Investing can feel overwhelming when people are talking about words you don’t know. But once you grasp the main ideas, it gets a lot easier. This collection of key financial concepts contains succinct, no-nonsense summaries and links to supporting information. If something isn’t clear, don’t be afraid to ask for help.
/// Ask a Question ///
All Concepts
Reading the Numbers
How to interpret Portfolio Charts data
CAGR
The compound annual growth rate (CAGR) is the annualized return that accounts for the compounded effects of gains and losses over time. It is always less than the average return, and better represents real-world returns.
Real Returns
Real returns are the portfolio returns that are adjusted for inflation. The related term for raw numbers before inflation is the nominal return. Nominal returns represent the change in the number in your bank account, while real returns represent the change in your purchasing power. All Portfolio Charts numbers are expressed in real returns.
Baseline and Stretch Returns
Baseline and stretch returns are unique Portfolio Charts measures that look at conservative and aggressive numbers less extreme than the min and max. The baseline return is the 15th percentile on the low end, and the stretch return is the 85th percentile on the high end.
Start-Date-Independent Backtesting
Start-date-independent backtesting is the method of studying all timeframes simultaneously and looking at the spread of outcomes instead of just one. Looking at data this way helps you see past deceptive historical snapshots to understand the uncertainty involved in any investing choice.
Portfolio Construction
General investing and portfolio theory concepts
Rebalancing
Rebalancing refers to the practice of keeping a portfolio at the desired target percentages. One can rebalance either by selling high assets to buy low assets, or by directing new savings towards the low assets to top them up. All Portfolio Charts calculations assume that portfolios are rebalanced once a year.
Tax-Loss Harvesting
Tax-loss harvesting is a technique for reducing taxes owed on sold appreciated assets. It involves selling shares at a loss to “harvest” losses that can be used to offset gains elsewhere.
Shannon’s Demon
Shannon’s Demon is a mathematical concept that explains how the act of rebalancing multiple, uncorrelated assets can measurably improve risk-adjusted returns. It is useful for understanding the multiple ways that diversified portfolios benefit investors.
Risk Parity
Risk parity is a portfolio construction framework that involves balancing the risk contribution of each asset so that they equally impact performance. The traditional method is to balance asset volatility, but other extensions of the idea involve things like balancing the impact of common economic conditions.
Risk Management
Different definitions of investing risk
Drawdowns
Drawdowns are the points in a backtest when a portfolio lost value relative to any high point along the way. When thinking about drawdowns, it’s important to study not only the maximum depth but also the maximum length.
Ulcer Index
The Ulcer Index is a composite number designed by Peter Martin and Byron McCann that measures the combined effects of drawdown depth, length, and frequency. It’s a nice way to compare general portfolio pain.
Volatility
Volatility is most commonly measured using standard deviation, and is a measure of how widely a return has differed from the historical average. Portfolio volatility can be mitigated either by adding less volatile assets to an allocation, or by adding equally volatile assets that move in different directions and at different times.
Sequence of Returns Risk
Sequence of returns risk is a shorthand way of saying that the order of returns has a major impact on the investor experience. Nobody receives the average return every year, and the sequence of returns determines how two investors experience the same long-term average.
Retirement
Terms related to living off your portfolio
Withdrawal Rates
A withdrawal rate is the percentage of a portfolio withdrawn each year, adjusted for inflation. Portfolio Charts tracks three types of withdrawal rates: safe, perpetual, and long-term.
The 4% Rule
The 4% rule is the standard rule of thumb for a 30-year safe withdrawal rate for investors in the US with a portfolio of large cap US stocks and short to intermediate bonds. While the number is often quoted as standard advice, it depends heavily on several assumptions that may not apply to you. Portfolio Charts expands those assumptions (asset choices, home country, etc) and measures how the withdrawal rate changes.
Financial Independence
Financial independence is when passive income is sufficient to meet your spending needs with no requirement of additional work income to pay the bills.