By David Pitt
Even the most financially savvy individuals encounter and sometimes let personal finance myths influence how they manage their money. Some of these misconceptions are rooted in faulty information right from the start. Still others might have been valid at one point, but have only since become outdated. Try this short quiz to test your knowledge of some essential facts about sound money management. (Answers at bottom):
1. After my payment history, the largest single factor that determines my credit score is:
(a) The length of my credit history; (b) Amount of debt I owe; (c) The number of credit cards I have; (d) The number of credit applications I’ve made within the last year.
2. If I own a target-date mutual fund in my 401(k), which minimizes my risk of stock market losses as I approach retirement, I shouldn’t invest in other mutual funds. That’s because a target-date fund is designed to be an all-in-one investment.
(a) Truth; (b) Myth.
3. Recent changes to credit card regulations mean that the interest rate on an existing credit card balance can’t be raised unless payments are 60-days past due.
(a) Truth; (b) Myth.
4. What’s the biggest difference between an Individual Retirement Account (IRA) and a Roth IRA?
(a) The investments you can choose from — stocks, bonds or CDs; (b) When you will pay taxes; (c) Where you can open an IRA — a bank or brokerage house.
5. When applying for a loan, what does the acronym APR stand for?
(a) Average Principal Return; (b) Average Percentage Rate; (c) Annual Percentage Rate.
6. What’s the difference between a money-market account and a money-market fund?
(a) There is no difference; (b) One pays interest, the other does not; (c) One is offered by a bank and is insured by the FDIC, the other is not.
7. If I’ve been automatically enrolled in my 401(k) at work I should be on track with my retirement savings.
(a) Truth; (b) Myth.
8. Of the three credit reporting agencies, I really need to look at just one report a year to make sure everything’s OK.
(a) Truth; (b) Myth
9. A tax credit is deducted from a person’s taxable income.
(a) Truth; (b) Myth.
10. The broadest indicator of how U.S. stocks are performing is:
(a) Dow Jones industrial average; (b) Standard & Poor’s 500 index; (c) Nasdaq composite; (d) Russell 2000; (e) Wilshire 5000.
11. Comprehensive auto insurance coverage means that you can be reimbursed for the cost of any damage to your car caused by a collision.
(a) Truth; (b) Myth.
Answers
1. (b) After your payment history (35 percent), the second largest factor used to determine your credit score is the amount you owe. According to FICO, it counts for 30 percent. This isn’t simply the total amount you owe, but weighs several related issues; among them: what’s owed on specific types of accounts; the number of accounts with balances; and the proportion of your total available credit that’s used. Check here for more details: www.myfico.com/CreditEducation/WhatsInYourScore.aspx .
2. (b) This is a myth. That said, there is nothing wrong with using a target-date mutual fund as the only investment if an investor decides, based on risk tolerance and time frame until retirement, that one fund fits his or her needs, said John Ameriks, head of Vanguard Investment Counseling & Research. In some cases, however, investors may choose to own shares in a target-date fund in addition to stock in the company for which they work. He added company stock should be limited to a modest percentage of the overall portfolio. Secondly, using a target-date fund as a core holding and adding additional stocks for a more aggressive portfolio, or bonds to be more conservative, can provide adequate diversification, Ameriks said.
3. (a) Truth. Credit card reforms enacted in 2010 added various consumer protections. Rates on existing balances can’t be raised unless the account is at least 60 days past due. If payments are made on time for six consecutive months, the original rate must be restored.
4. (b) The biggest difference is when you pay taxes. All or part of traditional IRA contributions are tax deductible depending on your circumstances, and you pay taxes when you make withdrawals from the account. Roth IRA contributions are not tax deductible, but upon withdrawal the earnings and principal are tax free if you’ve followed all the rules. The mix of investments you may choose are generally the same for both accounts.
5. (c) Annual Percentage Rate. It is the cost of a loan over a year’s time, typically including interest, insurance and origination fees (also called points). It’s used for home and car loans, and credit cards.
6. (c) A money-market account is an interest-bearing savings account offered through a bank and is insured by the FDIC. A money-market fund is short for money-market mutual fund, which invests in short-term debt such as Treasury bills or short term corporate bonds. Although their yields are now at historical lows, money-market funds generally offer a slightly higher return than money-market accounts. That’s in part because money funds don’t face the same overhead costs that banks do from operating branches.
7. (b) Myth. You need to take an active role in managing your account. An automatic enrollment plan likely starts you at a low level of contributions, often 3 percent of your income. That may not even be enough to capture your company’s match, which means you’re leaving free money on the table. In addition, the investments your money is placed in may not correspond to your personal retirement goals.
8. (b) Myth. There are three credit reporting agencies. They are Equifax, Experian and TransUnion. Federal law requires that they allow you to see your report at least once a year for free. The reports aren’t identical so you should look at all three. It’s best to look at one every four months to monitor your credit throughout the year. Get the free reports at www.annualcreditreport.com or call 877-322-8228.
9. (b) Myth. There’s a difference between a tax credit and a tax deduction. A tax deduction reduces the amount of your income that is taxable, such as the deductions parents take for dependent children. A tax credit is different in that the amount is deducted directly from the taxes you owe. So the first-time home buyer tax credit that was enacted to stimulate the economy directly reduced the tax bill of those purchasers by up to a maximum of $8,000.
10. (e) The Wilshire 5000 with more than 5,000 companies is considered the broadest measure of the U.S. stock market, tracking nearly all actively traded U.S. stocks. Although the Dow may be the most cited index and the most watched by Main Street investors, it includes just 30 companies. The S&P 500 is mostly large companies and is used frequently by fund managers and other institutional investors. The Nasdaq composite index tracks stocks on that exchange. The Russell 2000 tracks 2,000 small companies.
11. (b) Myth. Despite its name, comprehensive coverage refers only to a portion of an auto insurance policy that covers damage to the policyholder’s car not caused by a collision, such as weather, theft or vandalism.
Scoring System
0-3: It’s never too late to learn. But it’s time to get started.
4-5: You show some progress, but how about picking up a few personal finance books or checking out some websites.
6-7: This is not bad, but could be better. With a little work, you show promise.
8-9: Very good, you should be on solid financial footing.
10-11: Perfect. You have an exceptional wealth of personal finance knowledge. — AP
