Glossary

These definitions were created in the course of writing the Middle-Class Millionaire books and informed by Kendall Capital’s 30+ years of experience in fee-only financial advising in the Metro DC area. We hope you find this Glossary helpful in your financial journey.

A

Active Management/Passive Management: Investment assets are either actively or passively managed. In active management, the portfolio management team attempts to perform better than its benchmark index by actively buying and selling securities. Passive management attempts to replicate the returns of a benchmark.

Annuities/Annuitize: An annuity is a financial product in which the annuitant (person buying the annuity) purchases a stream of guaranteed income, typically for life. One way to provide some form of guaranteed income for life is to annuitize some assets, which will provide you income, in addition to Social Security benefits, throughout your life. Annuities can be fixed or variable, deferred or immediate.

Asset allocation: The act of creating a mix of portfolio assets that reflects your individual timeline and risk tolerance, among other factors.

B

Beneficiary designation: A beneficiary designation is the act of naming the person who will inherit an asset in the event of the account owner’s passing. It is vitally important to name and update designated beneficiaries on any account that could involve the transfer of assets when you die, including any kind of retirement account, company pension, annuity, or life insurance policy.

Bond coupons: The amount of income you will receive from a bond.

Bond duration: The degree of sensitivity of a bond to interest rate movement. A bond’s duration closely reflects its maturity. The longer its duration, the more a bond will be affected by interest rate movement.

C

Capital gains and losses: When a security appreciates in value or loses value, it incurs a capital gain or loss. However, that gain or loss isn’t realized until the security is sold. During the tax year, if you realize a capital gain and expect to owe capital gains tax, one way to reduce your tax liability is to sell another investment for a capital loss, thus offsetting the gain.

Catch-up contributions: A catch-up contribution is a type of retirement savings contribution that allows people aged 50 or older to make additional contributions to employer-sponsored retirement accounts, such as 401(b) or 457(b) accounts and individual retirement accounts (IRAs).

Certificates of deposit: Certificates of deposit are the most conservative form of investing. They are typically issued by banks and are guaranteed, but also typically pay low rates of interest.

Charitable trusts (CRTs, CLTRs): Charitable remainder trusts (CRT) and charitable lead trusts (CLT) provide a stream of income during one’s life after which the remaining assets are passed on to a beneficiary. In a CRT, a charity receives the end-of-life proceeds. In a CLT, a charity receives a stream of income during one’s life.

COBRA (Consolidated Omnibus Budget Reconciliation Act): COBRA gives employees the right to retain group health insur-ance should they lose their job. However, former employees must pay their own premiums.

COLA: Cost of living adjustments (COLA) are typically made each year on benefits, including Social Security benefits as well as those in the CSRS and FERS government retirement plans.

College savings accounts–529 college plans, custodial accounts: College savings accounts can take a number of forms. The two most popular are 529 state college savings plans and custodial accounts: Uniform Gifts to Minors Act (UGMA) and Uniform Gifts to Minors Act (UTMA).

Commodity: A raw material or agricultural product that can be bought and sold. Commodities are a form of alternative asset that can help to diversify an investment portfolio because of their low correlation with other assets.

Concentration risk: Concentration risk comes from having too much money invested in a single stock or other investment or in a group of investments that are in the same industry or economic sector. The risk comes from the chance that all the investments would lose value together if something happened to that one company, industry, or sector. Diversification can lower this risk.

Correlation of assets: The degree to which two or more assets tend to perform similarly. High correlation means their prices behave very similarly. Low or negative correlation can enhance risk management through greater diversification.

Credit ratings: The evaluation of the credit risk of a prospective debtor. The issuers of bonds, such as companies and governments, are rated according to their assessed level of riskiness based on their credit rating. Similarly, people are rated based on certain criteria and are judged for their creditworthiness when applying for loans, mortgages, or even rental leases.

CSRS: The Civil Service Retirement System (CSRS) is a public pension fund that since 1920 has provided retirement, disability, and survivor benefits for most US federal government civilian employees. It covers employees who were hired before 1984. Federal government employees hired since 1984 are covered by the Federal Employee Retirement System.

D

Deferred annuity: A deferred annuity is a contract with an insurance company that promises to pay the annuity owner a regular income, or a lump sum, at some future date.

Defined benefit plan: A defined benefit plan is an employer- sponsored retirement plan in which employee benefits are computed using a formula that considers length of employment and salary history, along with other factors.

Defined contribution plan: A defined contribution plan is a retirement plan in which the employee and/or the employer contribute to the employee’s individual account under the plan.

Dollar-cost averaging: The practice of investing the same dollar amount at regular time intervals, such as once a month. By buying the same dollar value, you purchase more shares when the price falls and fewer shares when it rises.

Donor-advised funds: A form of charitable giving in which donors can make a tax-deductible donation and have it invested in the donor-advised fund until a charitable distribution is made, possibly in a later year.

Dividends: The regular payment of a designated share of profits by a company to its shareholders on a per-share basis.

E

Emergency fund: Designated savings that you could draw on in an emergency. It is generally recommended that people should have a large enough emergency fund to pay for at least three to six months’ worth of living expenses.

ERISA: The Employee Retirement Income Security Act (ERISA) is a federal law that protects the retirement assets of American workers. It covers a variety of defined benefit and defined contribution retirement plans.

Ethical Investing: See: Socially responsible investing (SRI), or social investment

F

FEGLI: The Federal Employees Group Life Insurance (FEGLI) Program is a group term insurance program that offers a basic benefit plus three optional add-ons.

FEHB: The Federal Employees Health Benefits (FEHB) Pro-gram is the largest employer-sponsored health insurance pro-gram in the world, covering more than eight million federal employees, retirees, former employees, family members, and former spouses.

FERCCA: FERCCA stands for the Federal Erroneous Retire-ment Coverage Corrections Act. It addresses the long-term harm to retirement planning created when employees are put in the wrong retirement plan.

FERS: The Federal Employees Retirement System (FERS) is the retirement plan for US federal employees. The plan covers all employees in the executive, judicial, and legislative branches of the federal government. Under FERS, employees receive retirement benefits from three sources: the basic benefit plan, Social Security, and the Thrift Savings Plan (TSP).

Fiduciary: A person who acts on behalf of another person or persons to manage assets. A fiduciary has a legal and ethical responsibility to act in good faith.

G

GPO: If someone receives a pension from a government job but did not pay Social Security taxes while they had the job, through the Government Pension Offset (GPO) program, the federal government will reduce that person’s Social Security spouse, widow, or widower benefits by two-thirds of the amount of their government pension.

Green Investing: See: Socially responsible investing (SRI), or social investment

H

Health Savings Accounts (HSAs): A savings account dedicated to paying for medical costs. HSAs are tax-deductible, and earnings are tax-free. In addition, withdrawals for qualified expenses are tax-free.

High 36: The high-36 method of calculating government pen-sion benefits uses the average of the highest 36 months of basic pay divided by 36. This is generally the last three years of service and is sometimes called high three.

Home equity line of credit: When you build equity in your home, you can use that equity to obtain low-cost funds in the form of a “second mortgage”—either a home equity loan or a home equity line of credit (HELOC). HELOCs are a revolving source of funds, much like a credit card, that you use as you see fit.

I

Individual retirement account (IRA): Individual retirement accounts (IRAs) are investment accounts intended for retire-ment savings. They allow earnings to accumulate on either a tax-deferred basis (traditional IRAs) or a tax-free basis (Roth IRAs). The key difference between a traditional IRA and Roth IRA is that with a traditional IRA, you receive a tax break up front through a tax-deductible contribution, but you pay taxes on withdrawals; and with a Roth IRA, you don’t receive a tax break until you withdraw from the account. At that time, as long as certain conditions are met, you pay no taxes on the amount contributed to the Roth IRA or any earnings.

Insurance: This includes life insurance, liability insurance, and umbrella insurance. Life insurance is typically sold as a term (finite period) policy or permanent insurance (whole life/uni-versal life). Liability insurance protects against risks of liabilities imposed by lawsuits and similar claims. Umbrella insurance is a form of liability insurance that goes beyond what is covered by other policies, such as auto and homeowners insurance.

J

Joint and survivor annuity: A type of immediate annuity that guarantees payments for as long as the annuity owner or the beneficiary lives.

L

Leverage: The use of borrowing money when investing. Lever-age can magnify your potential investment losses as well as your potential gains.

Lifetime gifting: The act of giving assets to family members throughout your life rather than passing them on upon death.

Liquidity: The ability to easily turn assets or investments into cash. At one extreme, things like real estate have poor liquidity, while money in the bank has high liquidity. Short-term savings should have high liquidity, because you might need to access them at any time

Living trust: A trust that is created during your lifetime. It spells out your wishes regarding your assets, dependents, and your heirs.

Living will: A written statement detailing your desires regard-ing your medical treatment in the event that you are no longer able to express your informed consent, also known as an advance directive.

Long-term care insurance: A long-term care insurance policy is designed to cover long-term care needs, services, and support. In other words, it pays for needs arising from a chronic illness or medical condition.

Longevity risk: The risk of outliving your money. It is one of the primary reasons to make sure one has saved sufficiently for retirement.

M

Matching contribution: A type of contribution that an employer makes to its employees’ employer-sponsored retire-ment plan according to an established formula.

Medicare: A single-payer national health insurance program that covers seniors and is composed of various parts, includ-ing hospital insurance, medical insurance, and prescription drug coverage.

Money market funds: Mutual funds invested in short-term debt securities, such as U.S. Treasury bills and commercial paper. Money market funds are conservative, short-term investments.

O

Opportunity cost: Opportunity cost is the value of what you give up whenever you make a decision. It is the loss of potential gain had you chosen the alternative. If you spend $50,000 on a car, for example, an opportunity cost might be what that money would earn if you invested it instead.

P

Power of attorney: Written authorization for someone to act on behalf of another person in financial, medical, or other legal matters.

Price-to-earnings ratio, price-to-book ratio, price-to-sales ratio: Forms of stock valuations that use multiples or ratios that divide the stock’s estimated value by a metric such as earnings, book value, or annual sales.

Private mortgage insurance: A form of additional monthly insurance that typically is charged to home buyers who don’t have a minimum 20 percent down payment on their mortgage.

Q

Qualified charitable distributions: An otherwise taxable distribution from an IRA (other than an ongoing SEP or SIMPLE IRA) owned by an individual who is age 70½ or older that is paid directly from the IRA to a qualified charity.

R

Realized and unrealized gains: A realized gain is the gain that is recognized when you sell assets for a price higher than the original purchase price. Until you sell the asset, you have an unrealized, or paper, gain. Selling it realizes the gain. The gain would be taxable if it is not held in a tax-qualified or tax-deferred account, such as an IRA, Roth IRA, or 401(k) plan. You can offset realized gains to reduce the tax implications by selling other assets at a loss.

Realized and unrealized losses: A realized loss is the loss that is recognized when you sell assets for a price lower than the original purchase price. Until you sell the asset, you have an unrealized, or paper, loss. Selling it realizes the loss.

Required minimum distributions (RMDs): Mandatory with-drawals from an IRA, SIMPLE IRA, SEP IRA, or retirement plan account when you reach age 70.5.

Revocable/irrevocable trusts: A revocable trust has provisions that can be altered or canceled by the trust’s grantor (the person who creates the trust). An irrevocable trust can’t be modified, amended, or terminated without the permission of the trust’s beneficiary or beneficiaries.

Roth vs. traditional IRAs: See individual retirement account (IRA).

Rule of 72: The rule of 72 is a formula that estimates the number of years it takes to double an investment at a given annual rate of return or interest. For example, at a steady annual return of 8 percent, it would take 9 years to double an investment, but at a 4 percent annual return, it would take 18 years.

S

Securities: Investments traded on a secondary market. The most well-known examples of securities are stocks and bonds.

Socially responsible investing (SRI), or social investment: Any investment strategy that considers both financial return and social/environmental good to bring about social change regarded as positive. It is also known as sustainable, socially conscious, “green,” or ethical investing. For example, a socially responsible fund might avoid industries that negatively affect the environment and its people. However, it might include companies that produce or invest in alcohol, tobacco, gambling, and weapons. In other words, each investment fund or management team defines how it views social responsibility and why it considers that company socially responsible. Socially responsible investing can mean different things to different people, so it’s important to understand the underlying variables and philosophy of the investment and why the investment would be profitable.

Stock valuation: Methods of calculating theoretical values of companies and their stocks.

Survivor benefits: Benefits payable to your surviving spouse after you die. For example, if you retire under the Federal Employees Retirement System (FERS), the maximum survivor benefit payable is 50 percent of your unreduced annual benefit.

T

Target-date funds: Mutual funds or collective trust funds designed to provide a simple investment solution through a portfolio whose asset allocation mix becomes more conser-vative as the target date (typically one’s projected retirement date) approaches.

Tax-deferred accounts: Accounts (typically retirement accounts) in which investment earnings—including interest, dividends, and capital gains—accumulate tax-free until the investor takes distributions.

Tax loss harvesting: The process of selling an investment that has experienced a loss. By realizing, or “harvesting,” a loss, investors are able to offset taxes on capital gains and/or general income.

Testamentary trusts: A trust contained in a last will and testament that provides for the distribution of all or part of an estate.

Thrift Savings Plan (TSP): The TSP is a retirement savings and investment plan for federal employees. It is similar to a private sector 401(k) plan or state 403(b) and other similar plans.

Tranche: A portion of something. In a financial context, tranches are separated into short term, medium term, and long term. Each tranche or portion of your portfolio—short-term, medium-term, and long-term—should have a specific purpose and use a dedicated and appropriate set of investments.

U

Unrealized Gains: See: Realized and unrealized gains

Unrealized Losses: See: Realized and unrealized losses

V

Vesting: Vesting refers to the percentage of an employee’s retirement account that they own. While the contributions an employee makes to their plan are always 100 percent vested, the employer’s matched contributions are not always automatically vested. An employee might need to have a set number of service years for the matched contributions to be 100 percent vested.

Volatility: Volatility describes the tendency for investments, such as the stock market, to rise or fall. More volatile investments often have a higher potential return, while less volatile investments tend to have lower returns. In a sense, investors are rewarded for accepting volatile investments.

Voluntary Contribution Program: The Voluntary Contribution Program was developed for employees who are part of the Civil Service Retirement System (CSRS). It allows those employees to contribute their own money into an account that can later be used to increase their annuity when they retire.

W

Windfall Elimination Program (WEP): The WEP is a formula used to adjust Social Security worker benefits for people who receive “non-covered pensions” and qualify for Social Security benefits based on other Social Security–covered earnings.

Y

Yield: Yield refers to how much income an investment gener-ates, apart from the principal. It is commonly used to refer to interest payments an investor receives on a bond or dividend payments on a stock.