tracks 2500 companies and is 50% technology stocks.

There are also indexes for securities other than stocks. For example there is an aggregate bond index which tracks government and company bonds. There are housing and real estate indexes, and even gold and silver indexes.

Index Fund: A mutual fund or ETF that tries to replicate an Index. For example an S&P 500 Index Fund will try to replicate the S&P 500 Index by having the same amounts of the same companies. Index funds generally have very low expense ratios because they don’t have a manager who is trying to pick winning stocks. They just follow the index.

(Expense ratio) MER: Expense Ratio, also called Management Expense Ratio, is the percent of your invested money that is charged in management fees. For example if you have $10,000 in a mutual fund and the MER is 1%, you will owe $100/year. Typically the expense ratio is higher for actively managed funds (1%-2%) and lower for index funds (<0.5%). Index funds can have a very low MER because there is no need for a manager to pick stocks – it just follows the index.

The idea of an actively managed fund is that a smart fund manager (and his extensive team of financial analysts) can pick the best stocks to put into his fund. The expense ratio is the fee that he charges to help you beat the general stock market. The hope is that an actively managed fund will out-perform the general stock market by more than the 1%-2% fee it charges, but when you look at the last 15 years, 90% of actively managed funds not only failed to beat the market by 1%-2%, they actually underperformed the general market. So the expense ratio is essentially a fee you pay to have some financial manager perform worse than you would by yourself.

Another reason is that actively managed funds are buying and selling stocks to try to get ahead, but every time you sell a stock you have to pay taxes on it. Therefore actively managed funds have a higher tax burden as well.

Asset Allocation: This is the ratio of assets that you choose to hold. For example if you have 60% of your money in stocks and 40% in bonds you have a 60/40 asset allocation. Your asset allocation determines your risk. Since stocks are riskier than bonds a 60/40 asset allocation will be less risky than a 90/10 spit.

Your asset allocation should change as you grow older and closer to retirement. When you are younger it doesn’t matter how bad the stock market crashes, because you are still putting money into your retirement savings. The average market correction lasts 6 months, so if you are more than a couple years away from retirement, don’t worry about it.

If you are less than 5 years away from retirement you should be more conservative. A 60/40 stock/bond asset allocation is a good way to be able to weather market corrections while still allowing your nest egg to grow. The way to do this is to sell some of your stocks and use the money to purchase bonds.

Traditional IRA: An IRA, which stands for Individual Retirement Account, is a savings account that allows individuals to contribute a limited amount per year. As of 2021 people under 50 years old may contribute up to $6,000 per year and deduct those contributions from their taxable income. When in an IRA money can be invested in the stock market without having to pay dividend or capital gains tax. After the individual has reached age 59½ they may withdraw their money from their IRA. The withdrawals are then taxed at their current tax rate. A traditional IRA is considered a tax-deferred account because you don’t pay taxes on the money you contribute to your IRA, but you do pay taxes on what you withdraw. Also if you withdraw from a traditional IRA before you reach age 59½ you will have to pay a 10% penalty on top of the taxes.

Roth IRA: A Roth IRA is like a traditional IRA only you don’t get to deduct your contributions from you taxable income. The upside is that you don’t have to pay taxes on your withdrawals. This means that none the money that you get in interest or dividends is taxed. Another upside is that since you already paid taxes on your contributions, you can withdraw that money before you turn 59½ (though you still have to wait to withdraw the interest accrued or you’ll get slapped with a 10% penalty). Because of this perk, a Roth IRA can be an extremely helpful tool in pursuing early retirement. So which is better, a traditional IRA or a Roth IRA?

401(k): A 401(k) is very similar to an IRA (there are both traditional and Roth variants). The difference is that a 401(k) is employer sponsored. This means that you only get the investment opportunities that the employer has agreed to. They are usually target date funds and index funds so that’s fine. The advantage is that your employer may match some contributions you make to your 401(k) so that’s free money! Also the contribution limits on a 401(k) are $19,500 in 2021. That’s more than three times as much as you can contribute to an IRA.

Taxable account: This is a regular investment account also called a brokerage account. The money put into this account can be used to invest in the stock market. Unlike an IRA or 401(k) you can put as much money into this account as you and want and can withdraw money whenever you want. The downside is that you have to pay taxes on interest, dividends, and capital gains.

Dividend: A distribution of some of a company’s earnings to shareholders. When a company makes a profit for the year it has options for how it can use the money. It can hold onto the cash for a future time, it can use the profits to buy more equipment or capacity, or it can give money to its shareholders. All of these options increase the value of the company which then makes the stock valuable. Holding cash increases the company’s bottom line, investing in itself to increase capacity will make the company more profitable in the future, and passing profits along to shareholders makes the company’s stock more valuable to investors. Bigger companies that don’t have the ability to expand usually pay out higher dividends because they can’t find better things to do with the money.

Capital Gains: Capital gains are the profits you make on selling an asset. For example if you purchase you house for $200,000 and later sell it for $300,000 you capital gain is $100,000. In the case of the stock market, if you purchase 10 shares of a stock or index fund at $20/share and you sell them 20 years later for $100/share, your capital gains are $80 times the 10 shares or $800. If these stocks were held in a taxable brokerage account you would have to pay capital gains taxes on that $800 profit. If they were in an IRA or 401(k) you wouldn’t have to pay capital gains taxes on that $800 profit.

Short Term vs. Long Term Capital Gains: The IRS puts capital gains into two different categories, short term and long term capital gains. Short term capital gains are profits made from assets held for less than a year, and long term capital gains are profits made from assets held for more than a year. The reason for this distinction is because they are taxed at different rates.

Short term capital gains are taxed at you normal income tax level whereas long term capital gains are taxed at a much more convenient rate. This is to encourage people to buy assets (like index funds) and hold them until they retire. As you can see below a married couple filing jointly can sell stock for a profit of $80,800 every year without having to pay the IRS a dime. But if they didn’t hold the stock for a full year they would have to pay about $9,000 in taxes on that $80,000.

Tax rate	Taxable income bracket	Tax owed
10%	$0 to $19,900	10% of taxable income
12%	$19,901 to $81,050	$1,990 plus 12% of the amount over $19,900
22%	$81,051 to $172,750	$9,328 plus 22% of the amount over $81,050
24%	$172,751 to $329,850	$29,502 plus 24% of the amount over $172,750
32%	$329,851 to $418,850	$67,206 plus 32% of the amount over $329,850
35%	$418,851 to $628,300	$95,686 plus 35% of the amount over $418,850
37%	$628,301 or more	$168,993.50 plus 37% of the amount over $628,300

The regular tax rate for married couples, filing jointly

Long-term capital gains tax rate	Investment income bracket
0%	$0 to $80,800
15%	$80,001 to $501,600
20%	$501,601 or more

The long-term capital gains tax rate for married couples, filing jointly

Inflation: Inflation is the gradual rise in costs of goods and services. As a result of inflation, the purchasing power of the dollar decreases. The Federal Reserve attempts to keep inflation at around 3% per year. As a general rule this means that prices will double roughly every 20 years. This is important to remember for retirement because if you plan to retire in 20 years assume that things will cost twice as much as they do now.

Required Minimum Distribution (RMD): If you have a traditional or Roth 401(k) or traditional IRA, the IRS requires you to take withdrawals of at least a certain minimum by April 1 of the year following the year you reach age 72. This is to make sure they get their cut of your taxes. If you don’t withdraw at least the required minimum distribution, you get slapped with a penalty of 50% of that value. However if you have a Roth IRA there are no required minimum distributions because you have already paid taxes on that money.

This isn’t an exhaustive list of financial terms by any stretch of the imagination, but I hope it’ll be enough to at least get you started. What do you think? Did I miss any important jargon or fail to explain something clearly enough? Let us know in the comments below, and I’ll update this page!

FIRE