Understand and Manage Money Better

Wednesday, June 6, 2012, 2:00 AM | 1 Comment

Money is something we always want. Many folks perhaps even love it. And why not? Money can give us the comfort in our lives. It pays our utility bills in hot and cold weather, monthly mortgage or rent, pays for all our food and wants and wishes. Without money, our lives would come to an almost stand still.

In short, we work hard for the money so we can eat food of our choice, and shelter and clothe 0urselves.

However, it’s hard to understand money completely. I mean if we really, truly understood it, many of us would not be spending it so recklessly like we have been doing in recent years. We would not have incurred such huge debts.

If we completely understood it, we would be saving some of it to live on in our retirement. We would be investing our savings to grow it even more.

Essential understanding and managing money

It’s a good practice to go over your finances at least once a year and see where and how you can improve upon it.

• APR vs APY
• Retirement
• Mortgage
• Credit & Debit
• Investing
• General Information

APR vs APY
Understand the difference between APR and APY.

APR

APR stands for Annual Percentage Rate. You ought to know and understand fully what APR is whether you are investing money or borrowing it.

• It’s the total cost of credit or debt over a whole year. It includes interest rate and fee.
• APR is calculated with no compounding, just simple interest.
• If you put $1,000 in a bank account with a 3% APR, over the course of a year, the account would pay you exactly $30 in interest.

APR is NOT

• Annual Penalty Rate, what you owe if you don’t pay in full even though sometimes it may feel like it.
• Annual Payoff Rate, how long it takes to payoff debt.
• Average Payment Ration, what other people pay in debts similar to yours.

APY

APY stands for Annual Percentage Yield. You ought to know and understand fully what APY is whether you are investing money or borrowing it.

• APY is calculated with compounding interest.
• If you put $1,000 in a bank account with the same 3% APR as in the above example with interest compounding monthly, over the course of a year, the account would pay you exactly $41.60 in interest.

How industry advertises APR and APY

• When you borrow money, credit card issuers will advertise APR. Most of the time issuers compound interest daily.
• Saving institutions will advertise APY which is compounded monthly.
• You are screwed both ways. The lenders will charge you interest compounded daily whereas your savings interest is compounded monthly.
• That means your savings will accrue interest extremely slowly whereas your debt will accrue interest extremely fast.
• That’s why you should get rid of debt as soon as you possibly can.

 

Retirement
You can save for retirement in different forms. The two more popular ones are IRA and 401(k).

• IRA and 401(k) are both retirement savings accounts.
• 401(k) is offered through workplace, usually with employer contributions.
• IRA is funded with your own money, sometimes with contributions by employers even though it’s not very common.

Basic Retirement Inclusion

• Income and regular expenses
• Savings goals
• Unexpected or infrequent expenses

Benefits of 401(k)

• You get free money when your employer matches a percentage of your contributions each year.
• You get tax-deferred growth meaning no annual taxes on capital gains, interest or dividends.
• You get an immediate tax because your contributions come from your paycheck before taxes are withheld.

Option to Withdraw

• You can withdraw money from IRA or 401(K) at any age. However, if you withdraw before you turn 59 1/2, you will have to pay not only taxes but 10% penalty as well.
• To avoid the 10% penalty, wait till you are 59 1/2 years old.
• The tax you pay depends on your tax bracket at the time.

Must Withdraw

• You must start taking withdrawals from these accounts when you turn 70 1/2. Otherwise, if you don’t, be ready to pay heavy tax penalties.

 

Mortgage
The same APR concept applies to mortgage when you borrow money to buy a house, for example.

Underwater mortgage

Underwater mortgage is also known as negative equity.

• The phenomenon underwater mortgage comes into play in your finances when your home’s value is less than what you owe in mortgage.

Reverse mortgage

Reverse mortgage is a loan for homeowners 62 and older.

• It allows homeowners to convert home equity into cash without having to sell or vacate their home. The loan is repaid when they die, move or sell the home.
• You essentially sell a part of your share in your home to the lender.
• Your home equity obviously will decrease.
• Your kids will inherit when all loans are paid off.

Reverse mortgage is NOT

• An engagement to sell your home, once its mortgage has been paid in full, directly to the lender. The lender then pays the seller monthly mortgage installments.
• A one-time cash payout by lenders to reward homeowners who pay off their mortgage before its due date.

 

Credit & Debit
You get bill from your credit card issuer each month usually with grace period of 3 weeks to pay your bills by the due date either in full or partial payments. When you debit card, the money is withdrawn from your bank account right away.

Credit score

To borrow money, lenders look at your credit score. Most credit scores range from 300 to 850.

• You need to have high credit score to get the loan you want at the most favorable interest rate possible at the time.
• If you have lower than 620 score, you will have very hard time to get the loan. You might be able to get the loan but at a higher interest rate.
• There are a variety of ways to improve your credit.

Excellent credit makes big difference

You can get loan at the best possible interest rate with excellent credit score.

• If your credit score is 760 or better, you would get loan with interest rate about 1.5% lower than someone with credit score of around 620. That can make a good difference if you borrow $200,000 or more.

Credit report

Don’t get credit report from anyone other than the authorized one.

• A credit report is your borrowing and bill payment history.
• Annual Credit Report dot Com is the only authorized source for the free report that’s yours by law.

Credit report is NOT

• A list of your financial assets and liabilities.
• Your available credit line at lenders.

Who can access your credit report?

A variety of organizations can access your credit report.

• Employers that are considering you for a job.
• Lenders that are considering to issue you a loan or credit card.
• Insurers that are issuing you an auto policy.
• Of course, any government agency that exists today.

Credit cards

You must be careful using your credit cards in that you must not be late and pay your bills on time.

• There is a preset limit to how much you can spend.
• Remember that a credit card expense is short-term loan.
• By signing the receipt for your purchase, you are agreeing to repay the amount.

• No lender will charge you interest or any other fee on the transaction if you pay your bill in full and on time each month.

If your credit card is stolen

Federal law says that if your credit card is stolen,

• You are responsible for only $50 of any fraudulent charges.
• Many card issuers will waive any liability in clear cases of stolen card or number.

Debit cards

• When you use your debit card for purchase, the money comes directly out of your bank account.
• You can use your Personal Identification Number (PIN) or sign for your purchases.
• You should treat your debit card like cash.
• Some banks charge a fee, for example 35 cents per transaction.

 

Investing
The same APR definition applies here as well.

Certificate of Deposit (CD)

In some countries, this is perhaps known as Fixed Deposit.

• A CD is an interest-bearing savings certificate insured by Federal Deposit Insurance Corporation (FDIC.)
• It pays a fixed interest rate for a fixed term.
• Penalties result if money is withdrawn before the term ends.

Mutual Fund

A mutual fund is a pool of assets owned by many investors and operated by a manager.

Mutual Fund is NOT

A group of people who mutually agree to sponsor

• the same single stock.
• the same charity.

Stocks

• Investing in stocks means you have bought a part of the company.
• A stock has no expiration date.

Bonds

• Investing in bonds means you have loaned money to companies, governments or other organizations in exchange for interest payments
• Redemption of the bond when it matures.
• Bonds are issued for specified time periods.

The effect of interest rates on bond prices

When you buy bonds, you should consider the trend of the interest rates whether going up or falling down.

• When the interest rates increase, the prices of bonds fall.
• The reverse is true as well, meaning when the interest rates fall, the prices of bonds go up.
• Khan Academy has done a video explaining stocks and bonds.

 

General Information

Wall Street

• America’s financial epicenter called Wall Street was actually a wall built by Dutch colonists to defend against invaders.

The Dow Jones Industrial Average

• The Dow Jones Industrial Average is named after Wall Street Journal founder Charles Henry Dow and statistician Edward Jones.

Number of Federal Income Tax Brackets

• There are six Federal Income Tax Brackets: 10%, 15%, 25%, 28%, 33%, and 35%.

Benjamin Franklin wrote:

• “In this world nothing can be said to be certain, except death and taxes.”

In a Nutshell
Many folks get confused by some money terminology. Don’t be. It’s not as complicated as you might think.

 

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