Personal Finance – Common Scenarios: Cheat Sheet

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Essential Concepts

  • The statement balance is the amount you owe on your credit card at the end of a billing cycle, including purchases, cash advances, balance transfers, and fees, minus any payments or credits.
  • The outstanding balance is the total amount you currently owe on your credit card, which includes the statement balance as well as any new charges, cash advances, balance transfers, and fees since the last billing cycle.
  • Credit cards offer a secure and convenient way to make purchases, with the ability to cancel and replace them if lost or stolen, and provide greater consumer protections than debit cards; however, they can lead to overspending, incur interest charges if not paid in full, and may result in debt that can harm your credit history and score.
  • The average daily balance method is used by credit card companies to calculate interest charges by determining the average balance owed each day during a billing period, which is calculated by summing the daily balances and dividing it by the number of days in the billing cycle.
    • [latex]\text{average daily balance} = \frac{\text{sum of the daily balances}}{\text{number of days in the billing cycle}}[/latex]
  • A credit score is a three-digit number that evaluates your creditworthiness, determined by factors such as your payment history, credit accounts, credit utilization, length of credit history, and new credit inquiries, with a higher score indicating greater likelihood of timely debt repayment and a lower score indicating higher borrowing risk.
    • Possible ways to repair bad credit are loan consolidation, credit counselors, debt settlement plans, and bankruptcy.
  • A credit report is a comprehensive record of a person’s credit history, including credit accounts, payment history, outstanding balances, and public records, which is used by lenders and other entities to assess creditworthiness, while personal and financial details like marital status, income, bank account information, and education are not included in the credit report.
  • When purchasing a car, it’s important to consider your wants and needs, determine your budget including additional costs like insurance and maintenance, search for a suitable car within your budget, be aware of extra fees beyond the sticker price, and factor in additional costs like title and registration fees, destination fees, documentation fees, dealer preparation fees, extended warranties, maintenance plans, and sales tax.
  • An installment loan is a loan where you receive a set amount of money and agree to repay it in fixed monthly payments over a specific period of time, with a fixed interest rate and repayment schedule.
    • [latex]PMT = \frac{P(\frac{r}{n})}{1-(1+\frac{r}{n})^{-nt}}[/latex]
  • A down payment is an initial payment made by a buyer when purchasing something, typically a percentage of the total cost, to lower the loan amount needed and show commitment to the purchase, reducing risk for the lender or seller.
  • Leasing a car is a type of arrangement where you pay a monthly fee to use a vehicle for a specified period, usually a few years. The monthly depreciation for a car is:
    • [latex]MD=\frac{P−R}{n}[/latex], where MD is the monthly depreciation, P is the price paid for the car, R is the residual value of the car, and n is the number of months of the lease.
  • The lease payment formula is similar monthly depreciation formula.
    • [latex]PMT=\frac{(P−R)}{n}+(P+R)×MF[/latex], where P is the price paid for the car, R is the residual value of the car, n is the number of months of the lease, and MF is the money factor for the lease.
  • Leasing a car involves renting it for a few years with lower monthly payments, no ownership at the end of the lease, mileage restrictions, and potential penalties for early termination.
  • Buying a new car means higher monthly payments, ownership, no mileage limits, potential for equity, but higher depreciation and maintenance costs.
  • Buying a used car offers a lower purchase price, slower depreciation, and lower insurance costs, but may have an uncertain history, higher maintenance expenses, and limited options.
  • Owning a car has other costs including various types of insurance, maintenance costs and fuel cost. The annual fuel cost is:
    • [latex]\text{ annual fuel cost } = \frac{\text{miles driven annually}}{\text{miles per gallon}} \times \text{ price per gallon of gas}[/latex]
  • Renting a home involves signing a lease with a landlord, while advantages include lower cost, little maintenance cost, flexibility, and amenities, disadvantages include no tax incentives, rising rent, no equity, restrictions on occupants and decorating, uncertainty, and upfront fees like security deposit and credit check fees.
  • Buying a home offers advantages like tax benefits, unrestricted occupancy, control over decorating, fixed housing costs, investment potential, and stability, but disadvantages include higher costs, responsibility for maintenance and repairs, and less mobility.
  • Closing costs associated with buying a home include appraisal fees, home inspection fees, title search costs, prepaid taxes, credit report fees, origination fees, application fees, underwriting fees, attorney fees, and state or local fees.
  • A mortgage is a long-term loan used to buy property, where the property acts as collateral, and regular payments over many years repay both the borrowed amount (principal) and the borrowing cost (interest).
    • Monthly payment is: [latex]pmt=\frac{P\times\frac{r}{12}\times(1+\frac{r}{12})^{12\times t}}{(1+\frac{r}{12})^{12\times t}−1}[/latex]
    • Total payment is: [latex]T=pmt\times12\times t[/latex]
    • Cost of financing the mortgage is: [latex]CoF=T−P[/latex]
  • An escrow account is a mortgage lender-managed account that pays property-related expenses such as property taxes and homeowners insurance on behalf of the homeowner.
  • Social Security is a government program that provides financial support to retired, disabled, and surviving individuals through regular payments funded by payroll taxes.
  • Social Security benefit amounts are calculated based on a person’s average indexed monthly earnings (AIME), which summarizes their earnings over up to 35 years, adjusted for wage level changes.
    • The AIME is then used to compute the primary insurance amount (PIA), which determines the foundation of the benefits.
    • The PIA is the sum of three percentages based on specific dollar amounts known as “bend points.”
    • The final retirement benefits can be higher or lower than the PIA, depending on the chosen retirement age, with reduced benefits for early retirement and increased benefits for delayed retirement.
  • In a traditional 401(k), contributions are made with pre-tax dollars, reducing taxable income, but withdrawals in retirement are taxed as ordinary income.
  • In a Roth 401(k), contributions are made with after-tax dollars, but withdrawals in retirement are tax-free. However, early withdrawals from both types may have tax implications, and employer-matched contributions are subject to taxation upon withdrawal.
  • A pension plan is a retirement plan provided by an employer, where a pool of funds is set aside to provide employees with a fixed monthly income during their retirement years.
  • Employee Stock Ownership Plans (ESOPs) are retirement plans where a company contributes its stock to benefit employees, allowing them to own a portion of the company.
  • Profit-Sharing Plans involve employers sharing a portion of company profits with employees by contributing to their retirement savings, with the amount varying based on the company’s profitability. Contributions are placed into individual accounts, invested, and the returns are credited to the employees’ accounts.
  • In a traditional IRA, contributions may be tax-deductible, earnings grow tax-deferred, and taxes are paid upon withdrawal in retirement, with a penalty for early withdrawal.
  • In a Roth IRA, contributions are made with after-tax income, allowing tax-free and penalty-free withdrawals of contributions at any time. After reaching a certain age and holding the Roth IRA for a specified period, both contributions and earnings can be withdrawn tax-free and penalty-free.
  • Bonds are debt instruments issued by governments or corporations to raise funds, and they pay periodic interest to the bondholder until the bond matures, at which point the principal is repaid.
  • Certificates of Deposit (CDs) are time deposits offered by banks where individuals deposit a fixed amount of money for a specific term, and in return, they receive a fixed interest rate until the CD matures, at which point the principal and interest are returned to the depositor.
  • Stocks, also known as shares or equities, represent ownership in a company. When you buy stocks, you become a partial owner of that company and have the potential to earn money through dividends (a share of the company’s profits) or by selling the stocks at a higher price than what you paid for them.
  • Percent yield and price of earnings are common metrics for stocks.
    • The price to earnings ratio of a stock is [latex]\text{P/E}=\frac{\text{Share Price}}{\text{Dividend}}[/latex]
    • The percent yield for a stock is [latex]\text{Yld}\%=\frac{\text{annual dividend}}{\text{share price}}\times100\%[/latex]
  • Mutual funds are investment vehicles that pool money from multiple investors to buy a diversified portfolio of stocks, bonds, or other securities. They are managed by professionals and offer broad exposure to various assets, reducing risk.
  • ETFs are similar to mutual funds but traded on stock exchanges like individual stocks. They track specific indexes or asset classes and provide diversification while being tradable throughout the trading day.
  • Real estate investments include rental properties, REITs, and real estate crowdfunding. Rental properties offer income but require management. REITs allow investment in portfolios of real estate assets and provide dividends.
  • Cryptocurrencies are digital currencies based on blockchain technology. Investing in cryptocurrencies can be profitable but comes with high risk due to their volatility. Thorough research and understanding of risks are essential. Cryptocurrencies should not replace traditional retirement plans and should be considered as part of a broader investment strategy.

Glossary

amortization table

a table that provides the details of the periodic payments for a loan where the payments are applied to both the principal and the interest

bonds

are investments where one lend money to an issuer like a corporation or government in exchange for regular interest payments and the return of the principal at bond maturity

certificates of deposit (CDs)

a safe investment option where one lends money to a financial institution for a fixed term, and in return, receive predetermined interest

credit report

a document that contains information about a person’s credit history, including their credit accounts, payment history, outstanding balances, and public records such as bankruptcies or foreclosures

credit score

a three-digit number that represents your creditworthiness that is calculated based on your credit history, which includes information about your past and current credit accounts, payment history, credit utilization, length of credit history, and new credit inquiries

down payment

a sum of money paid upfront by a buyer as a partial payment towards the total cost of a purchase

employee stock ownership plans (ESOPs)

a type of retirement plan in which the company contributes its stock to the plan for the benefit of the company’s employees

escrow account

a type of account that one’s mortgage lender sets up on your behalf when you close on your home

Exchange-Traded Funds (ETFs)

similar to mutual funds, but they’re traded on stock exchanges, much like individual stocks

individual retirement account (IRA)

a type of savings account that is designed to help one save for retirement with tax-free growth or on a tax-deferred basis

installment loan

a type of loan that is repaid in regular, predetermined payments over a specific period of time

landlord

the person or company that owns property that is rented

lease

a contract between a renter and a landlord

manufacturer’s suggested retail price (MSRP)

the price at which the manufacturer of a product recommends that retailers sell that product to consumers

mortgage

a type of loan that individuals or businesses take out to purchase real estate

mutual funds

investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities

outstanding balance

the total amount of money that one currently owes on their credit card account

profit-sharing plan

employers share a portion of company profits with employees by contributing to their retirement savings

prospectus

a pamphlet or brochure that provides information about the mutual fund

Roth IRA

contributions are made with post-tax income, meaning you pay taxes now rather than in retirement

security deposit

a sum of money that the landlord holds until the renter leaves the rental property

statement balance

the amount of money that one owes on their credit card at the end of a billing cycle

stocks

investments that grant ownership shares in a corporation, potentially enabling investors to share in a company’s success through increases in the stock’s price and dividends

traditional IRA

contributions are often tax-deductible, depending on your income, filing status, and whether you or your spouse have a retirement plan at work

Key Equations

annual fuel cost

[latex]\text{ annual fuel cost } = \frac{\text{miles driven annually}}{\text{miles per gallon}} \times \text{ price per gallon of gas}[/latex]

annual percentage rate for a lease

[latex]APR=2400×MF[/latex]

average daily balance method

[latex]\text{average daily balance} = \frac{\text{sum of the daily balances}}{\text{number of days in the billing cycle}}[/latex]

cost of financing

[latex]CoF=T−P[/latex]

lease payment formula

[latex]PMT=\frac{(P−R)}{n}+(P+R)×MF[/latex]

loan payment formula

[latex]PMT = \frac{P(\frac{r}{n})}{1-(1+\frac{r}{n})^{-nt}}[/latex]

monthly depreciation for a car

[latex]MD=\frac{P−R}{n}[/latex]

mortgage payment formula

[latex]pmt=\frac{P\times\frac{r}{12}\times(1+\frac{r}{12})^{12\times t}}{(1+\frac{r}{12})^{12\times t}−1}[/latex]

percent yield for a stock

[latex]\text{Yld}\%=\frac{\text{annual dividend}}{\text{share price}}\times100\%[/latex]

price to earnings ratio of a stock

[latex]\text{P/E}=\frac{\text{Share Price}}{\text{Dividend}}[/latex]

total payment formula

[latex]T=pmt\times12\times t[/latex]