UGBA 135 Midterm (Fall 2023)

Index Funds vs. Mutual Funds

In fact, most index funds are a type of mutual fund. The main difference is that index funds are passively managed, while most other mutual funds are actively managed, which changes the way they work and the amount of fees you'll pay.

Credit card account

- Make charges to credit card - Make payments - Charged interest for unpaid balance - Balance is how much money you currently owe

Ways to improve and lower utilization on credit card?

- Mid-period payments - Get a higher credit line (just don't max it out) Try to keep utilization <10%. But lower income, likely lower credit limit

Example Experian credit report

- Name(s) - Addresses - Employers - Open accounts - Closed accounts - Status of each account there, including outstanding balance What's NOT on there? - Income - Credit score!

Advertisements for online trading tend to emphasize which of the following?

- That trading is fun - That it is easy to trade online - That making your own trading decisions puts you in control

Investment account

- Typically opened at a bank, a brokerage company, or a mutual fund company (eg. Vanguard, Schwab, Fidelity, etc) - You deposit money (eg. from paycheck) or transfer investments as stock from another account - You may also receive interest or dividend payments - You buy and sell investments (mutual funds, ETFs, stocks, bonds, crypto, etc) - You can also have cash in an investment account - Your balance is the value of what you currently own, including cash, mutual funds, and other investments - Some investment accounts are tax-advantaged, eg. 401(k), IRA, Roth. IRA

Common features of accounts

- Your name - An account number - A record of transactions, such as deposits, withdrawals, payments, interest payments, purchases, and sales - A current balance (a list of what you own... or owe)

Risks to individual stocks

- bad business plan - economy does badly - competition by others - innovation by others - poor management - expropriation of value by controlling shareholders - expropriation of value by management - fraud - insider trading (when buying and selling) - disasters and mistakes (eg. Tohoku tsunami, Bhopal, Barings Bank) - investor sentiment

True or False: It is harder to predict which companies' stocks will outperform the market in the next year than it is to determine which companies are better run.

True Better to determine which companies are better run, because it's harder to predict which companies' stocks will outperform the market in the next year

True or False: Most individual investors who trade commodities are simply speculating.

True Most individual investors who trade commodities are simply speculating.

Which FICO score?

- FICO 8 for most non-mortgage decisions - FICO 2, 4, 5 for mortgages (typically lower than 8)

Your first credit card tips

- Go slow, wait a couple months before charging anything - Then put an expense on the card that you must pay every month, eg. mobile phone bill. Pay that balance in full every month! - Then buy something with the card you know you are going to buy anyway. Pay that balance in full when the monthly statement comes.

What counts as recent inquiries?

- Hard pull - Soft pull

Credit card swipe fees and perks

- In the US, swipe fees charged by credit card companies to merchants average 2.25%... 8 times as much as in the EU. - Merchants raise prices to cover swipe fees - Poorer people, paying cash or with debit cards, pay these higher prices - Wealthier people with credit card perks get reimbursed with cash or airline miles

Strategies to save more include which of the following:

- Increase your income - Automate your savings - Focus on the big stuff - Don't neglect the small stuff DO NOT: - Buy on credit - Not comparison shop

If I've never paid a time in credit card interest, how do banks make money off of me?

- Interchange (~1.8%) - Annual fees - Balances out their credit portfolio And of course, interest too if it counts

What factors directly affect your credit score?

- Length of credit history - Payment history - Debt burden Annual income does NOT affect your credit score.

Credit Report Vs. Credit Score

- Credit report: individual report card telling you if you have been making CC and loan payments on time and personal info - Credit score: credit report DETERMINES credit score Think transcript (credit report) vs. GPA (credit score)

Checking account

- Deposit and withdraw money - Auto-deposit paycheck - Write checks - May include debit card - Electronic transfers - Most checking accounts pay low or no interest - May require a monthly fee or a minimum balance - Balance is how much money you currently have in the account

What is more valuable: $1000 today or $1000 a year from now?

$1000 today

Before making an investment, what should you ask?

"If no-one were ever willing to buy this from me, would I benefit from owning it?" Examples: - Apple stock: pays dividends - S&P 500 Index Fund: pays dividends - A house: you can live in it - Bitcoin/NFT? Not so much lol get rekt

If the annual interest rate is 10%, what is the present value of receiving $110 one year from now?

$100 Steps: x(1.1) = $110 x = $110/1.1 x = $100

Savings account

- Deposit and withdraw money - Earn interest (amount varies greatly) - Make electronic transfers - Balance is how much money you currently have in the account

If you deposit $100 in a savings account that pays 10% annual interest how much money will you have in the account after two years? (Assume that this is the only money deposited in the account, that you do not make withdrawals, and that the bank pays interest annually.)

$121 Steps: ($100 x 1.1) x 1.1 = $121 or $100 x 1.1 = $110 (1 year) $110 x 1.1 = $121 (2 years)

Loan account

- Bank (or other institution) lends you money, eg. mortgage, car loan, etc - You make payments - You are charged interest - Balance is how much you currently owe

Credit cards

- Convenient - Can help you build your credit score - Some consumer protections - Interest rates charged on unpaid balances are VERY high - You will almost certainly spend more money if you use a credit card (you may or may not spend money you cannot afford to... don't do that!) - Credit card debt is a huge problem in the US - Credit cards tend to benefit the wealthy at the expense of the less wealthy

Risks to bonds

- inflation risk - interest rate risk - default risk (credit risk) - call risk - liquidity risk - market risk (ie. supply and demand)

5 components of a credit score

- recent inquiries (10%) - payment history (35%) - utilization (30%) - average age of accounts (15%) - mix of credit (10%)

Holding a diversified portfolio of stocks rather than an undiversified portfolio...

... increases the likelihood that you will own at least one stock that performs poorly.

Svi Bodie invests in...

... inflation protected US bonds.

If you buy a company's bond...

... you have lent money to the company

If you buy a company's stock...

... you own part of the company

What % of credit score is recent inquiries?

10%

What % of your credit score is utilization?

30%

FICO score range

300-850 (750+ is a good score)

What % of your credit score are on-time payments? (payment history)

35%

According to the Rule of 72, how long would it take for money to double at a 12% rate of return?

6 years Steps: 72/12% = 6 years Note: - Not counting recurring contributions / regular additions to the account - The amount of money you start with not needed to solve this question

How long do missed payments hurt you?

7 years

Bonds

A certificate issued by a government or private company which promises to pay back with interest the money borrowed from the buyer of the certificate: The city issued bonds to raise money for putting in new sewers.

FICO score

A three-digit number (300-850) that summarizes your credit risk based on your credit file at one of the three major consumer bureaus at a particular point in time. They are used in 90% of lending decisions. They help lenders evaluate credit risk and can influence the credit that's available and the terms, such as interest rate, that lenders offer.

Credit score

A way for a creditor to assess your ability and likeliness to repay on time

Which of the following does NOT describe a credit card? A) The card provides access to free money. B) The card allows you to postpone paying for your purchases. C) The card often provides cash, frequent flyer, or other rewards. D) The card provides protection against fraudulent charges.

A) The card provides access to free money. A credit card is NOT free money. You need to pay it off!

What is an account?

An agreement between you and a business such as: - A bank - A brokerage - A credit card issuer (often a bank) - A utility company & A record of transactions

Index funds

An index fund is a portfolio of stocks or bonds designed to mimic the composition and performance of a financial market index. In other words, they are mutual funds that attempt to mirror the movements of an existing stock index

Jamie and Joe are the same age, have the same job, and earn the same salary. Both Jamie and Joe estimate that they will need $3 million to retire. At age 25, Jamie sets up automatic contributions of 15% of his salary to his 401(k). Joe doesn't start contributing to his 401(k) until age 40. If Joe wants to retire at the same age as Jamie he will need to. A) Save the same each month that Jamie saves. B) Save more each month than Jamie saves. C) Save less each month than Jamie saves.

B) Save more each month than Jamie saves. Why? Because he started saving later. If he wants to retire at the same age as Jamie, then he needs to contribute more in order to catch up, seeing as Jamie started at 25.

If a company files for bankruptcy, which of the following securities is most at risk of becoming virtually worthless? A) The company's bonds B) The company's stock

B) The company's stock Common stock shares will become effectively worthless and dividends will cease to be paid while the company is in bankruptcy.

What is a credit bureau?

Bureaus just collect a provide information; they do not make lending decisions Examples: Transunion, Equifax, Experian

Suppose you put $100 in a bank savings account that pays 7% annual interest (and charges no annual fee). You keep that money in the account for two years (with no withdrawals or additional deposits). How much money will you have at the end of two years? A) Less than $100 B) $100 C) More than $114 D) $107 E) $114

C) More than $114

What is not a major Credit Bureau? A) Experian B) TransUnion C) Equifax D) Moody's

D The three major credit bureaus are Experian, TransUnion, and Equifax.

Which of the following should be a higher priority? A) Paying off your mortgage as soon as possible B) Paying off student debt as soon as possible C) All three should have the same priority D) Paying off credit card debt as soon as possible

D) Paying off credit debt as soon as possible should be the highest priority out of everything on the list.

In the video "Prioritizing Savings" which of the following do I NOT recommend? A) Pay for the things you want in advance B) Start saving early in life. C) If your employer makes a matching contribution to your 401(k) plan always contribute enough to get the match. D) Save first for your children's education, then for your own retirement.

D) Save first for your children's education, then for your own retirement. Save for your retirement FIRST, then children's education.

Which of the following is a good use of a security fund (also called an emergency fund or a rainy day fund)? A) To take the place of health insurance B) To purchase the latest model Android or iPhone C) To go skiing on a weekend after a good snowstorm D) To help you pay your bills if you lose your job

D) To help you pay your bills if you lose your job

Debit vs. Credit Card

Debit card transactions are deducted out of checking, credit cards are loans DEBIT CARD - Instantly deducts from your account - Most similar to paying cash - Can get "cash back" at retailers - Usually also an ATM card - Hard to overspend/overdraw - Usually get one when opening a checking account - No annual fees - No impact to your credit score/report - Typically no rewards programs CREDIT CARD - After getting approved, you get extended a "Credit Line" (limit), tied to your income & credit report/score - Basically a 30-day loan - It's not free money. Very easy to get in trouble here. - Know yourself. Freeze it if necessary. - Charges crazy high interest if not paid off by Due Date - Offers more purchase protection - Not an ATM card - Often earns rewards/miles/points

ETF

Exchange-traded fund. ETF's are listed as individual securities in the equity markets and are used to replicate an index or a portfolio of stocks. (Can be traded as stocks.)

Fixed expenses

Expenses that do not change from month to month, such as auto insurance or rent.

Variable expenses

Expenses that vary from month to month, such as entertainment, car repairs, or doctor bills.

True of False: Compound interest is interest paid on the principal and not on accrued interest.

False

True or False: Asset allocation refers to deciding which individual stocks to buy.

False

True or False: Benjamin Graham recommended holding no more than 75% of one's portfolio in stocks and no less than 25% in gold.

False

True or False: If the market drops 30%, it is certain to recover during the next year.

False

True or False: The retirement portfolio of most people in the US should include a 10% allocation in gold.

False

True or False: Investments with higher risk always have higher expected returns.

False Higher risk does NOT equal always higher expected returns

True or False: In most cases, as people approach retirement age, it is recommended that they increase the percentage of their financial investments held in stocks and decrease the percentage held in bonds.

False It is recommended that, as people approach retirement age, they decrease the percentage of their financial investments held in stocks and increase the percentage held in stocks.

True or False: It is harder to predict which sports team will win a game than which sports team will beat the spread.

False It's easier to predict which sports team will win a game than which sports team will beat the spread.

True or False: Thaler and Benartzi's "Save More Tomorrow" plan is to wait until you've been at a job for at least six months and then sign up for the 401(k) plan

False Sign up right away when you can!

True or False: Actively trading common stocks is the best long-term investment strategy for most investors.

False!

True or False: Most people's emergency (security or rainy day) fund should be invested in the stock market.

False. Most people's emergency (security or rainy day) fund should NOT be invested in the stock market.

Hard pull vs. Soft pull (recent inquiries, 10% of credit score)

HARD PULL - When a lender check your credit. You give out SSN. - ONLY do this for a good reason!!! Clump these together within 30 days: auto, student loan, mortgage, etc. Try not to let a landlord pull your credit report/score. SOFT PULL - When you check your own credit report - Pre-approval offers, existing lenders check - These don't affect you

What hurts/helps your credit score?

HURTS - # of recent inquiries up (10%) - Avg age of accounts down (15%) HELPS - Utilization down (30%) - One-time payments up (35%)

Budgeting simple equation

Income - Fixed Expenses - Variable Expenses = Leftover (small amount)

Simple interest

Interest earned only on the original principal amount invested Examples: Year 1: $100 x 10% = $10 Total $110 Year 2: $100 x 10% = $10 Total: $120 Year 3: $100 x 10% = $10 Total: $130

Load fees

Loads are commissions usually charged when you buy and fund and shared by the mutual fund company with the advisor who sold the fund to you. & front-end load is commission or sales charge Don't buy mutual funds with load fees. Always pay attention to fees. When comparing fees, be sure to compare similar funds.

What happens with the growth of private equity?

Lowers supply of publicly traded stocks

Are all index funds and ETFs inexpensive?

No, they're not all inexpensive.

What is a secured credit card?

One that requires the cardholder to maintain a savings account as security for the card's line of credit. - You put down a deposit, that is your limit. - Pay your deposit each month; if you don't, they deduct from your deposit. - Reports to credit bureaus each month - After 12-18 months, you apply for a normal credit card, if you have managed your secured card well.

Index Funds Pros and Cons

PROS - inexpensive - well-diversified - liquid - relatively tax-efficient - works well in a well-regulated market that has a lot of active management CONS - overweight, overvalued stocks - concentrate voting rights at mutual fund companies - have potential tax disadvantages -- not relevant in tax-advantaged retirement accounts - may be contributing to mispricing in poorly regularly markets with insufficient management

If you have a credit card, what should you always do at the end of each month?

Pay your entire credit card balance each month! Debt is no joke :/

Which factor has the largest direct impact on your credit score?

Payment history

A good strategy for saving for retirement is:

Set up automatic contributions to your retirement savings account

"SMART" format

Specific, Measurable, Attainable, Relevant, Time-bound Life goals often involve money Financial goals == life goals

Bonds vs. stocks

The biggest difference between stocks and bonds is that with stocks you own a small portion of a company, whereas with bonds you're loaning a company or government money. Another difference is how they make money: stocks must grow in resale value, while bonds pay fixed interest over time. BONDS: -Creditor stake in the company -Defined terms and maturity date -More certainty -Typically lower yield / rate of return STOCKS: -Ownership in the company -Voting rights -Potential for dividends -Value fluctuates more -Greater potential for higher rate of return

Should most people save first for retirement or for their children's education?

Their retirement

True or False: Never buy mutual funds with front or back end loads.

True!

True or False: Most target date funds decrease their allocation to stocks over time.

True! Most target date funds decrease their allocation to stocks over time.

True or False: Lenders use credit reports to help them decide whether to loan you money and what interest rate to charge.

True! Lenders use credit reports to help them decide whether to loan you money and what interest rate to charge.

What is the Rule of 72? How is it calculated?

Way to calculate length of time to double your money: 72/interest rate = number of years to double money Example(s): 8% rate of return (72/8% = 9 years) 12% rate of return (72/12% = 6 years) What rate would you need to double in 4 years? (72/4 = 18&) Note: This does not include recurring contributions

What is a dividend?

a sum of money paid regularly by a company to its shareholders out of its profits

Target date funds

attempt to maintain a desirable balance of risk and growth potential based on a target retirement date AKA: funds that automatically adjust the retirement account mix based on the employee's age. Also known as life-cycle funds.

Examples of accounts

checking, savings, loan, investment, credit card, etc

"Save More Tomorrow"

commit to putting half of every future raise towards savings Strategies to increase savings rate Bernartzi & Thaler - Increase at future income increases - Annual raises, promotions, etc - Paula Pant & saving 1% each month

Mutual fund

fund that pools the savings of many individuals and invests this money in a variety of stocks, bonds, and other financial assets

Future Value equation

fv = pv(1+r)^n r = rate, n = years

What is a Consumer Price Index (CPI)?

instrument that measures change over time for costs of a group of goods and services Think inflation. - A comparison across different years of the cost of a basket (list of) goods (ie. things you might buy) - A measure of purchasing power of the dollar in different periods When comparing the cost of something today and its cost many years ago (eg. tuition), you need to adjust for inflation using the CPI.

Compound interest

interest earned on both the principal amount and any interest already earned Examples: Year 1: $100 x 10% = $10 Total: $110 Year 2: $110 x 10% = $11 Total: $121 Year 3: $121 x 10% = $12.10Total: $133.10 Compound interest - hypothetical growth of annual maximum IRA contributions, etc.

What happens when interest rates go down?

it costs less to borrow money so aggregate demand increases - Cheaper borrowing for companies - Bonds become less desirable to investors (because bonds pay fixed interest over time and have more certainty, but tend to typically have a lower yield/rate of return)

Vantage Score 3.0

joint credit score from the three major credit bureaus

In the book "All Your Worth", Elizabeth Warren and Amelia Warren Tyagi recommend:

that you budget no more than 50% of after-tax income for expense that you must pay every month.

What is liquidity?

the ability to easily convert financial assets into cash without loss in value

Future Value (FV)

the amount to which a cash flow or series of cash flows will grow over a given period of time when compounded at a given interest rate

Asset allocation

the process of spreading your assets among several different types of investments to lessen risk. For financial investments, the three main asset classes are equities (stocks), fixed income (governmental/municipal/corporate bonds), and cash