THE FI DICTIONARY: 25 KEY TERMS & PHRASES OF THE FINANCIAL INDEPENDENCE MOVEMENT

“Understanding comes through communication, and through understanding, we find the way to peace.” –Ralph C. Smedley

INTRO

There are few things more frustrating than listening to a podcast, watching a webinar or reading some wierdo’s financial independence blog (*cough cough*) and finding your desire to learn and understand being hindered by the helpless realization that you don’t know the meanings of many of the terms and phrases the host is using. Without a base level of knowledge, as the content gets more and more complex the feeling of anxiousness, frustration and stress only compounds. We have to learn to walk before we can run.

When it comes to the pursuit of financial independence, there are particular terms and phrases that you’ll come across in almost every single book, podcast and blog. Many of these terms and phrases you’ve likely heard of in your everyday life even outside of the financial independence movement (we’re talking about you, “401(k)”). Others may have different meaning depending on the context or your specific circumstance. What’s important is that you have the foundational knowledge to enable you to link key concepts and ideas in order to progress towards your goals. That all starts with understanding the basic lingo. In this post, we start laying the groundwork for your pursuit of financial independence by looking at 25 terms and phrases that are frequently used when discussing FI. Many of these terms have, or will soon have, their own separate blog post exploring the specifics at a more granular level, but for purposes of this post the summaries below are intentionally high-level. Enjoy!

THE FI DICTIONARY

1. 401(k): A tax-deferred retirement savings plan offered to employees by most employers. Under a traditional 401(k) plan, an employee is able to make pre-tax contributions to his or her 401(k). This means that money comes from the employee’s paycheck before income taxes have been deducted. An employee’s contributions thus reduce his/her taxable income for the year. Taxes are not due on the money contributed or the investment earnings until the money is withdrawn. Any funds withdrawn before the qualifying age (currently 59½), absent other qualifications, will result in an early distribution penalty tax (currently 10%). Contrast this with the Roth 401(k) discussed below.
2. 529 Plan: A tax-advantaged savings account designed to be used for certain education expenses. 529 plans allow for tax-free withdrawals and other benefits when used to pay for the designated beneficiary’s qualified education expenses, which include, but are not limited to, kindergarten through 12th grade tuition, college and apprenticeships.
3. Backdoor Roth IRA: A conversion strategy that allows high earners who otherwise would not be able to contribute to a Roth IRA due to IRS-imposed income limits to open and fund a Roth IRA. Post-tax funds are deposited into a traditional IRA, and the funds are then converted to (or backdoored into) a Roth IRA. Any post-conversion investment income then grows tax-free.
4. Brokerage Account: An taxable account from which investments such as stocks and bonds can be bought and sold. Brokerage accounts have no contribution limits or early withdrawal penalties. Most brokerage accounts are not tax-advantaged accounts—you’ll be funding the account and purchasing investments with post-tax dollars (g., wages earned at a W-2 job). Income from investments is subject to capital gains taxes.
5. Compounding: The process in which an asset’s earnings are reinvested to generate additional earnings over time. The investment generates earnings from both its initial principal and the accumulated earnings from preceding periods. Interest on interest boosts returns over time, slowly at first and in greater and greater magnitude as time passes. Compounding is one of the biggest reasons why you should be focusing on time in the market as opposed to timing the market.
6. Emergency Fund: Money that is set aside for unexpected costs and expenses, such as medical bills, car repairs, housing CAPEX (that water heater is going to go out at some point), and loss of employment.
7. Employer Match: Funds that an employer contributes to an employee’s 401(k), up to a specified percentage, based upon the employee’s contributions to his/her 401(k).
8. ETF: An exchange-traded fund. At a base level, exchange-traded funds can be thought of as a pool or basket of different securities that you are able to buy just like an individual stock. Exchange-traded funds come in all different shape and sizes. Some track a specific index (g., S&P 500). Others track industries (such as tech) or commodities (such as gold). Exchange-traded funds are comprised of diversified holdings, and thus aim to diversify exposure.
9. Expense Ratio: The annual cost, expressed as a percentage of one’s investments, of owning a mutual fund or an ETF. For example, if you have $100,000 invested in an ETF with an expense ratio of .03%, you will pay $30 annually, which will typically be used for administrative, management and other fund expenses.
10. FI: Financial Independence. At its roots, FI is about saving enough money so that the income that saved money generates can indefinitely cover one’s spending without the need for additional funds. Over the last decade, the pursuit of FI at an age well before what is still thought of as the “typical” retirement age has morphed from a far-fetched idea to a full-on movement, with folks across the globe working to save enough money to live a lifestyle of freedom and flexibility at a younger age.
11. FIRE: Financial Independence, Retire Early. FIRE takes the concept of FI described above, and adds the additional step of retiring The definition of “retirement” varies across the FIRE community. Some passionately argue that to truly achieve FIRE, you’ll need to have stopped working. For others, it means being able to do only the work you truly enjoy (e.g., quitting that corporate job to coach youth sports or become a fishing guide).
12. Four Percent (4%) Rule: The oft-cited retirement withdrawal strategy that proposes “retirees” can withdraw an amount equal to 4% of their savings during the year they retire and then adjust for inflation each subsequent year for 30 years. While often described like a hard-and-fast canon, the 4% rule is really more of a starting place that should be re-evaluated and adjusted as necessary on a regular basis.
13. High-Yield Savings Account: A bank account similar to a traditional savings account, but that offers yields exponentially higher than a traditional account. At the outset of 2024, high-yield accounts were offering 5%+.  At our home bank, starter savings accounts yield 0.04%.
14. House Hack: A real estate investing strategy through which income is earned by renting out some or all of your primary residence. The common example seen throughout the FI community often involves purchasing a multifamily property such as a duplex, and renting out one side while living in the other. House hacking can take other forms, such as renting out individual rooms within your residence.
15. HSA: A tax-advantaged account that can be used to pay for qualified medical expenses, including copays, prescriptions, and dental care. HSAs are tax-advantaged because contributions reduce taxable income and the funds aren’t taxed while in the account, even if interest or investment returns are earned. Additionally, as long as HSA funds are used for qualified medical expenses, taxes aren’t owed when money is withdrawn.
16. Indexing: A passive investment strategy for gaining low-cost, targeted exposure to a specified market segment, typically through investing in ETFs or mutual funds.
17. Inflation: The increase in the prices of goods and services in the economy, often measured using the consumer price index. Inflation leads to a reduction in the purchase power of currency.
18. IRA: An individual retirement account with contribution limits that, similar to a 401(k), can offer certain tax advantages. Also similar to a 401(k), money held in an IRA typically can’t be withdrawn before age 59½ without incurring a tax penalty of 10% of the amount withdrawn.
19. Passive Income: Money that can be earned with relatively low amounts of (but usually at least some) ongoing efforts.
20. Roth 401(k): An employer-sponsored retirement account that is funded using after-tax dollars. This means that income tax is paid immediately on the earnings that the employee deducts from each paycheck and deposits into the account. Withdrawals from the account are tax-free upon retirement. This type of plan is different from a traditional 401(k) plan, which is funded with pre-tax money.
21. Roth Conversion: The transfer of pre-tax IRA funds to a Roth IRA account. Unlike most backdoor Roth IRAs (if done correctly), a standard Roth conversion will trigger income tax on the amount converted since the funds had not yet been taxed.
22. Roth IRA: An individual retirement account to which after-tax dollars are contributed. Contributions and investment earnings grow tax-free.
23. Savings Rate: The amount of your take-home pay that is being saved and invested (or put another way, not spent). Having a high savings rate is one of the main pillars of the financial independence movement. Many committed individuals pursuing financial independence target a savings rate of 50-70% of their take-home pay, and sometimes more.
24. Side Hustle: An additional opportunity outside of a person’s full-time job that provides supplemental income. Side hustles commonly have more freedom, and a person typically has more control over what and when tasks are done. Side hustles require ongoing work, and should be contrasted against passive income. Think driving UBER or restoring and reselling furniture.
25. Tax-Advantaged: An account, investment, or savings plan that is tax-exempt (g., Roth IRA), tax-deferred (e.g., 401(k)), or that offers other types of tax benefits.

ACTION ITEMS

Okay, so you’ve read (quickly skimmed?) through the definitions. Now what?! We encourage you to do one or both of the following:

1. Pick 5: Pick the five terms from above that most interest you, write them out, and go find two more resources on each one. Let yourself go down a rabbit hole. Knowledge stacking is the key to success.
2. Make a Move: Look into opening one or more of the accounts noted above. Our suggested first step is to check with your personal bank to confirm that your savings account is in fact a high-yield savings account. If it’s not, make the call and get it changed over. This is typically just and administrative task on the side of the bank, and the whole process usually takes less than 15 minutes. In a quarter of an hour, you can increase your percentage yield exponentially—in many cases a standard account will yield negligible returns whereas in today’s market it’s not uncommon for high-yield accounts to still offer over 5% with short-term rate locks.

IN CONCLUSION

This post examines some of the FI community’s most frequently used terms and phrases. By understanding the basic terminology, you are able to start laying the foundation upon which your pursuit of financial independence can progress.

Thanks for reading. We hope you’ve enjoyed this post, and invite you to continue exploring As Easy As FI.