checkup
Business

Financial Analysis – A “Check-up” for a Business

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Every year or two, most of us go to the doctor’s office to receive a check-up on the state of our physical health. The doctor typically checks several measurements (height, weight, blood pressure, etc.) in order to gauge how our health has progressed over the past year. They can then use their results to determine if there is any immediate threat to our well-being or to make helpful recommendations (“you seem to have gained 45 pounds, sir; I suggest you go on a diet”).

Just like we all care about our personal health, managers and investors care about the health of their company. How can they perform a “check-up” on their business in order to determine its progress and financial health? Instead of weight or blood pressure, analysts use financial ratios. We’ll talk about three categories of ratios: profitability, liquidity, and solvency.

Profitability

When a company sells goods or provides services, the money they receive from customers comes in as sales (the terms revenue and sales are interchangeable). However, before they can put it in the bank, there are always expenses that the firm has to pay—wages for employees, marketing costs, taxes, and many more.  Profitability ratios examine what’s left over after paying off those expenses. With each of the following metrics, a higher number is better because it means less money going out for expenses and more retained as profit.

Gross Margin

Gross Margin = (sales – cost of goods sold) / sales

Gross Margin

Gross margin compares the first two lines on the income statement: sales and cost of goods sold. Cost of goods sold is the amount a company spends to obtain the goods they are selling. Let’s say I own a hat company. My cost of goods sold would be the money I spend either buying the hats from a supplier or on the materials and direct labor necessary to produce them myself. For many companies, cost of goods sold is the largest expense.
The main insight we can gain from gross margin is a look at the strength of our relationship with suppliers. If I’m earning a 50% gross margin on my hat business but a rival firm that sells the exact same hats gets a 60% gross margin, I am doing something wrong. I likely need to either renegotiate or find a new supplier that can provide the goods that I need at a cheaper price. A gross margin below industry average is a bad sign for a company and indicates a potential long-run competitive disadvantage.

Operating Margin

Operating Margin = (sales – cost of goods sold – operating costs) / sales

This ratio simply builds upon the gross margin, this time also subtracting out operating expenses. Operating expenses are anything that is involved with the operations of the firm; this commonly includes selling and administrative expense, research and development, and depreciation.

Operating expenses are one area that managers have a greater amount of control through strategic choices they can make. Their goal is to keep operations as lean and efficient as possible by maximizing output from each employee, limiting unnecessary outflows, and tactically designing marketing and R&D spending policies that perform effectively without bleeding the company dry of profits.  Managers are often compensated based upon their ability to cut operating costs.

Net Margin

Net Margin = net income / sales

Net margin gets right down to the most important detail—what amount of our sales are we able to take to the bottom line? To reach net income, we have to subtract out interest expense and income taxes from our previously calculated operating margin.

When comparing companies, net margin is one of the most essential metrics to judge a firm by. Companies that are able to keep greater percentages of their sales as earnings will bring in more money in good times and will be more likely to keep a positive net income in tough economic times. If my hat shop has a healthy 15% net margin and my competitor is at 2%, odds are that in tough times (say, when people are buying less hats and we have to lower prices to drive sales) my earnings will hold up better than the rival, who could quickly shift to actually losing money.

Liquidity

liquidity

Whereas those profitability ratios focused on income statement items, liquidity and solvency are mainly concerned with the strength of a company’s balance sheet. The concept of liquidity centers upon a business’s ability to handle short-term obligations like accounts payable, accruals, and debt that is due within one year.

Short-term liabilities aren’t a bad thing— nearly every company needs to use them to operate—but managers must make sure there is enough cash around to handle them. If $200 million is due in a month and we only have $50 million available to pay it, our company needs to scramble to collect or borrow an additional $150 million or we could go into default. Defaulting is a disaster for companies and can lead to a credit downgrade, higher interest rates, or even bankruptcy if creditors are alarmed and want their money back faster.

To ensure our business avoids such unpleasantries, we need to keep an eye on liquidity ratios.

Current Ratio

Current Ratio = current assets / current liabilities

This is a simple calculation as both current assets and current liabilities are added up for us on the balance sheet. However, it is important to make sure that the current ratio doesn’t dip too low—a higher number is better as it means we have more liquid assets available to counteract our short-term obligations. A current ratio of 2 or higher is often seen as “safe”, but that number varies depending on the company.

The problem analysts should watch for is a major drop in current ratio between one period and the next. If my hat business has a current ratio consistently around 2 from 2012-2016 but this drops to 1.2 in 2017, it could mean something is going very wrong. We may have borrowed too much money, customers might not be paying us on time, or we may have spent too much of our cash reserves on a long-term asset (such as a new factory). As long as the problem is caught early enough, there is usually a way to raise short-term funds through long-term financing and ensure that the business isn’t going to run into any liquidity problems.

Quick Ratio

Quick Ratio = cash and cash equivalents / current liabilities

The quick ratio tells us similar things to the current ratio, except it only includes cash and cash equivalents (which can include money market accounts, short-term securities, or anything else we can quickly turn into cash). The point of this is that current assets besides cash (like accounts receivable and inventory) are riskier than cash itself. If we owe the bank $10 million in a month, they won’t accept $10 million in hat inventory. We would have to hope we can sell that inventory to raise cash, which is not a certainty by any means. Again, a big drop in the quick ratio is the main problem an analyst would want to watch for.

Solvency

Solvency ratios are focused on looking beyond the short term and determining how a company is financially positioned to survive in the long term. This mostly looks at how much long-term debt a business is holding relative to other accounts and the amount of interest expense a firm is shelling out every year.

The stakes are high here. If our company has too much debt and has to spend too much on interest, we are going to go bankrupt. The economic cycle is very important to keep in mind, because what may be an ok amount of debt in good times can quickly turn into way too much in a recession. It’s the analyst’s job to think ahead and make sure that if there’s a downturn and our earnings drop off, we are positioned to survive.

Debt-To-Equity Ratio

Debt to Equity = Total Liabilities / Total Equity

Business is good!
Counting both my inventory and my cash

This is one of the most common solvency ratios that analysts use. Essentially, it shows us a comparison between the amount of debt financing (borrowing) that we use versus the amount of equity financing (for example, selling common stock). Generally speaking the lower this ratio is, the safer the company’s balance sheet. Debt to equity varies widely depending on the company and the industry.

The most useful thing we can do is compare debt/equity ratios across an industry. If the average debt/equity in the hat industry is 1 (equal use of debt and equity) but my business is running at 3.5, there’s a good chance that in a downturn my company will be the first to go bankrupt. Alternatively, if a company has had a debt/equity of 0.5 for the past five years but in 2017 it leaps to 2, investigation needs to be done as to why so much debt was added and whether or not the business can handle it.

Interest Coverage

Interest Coverage = earnings before taxes and interest (EBIT) / interest expense

This is a really useful ratio to see how well a company can handle their interest payments. It tells us how many times we can cover our interest expense (found on the income statement) using our EBIT or operating income. The higher the ratio, the more comfortably we are managing our interest. A major drop-off in the interest coverage ratio means that either we’re earning less or paying out more interest—either is concerning!

price-ceiling
Economics, N - T

Price Controls

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Definition

“Price Controls” are artificial limits that are put on prices. If the limit is put in place to prevent prices from getting too high, they are called Ceilings. If they are in place to prevent the price from getting too low, they are called “Floors”.

Price Ceilings

price ceilingPrice Ceilings are controls put in place to prevent the price of some good or service from getting too high. This type of control is most common with food, where there might be a maximum price that businesses can charge for things like flour or electricity.

These controls are put in place to protect consumers and to prevent price gouging, particularly so the poor are able to afford basic goods and services. When there is a price ceiling, suppliers cannot sell above a certain price, and this creates a Market Shortage.

With a Market Shortage, the quantity producers are willing to supply is less than the total quantity that consumers demand at the given price. This can result in rationing, or lottery systems to determine which consumers are able to buy.

In extreme cases, it can result in “Bread Lines”, where essential goods are not supplied in sufficient amounts, so consumers need to join waiting lists to get their necessary share.

Price Floors

price floorPrice Floors are the opposite – a control put in place to ensure that a certain amount of something is produced by making sure producers are guaranteed at least a certain price for what they supply. These types of control are common for milk.

These controls exist to prevent shortages, by making sure suppliers get at least a certain price, it encourages production. When there is a price floor, the producers are willing to supply more than consumers demand at a given price, creating a Market Surplus.

With a Market Surplus, the government needs to buy the excess production, or else the market price will collapse back down. In the case of milk, the government typically buys the excess production and stores it, uses it as part of disaster relief, or tries to sell it on international markets.

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A - G, Economics

The Business Cycle

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What Is The Business Cycle?

The Business Cycle is the broad, over-stretching cycle of expansion and recession in an economy.

The Business Cycle is concerned with many things – unemployment, industrial expansion, inflation rates, but the most important indicator is GDP (Gross Domestic Product) growth. Below you can see a graph of the GDP growth rate in the United States since 1946 – the grey bars highlight periods of a recession.

GDP growth

The Business Cycle can also be thought of as how Real GDP moves above and below its Potential Levels.

What Is Real GDP?

GDP, or “Gross Domestic Product”, is the total amount of finished goods and services produced in an economy during a given year (for more information, read our full article on Common Economic Indicators). If you just add up the value of all the finished goods and services in one year, you will have the Nominal GDP.

[econ]The most common way to measure inflation is the Consumer Price Index, or CPI. But there are others! Try to find other ways to calculate inflation![/econ]

Unfortunately, you cannot directly compare the Nominal GDP of one year with the Nominal GDP of another year, because the same goods and services change price over time. If we want to compare the GDP of different years, we need to adjust the Nominal GDP by the Inflation Rate. Once you adjust your Nominal GDP by the Inflation Rate between years, you have the Real GDP, which you can use to directly compare different years.

What is the Potential Level of GDP?

The “Potential Level” of GDP is the total output an economy can sustainably produce in a year.  This is the potential output if every laborer is using their skills the most efficiently, with businesses using their capital goods to the best of their design at the current levels of technology, and public institutions are operating at their peak efficiency. Every time workers learn new skills, technology increases that allows us to make new goods (or the same goods but more efficiently), or changes to the government or culture take place that promote economic growth, the Potential Level of GDP increases.

[econ]It is not possible to tell if the economy is growing above the Potential Level during an expansion, but it usually becomes obvious after a crash![/econ]

The Real GDP growth rate swings above and below the Potential GDP growth rate, which is called the Business Cycle.

Running Below Potential Levels

It is easy to see how an economy can be running below the potential levels – if workers are not matched with jobs that make the best use of their skills, or if machines are not properly maintained, or even if the government has poor leaders that make less-than-optimal laws and policies, it will cause the Real GDP growth rate to fall below the potential level. If it falls too far below, the economy could enter a Recession. Inflation is usually low when an economy is running below its potential levels.

Running Above Potential Levels

The economy can also run above Potential Levels. Remember – the Potential Level is based on what can be sustainably produced. This means that if current growth levels are the result of over-borrowing, or asset bubbles, output might actually be growing at a higher-than-sustainable rate. Economies very often run above their potential levels for short periods of time with no problems, but going too far above for too long can result in a crash. Inflation is usually higher when the economy is running above its potential, which serves to bring the Real GDP back down to its potential levels.

Expansions and Recessions

When the GDP growth rate is positive and unemployment is relatively low, it is called an Expansion. If the GDP growth rate is very low or negative, with higher unemployment, it is called a Recession.

Economic Expansions

stock broker
This part-time lifeguard would prefer to be a full-time stock broker

Most of the time, the economy is an “Expansion” phase. This does not mean everyone is doing well – even during very strong expansions, the unemployment rate usually stays around 5% (meaning 1 out of every 20 people who wants a job can’t find one), with the underemployment rate (people who are working part-time but want a better job) is usually much higher.

What an Expansion does mean is that new jobs are being created, and the total value being produced by an economy is going up. Growth also promotes growth – the more resources that are available, the more resources can be allocated towards researching new technologies and building new skills.

Economic Recessions

Recessions typically occur every 7-15 years, often following an asset bubble bursting, followed by a large loss of value in an economy. Recessions typically have higher levels of unemployment, with low or negative GDP growth. Even if GDP growth is never negative, recessions hurt. Other than GDP, the biggest indicator of a recession is a sharp decrease in consumer spending, and inflation tends to fall.

Higher unemployment rates mean that people lose their jobs, and new workers have a hard time finding their first position. Losses in the financial sector hurt retirement accounts and individual savings and investments, which can severely disrupt life plans. Thankfully, recessions are temporary, and the business cycle can usually move back into an expansion phase fairly quickly.

A - G, Personal Finance

Credit Cards

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What are Credit Cards?

Credit cards is a form of unsecured credit (meaning a loan without collateral) that you can use to make everyday purchases. All credit card purchases are made using a loan – you borrow money from your credit card issuer, and later pay it back with interest.

Credit Cards Vs Debit Cards

credit card

Credit cards can be used at all the same places as debit cards. In fact, some business only take credit cards (like most car rental companies and many hotels) specifically because it works as a line of credit – a business accepting a transaction from a credit card knows it will be paid immediately. If you have both a debit card and a credit card, you should choose carefully which you use most for your everyday transactions.

Advantages over Debit Cards

There are some good reasons to use credit cards for every-day purchases instead of your debit card:

  • Your debit card may have a transaction limit or transaction fees – credit cards typically do not
  • Credit cards often offer “Cash back” and other rewards programs for most purchases
  • Credit cards are accepted more widely than debit cards (especially if you are travelling overseas)
  • Using your credit card will build your credit history, which can lower your interest rate and increase your credit limit on other loans
  • You can “Float” credit card purchases, using it as a short-term loan before your next paycheck

Disadvantages over Debit Cards

There are also some good reasons to use your debit card instead of a credit card:

  • If you miss your grace period, your purchases will be charged interest with a credit card, making them more expensive
  • Since you do not need to pay the full balance on credit card purchases every month, it makes it easier to over-spend
  • If you start to fall behind on your payments, it can be very difficult to fully escape credit card debt
  • Credit card billing cycles are usually 20-25 days instead of one month, making it more difficult to schedule payments compared to other types of bills.

Credit Balance Types

When you use your credit card, there are several different types of balances that will appear on your credit card statement:

New Purchases

Your new purchases are the things you’ve bought using your credit card during the current billing cycle. You will not be charged interest on this balance until the end of your grace period, so it is usually a good idea to pay off this balance first and avoid finance fees. If you miss your grace period, you will be charged interest on the balance for every day you had it.

Balance Transfers

If you don’t pay off all your purchases in a month, the remaining balance will carry over to the next month as a Balance Transfer. Balance transfers do not have a grace period, so they will accumulate interest for the entire billing cycle.

Cash Advancesincome

This is the most expensive type of charge you can make on your credit card. Cash advances are when you take money out of an ATM using your credit card. Cash advances also typically do not have a grace period, and they usually have a higher interest rate than balance transfers.

Finance Charges and Interest Rates

Credit card companies have finance charges as a condition to using the credit card – the most important one is your interest rate.  Each one of your balance types has a different way interest is charged

How Interest is Calculated

Different credit cards may calculate the interest you owe differently, and this difference might make a big difference on your bill. The two most common methods are “Daily Balance” and “Average Daily Balance”.

Previous Balance

The previous balance method uses your balance at the beginning of the billing cycle to calculate your interest. This means that payments you make during the billing cycle will not lower your total interest payment, but will only impact your bill next month.

Adjusted Balance

This method is similar to the previous balance, but also subtracts any payments you make. This method gets you the lowest total interest charges, but is very rare for credit card companies to offer it.

Ending Balance

The ending balance adds your balance transfer to all the charges you made during this billing cycle, and subtracts any payments you made. The interest is then calculated based on that final total.

Average Daily Balance

This method is the most common. Your credit card company takes the average balance of all days and multiplies that by your daily interest rate, then adds it together for every day in the billing cycle.

Grace Period

Every credit card has a grace period, usually about 21 days. If you pay off any new purchases within 21 days of making them, you will not get an interest charge for those purchases. If you miss the grace period, you will be charged the full interest amount. There is no grace period for balance transfers and cash advances, so you will be charged for every day you have a balance outstanding on these balances.

Minimum Payments

Your credit card will have a minimum payment every month, which is the absolute least you can pay to keep your account in good standing. Your minimum payment is based on your outstanding balance. The payment is generally enough to pay off new interest, plus some of the principle balance.

Just making the minimum payments is the absolute longest way to pay off credit card debt, and it will result in the absolute highest possible amount you pay in interest.

Note that there are some conditions that can cause your minimum payment to be less than interest, in which case you will never fully pay off the debt. If your minimum payment is lower than or equal to your interest charge, you can continue making payments on interest forever without ever paying off your debt.

credit card debt

Missing Payments

Missing your credit card payments can result in defaulting on your account. Defaulting on your account has a few impacts:

  • If you had any promotional interest rate, you will retroactively lose it (meaning all your previous outstanding balances will now use the higher interest rate instead of the promotional rate, making your bill even higher)
  • You will get “Late Payment” fees, which is added to your balance transfer into the next billing cycle
  • Missed payments are reported to the credit reporting agencies and will lower your credit score
  • Your credit card may also lower your credit limit and increase your interest rate

If you miss a certain number of payments, your credit card may cancel your line of credit entirely, and send your case to a collections agency. This will further damage your credit score, and make it extremely difficult to get any new credit cards or loans for the next several years.

The CARD Act of 2009

In 2009, the federal government passed the Credit Card Accountability, Responsibility, and Disclosure Act of 2009, which bans certain types of behavior from credit card companies. It also gives credit card holders more tools to help keep their credit cards in good standing.

The CARD act bans credit card companies from:

  • Increasing your interest rate on existing balances (so if your rate goes up, it only applies to new purchases). This doesn’t apply to removing promotional rates
  • Your interest rate cannot go up in the first year of holding your account (except if you have a variable rate credit card, then your base rate can’t do up but the variable rate can)
  • Processing your payments late (all payments must be processed on the day they are received)
  • Charging fees for different methods of payment
  • Using a double billing cycle (where you would be charged interest based on the last period’s balances instead of just the current period)
  • Issue credit cards to people under 21 without a co-signer

As the card holder, you also get new rights with your credit card:

  • If you default on one credit card, credit card companies can’t automatically charge you a higher “penalty rate” on other cards you have
  • You have at least 21 days after your bill is mailed to pay it without any interest charge
  • If you pay more than the minimum payment, all the extra is paid towards your balance with the highest interest charges first (so if you make higher than the minimum payment, the extra would go towards your cash advances before your balance transfer)
  • You can opt-out of over-the-limit fees. If you do, trying to charge more than your credit limit would result in a declined transaction instead of letting it go through with a fee
  • You can opt-out of interest rate increases. If you do, your credit card will be cancelled once you pay off your balance (this might impact your credit score).
Personal Finance

All About Budgeting

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If you want to start building your first workable budget, it is important to know exactly what should be in it, how to keep it updated, and the specific reason you want to have this budget.

What does a budget look like?

spreadsheet

A budget is usually a spreadsheet or table. On one side or column, you will list your planned expenses, while on the other side you list your planned income.

You can use a budget for many different things, depending on the budget type. Using a mix of different budget types, as each situation finds appropriate, can be one of the most effective ways to reach your short term financial goals.

Budget Types

There are two types of budgets, each of which has its own place in your personal finance toolkit.

The Project Budget

A project budget is something you make just once for a specific purpose. For example, you might make a single-use budget when evaluating apartments you might move to (outlining costs of rent and transportation between a few different alternatives).

The project budget is the easiest budget to make because you do not necessarily need to keep managing it in the long term – this is a “one and done” way to address a specific problem.

The first budget most people make is a project budget to help look at their current expenses and see what adjustments need to be made. The problem with this approach is that project budgets work very well for short-term thinking, but tend to be difficult to follow for longer periods of time.

Project Budget Components

Your project budget is looking at a snapshot in time. This means you are comparing some known fixed expenses to a specific amount of income or money you can dedicate towards paying for it. The specific components are:

  • Itemized list of known expenses for this period in time
  • Total expected income or starting cash you have to allocate to this period in time
  • Surplus – the total income minus the total expenses.

The purpose of the Project Budget is to maximize that surplus, or the money you have left over to allocate to other things.

Common uses for a Project Budget

  • Comparing alternative apartments (building a sample budget for each alternative to compare)
  • Planning a vacation
  • Paying off short-term debt
  • Other short-term crisis or goals

The Living Budget

Unlike the Project Budget, a Living Budget is meant to “grow” and adjust over time. These budgets are not designed for a specific goal or purpose, but instead to help you keep a general idea of where your money is going from month to month, and help you adjust your spending to reach your financial goals.

One of the major differences with a Living Budget is that while you make them looking forward, you also should look back regularly and make adjustments (not start over as needed).

Living Budget Components

grocery bill

Your living budget needs to be regularly adjusted and updated. To set up an effective living budget, you will need the following components:

  • Regular monthly income (things like your paycheck)
  • Variable income (gifts, one-off payments, ect)
  • Regular monthly expenses
  • Regular contributions to savings or other financial goals
  • Expected variable expenses

Using Your Living Budget

Unlike the Project Budget, the goal of the living budget is not necessarily to maximize your surplus. Instead, your Living Budget has your savings and other financial goals built in, and you can adjust these every month or two along with your variable expenses.

With your Living Budget, having a big surplus every month is not necessarily a good thing, since that might be a sign that your financial goals might be set too low.

Expense Categories

With the Living Budget, you will notice that there is a difference between “regular”, or fixed, income and expenses with the “variable” income and expenses. When you set out to outline your budget, it is important to keep these distinctions separate.

There are 2 types of expenses, which each have 2 flavors.

  • costsTypes:
    • Fixed Expenses
    • Variable Expenses
  • Flavors:
    • Needs
    • Wants

Most people new to budgeting only consider needs and wants, but without fully breaking down where your money is going, it will be much harder to build a workable budget.

Category Breakdown

Each category has its own place in your budget, and when you want to reach a specific savings goal, these separations make it much easier to hit your targets.

Fixed Needs

Your “Fixed Needs” are things like paying rent, utilities, car payments, and groceries. These costs should not change very much from month to month.

When you are engaging in short-term financial planning, there is not much you can do to change your Fixed Needs expenses. With mid-term and long-term planning, finding ways to cut down or reduce these costs (or any increases to them, like getting a better apartment or car) will likely make the biggest changes impacting your long-term goals.

Fixed Wants

coffee

Your “Fixed Wants” are the costs that add up quickly over time, but most beginners frequently forget to include in their budgets. This includes things like morning coffee from Starbucks, going out for lunch with your friends or co-workers instead of bringing lunch from home, having dessert after dinner, and any other regularly-occurring expenses.

Your “Fixed Wants” include all the little pleasures or extras that you normally get in your day-to-day life – things that you know you could probably live without, but removing them would really sour your days.

Variable Needs

Your “Variable Needs” are expenses that are important, but you may not have them every month. This includes the extra money you will probably spend on heating in the winter, or semi-annual visits to the dentist, or Christmas/birthday gifts for friends and family.

Unlike your Fixed Needs, even with long-term financial planning, there probably will not be very much you can do to change your Variable Needs costs in the long run – you will always need heat in the Winter, always need your teeth fixed when they break, and always need oil changes on your car.

Variable Wants

“Variable Wants” are your expenses that come more “spur of the moment” – things like a night out for drinks with friends, shopping for some new clothes, or buying a new video game.

You usually will not be able to make a line-item budget for your variable wants, but you can estimate how much you spend each month based on your receipts and account reconciliation from the previous month. Once you know how much your Variable Wants are costing you, the next step is taking steps to make sure those costs are under control.

How To Use Your Living Budget

When you are making your Living Budget, you should do so shortly after your latest account reconciliation, where you lay out your 10 or 20 biggest purchases over the last month and consult your bank account. You may know off hand how much you spend on rent and electricity, but building realistic estimates for your variable expenses (both wants and needs) means you need to look at exactly how much you are already spending.

Once you have your expense breakdown from the previous month, you can build your budget for moving forward. This means setting some specific financial goals:

  • Deposit $300 per month into your savings account
    • This means you need to already have a surplus of $300, or make a separate goal to get this money from somewhere else
  • Reduce Fixed Wants costs by $50 per month by brewing your own morning coffee 3 times per week
  • Increase surplus by $100 per month to afford a nicer apartment
  • Reduce Variable Wants costs by $75 per month, and apply that savings towards a yearly vacation savings fund

Putting Your First Goals Into Practice

coins-currency-investment-insurance-128867

To help make sure you hit your savings goals, split your “Savings Targets” in half for your budget. One half should go into your “Fixed Needs” category – this is money you are setting aside as soon as you get paid. The other half should be filed as a “Variable Want”, meaning a target you are setting, but until you have a few months of practice adjusting your budget, you might not be able to reach.

One common problem beginners face is combing both of these items together, then simply trying to increase their surplus by the amount they want to save per month. This tends not to work, simply because there is no concrete line item that you can admit to not reaching – it becomes easy to just roll over that goal by saying “I can just save more next month to make up for it!”.

By separating your first goal into smaller parts, it makes both parts easier to obtain. Having the fixed necessary savings means that you will make progress towards your goal even if everything else goes poorly, while the second half works as an extra incentive showing you have effective money management.

As you become more experienced building your Living Budget, you can shift a bigger percentage of your savings goals into your Fixed Needs category to have more stability, and more effective planning for the future.

If you want to start building your first budget, click here to try the Home Budget Calculator!

TrailingStop Orders
Updates, Using HTMW

Trailing Stops Have Arrived!

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If you have ever wanted to protect your portfolio on HowTheMarketWorks from losses, you have definitely used Stop Orders. The biggest downside of stop orders is, of course, the fact that you have to constantly update them as your investments grow to “lock in” your gains…

What are Trailing Stop Orders?

Trailing Stop orders work a lot like regular stop orders evolve with the market. This means you can set a Trailing Stop sell order to sell if your stock’s price falls by $2.00, or even 2%. As your stock’s price grows, the trailing stop price goes up with it. It will only execute when the stock’s price falls by your Trailing Stop threshold from its peak – meaning you lock in your gains without constantly updating your stop orders.

How Does It Work?

Good question! Check out our tutorial video below to see how to use Trailing Stops with your portfolio.

Advanced, Charts and Patterns, Guest Posts

Crude Oil Prices: Bullish Trends Amid U.S. Output Increase

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Crude oil prices have been climbing up steadily in the last couple of months as investors continue to expect a balance in the demand and supply dynamics of oil. Last year, OPEC announced that it has worked out a deal with its member nations and some other producers to cut production volumes in order to force an increase in oil prices. Data on oil output in January shows a 90% compliance level among member nations as the promised production cuts become evident. Russia and other non-member nations have also started reducing their output to uphold their ends of the deal.

Oil prices started falling some two years ago after an increase in the supply of oil and a decline in the demand shifted the dynamics of oil trade. The entry of U.S. shale oil and the return of OPEC producers such as Libya and Iran caused the supply of oil to surge. To OPEC’s credit, last year’s deal to reduce the supply has shown that the cartel is not a toothless dog and investors are more optimistic about the prospects of oil. This piece seeks to provide insights into what commodity traders can expect from crude oil going forward.

Oil prices are on a bullish rally

Stakeholders in the global energy industry are optimistic that oil prices will rise – commodity traders must pay attention to this rising bullish sentiment. Since OPEC announced the deal to cut output on November 30, 2016, Brent Crude has gained an impressive 12.93% and the West Texas Intermediate has gained a decent 7.18% as shown in the chart below.

At the start of the new week ending February 24 crude oil was up across the board. April contracts for the Brent crude oil had gained 0.49% to trade at $56.08 per barrel.  March contracts for the U.S. West Texas Intermediate was booking gains of 0.32% to trade at $53.95 per barrel.

The aforementioned gain in oil prices is particularly interesting and impressive because investors and traders are bullish even though U.S. producers could erase the production cuts from OPEC by flooding the market with more shale oil. Peter Sawyer, an analyst at Stern Options observes that “an increase in U.S. oil is a worrisome move that could potentially sustain the supply glut and water down the effects of the production cuts that OPEC is celebrating.”

Analysts at Goldman Sachs have observed that U.S. current oil rig count and been increasing for five straight weeks and the increase suggests that U.S. output could increase by 130,000 barrels per day this year. The U.S. Department of Energy also echoes the same sentiments about an increase in U.S. oil output. The Department of Energy notes that U.S. oil production could climb to 9 million barrels per day up from 8.9 million barrels per day in 2016.

In essence, stakeholders must contend with the realities of OPEC’s output cut on the one hand and rising U.S. output on the other hand. However, the fact that global oil prices are rising despite the two sides of the market coin suggests that investors are betting on increased bullishness ahead.

Final words

Crude oil is currently enjoying bullish tailwinds because investors are rewarding OPEC with goodwill for pulling off the historic deal to cut oil output. In fact, investors are starting to place speculative trades on the increased bullishness of crude oil. Bloomberg’s CFTC NYMEX crude oil net speculative positions have soared to another record high of 557,570 after gaining 29,704 points. Of course, there’s the attendant risk that crude oil could suffer a massive crash if OPEC loses its bullish goodwill. However, crude oil should continue to rise going forward inasmuch as OPEC continues to record an impressive level of compliance in the deal to cut oil production.

Updates

The Dashboard Has Arrived!

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Do your students have a hard time getting started with their portfolio? Do you want a place where you can see all your tools in one place? Us too, which is why we added the new Dashboard to HowTheMarketWorks!

dashboard

The dashboard is just the newest addition to our new design, with your entire suite of tools at your fingertips.

We have divided up all the tools into 5 categories:

  • My Portfolio – here you can find things you own, your assignments, account balances, and graphs
  • Trading – Make a trade, or see your transaction histories
  • Contests – See your ranking, join a new contest, or create your own
  • Research Tools – Start doing some investment research, with a wide range of tools to choose from
  • Trading Ideas – See the most popular stocks and mutual funds, what the brokers are saying, and a lot more

We have more great new features coming, so stay tuned!

Advanced, Charts and Patterns, Guest Posts, Other Guides, Technical Analysis

What Do Traders Look for with Gold?

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Gold Chart

Gold is currently trading at $1,215.85 per ounce, up 0.96% or $11.55. The precious metal has gained 6.40% over the past 30-day period, up $72.40. For the year to date, gold is up 4.7%, and it has an average return of 10.7% since 2002. Its best year on record in that time is 2007 when the price advanced by 30.9%. It should be remembered that gold is a safe-haven asset that thrives during times of geopolitical uncertainty. The recent appointment of Donald Trump to the presidency has had a jarring effect on financial markets. In the run-up to the election, and the immediate aftermath Wall Street equities rallied.

Indices, Currencies, FX and Commodities

The Dow Jones Industrial Average is hovering around the 20,000 level, and sharp gains have been reported with the S&P 500 index, the NASDAQ Composite Index and other minor indices. However, the rally appears to have faded somewhat after Trump’s inaugural address. The USD has been casualty number one after comments made by Trump to various newspapers to the effect that the greenback is overvalued and this is detrimental to US economic growth. An immediate selloff in the USD ensued, and this is evident in the currency cross-exchange rates of major pairs, minor pairs and exotic pairs.

  • The USD/EUR pair is down 0.3426% or €0.0032 at 0.9308
  • The USD/GBP pair is down 0.87% or £0.01 at 0.8012
  • The USD/JPY currency pair is down 1.23% or ¥1.402 at 113.193
  • The USD/CNY currency pair is down 0.31%, or CNY 0.02, at 6.8513

Dollar weakness is confirmed across multiple currencies, and the US dollar index. The vaunted DXY is trading 0.40% lower, down 0.40 at 100.23, slipping away from its 52-week high of 103.82. The index has a 52-week low of 91.92. The DXY measures the performance of the greenback against 6 major currencies including the JPY, EUR, CHF, GBP, CAD and SEK. The most heavily weighted currencies in the DXY are the EUR at 57.6%, the JPY at 13.6% and the GBP at 11.9%.

The Gold Price and the Greenback

The recent weakness in the USD was met by increasing demand for gold, which makes sense. However, as a dollar-denominated asset, gold has also moved independently of the USD. The main driver of gold demand is speculative behaviour and investment activity on major funds like the GLD SPDR Gold shares on the New York Stock Exchange. This ETF is the most important gold fund in the world. This fund is valued at $31.225 billion with 809.15 tonness of gold under its control. Any major capital inflows into this fund naturally fan out into the markets raising the price for gold bullion. In much the same way, any major outflows from GLD will negatively affect the gold price.

The Gold Price and Interest Rates

The gold price has an interesting relationship with interest rates. If rates rise, gold loses favour. The rationale behind this is simple: gold is not an interest-bearing asset. This means that the opportunity cost of holding gold when interest rates are rising is high. Since gold does not pay interest, investors tend to shy away from gold when rates are rising. Instead, they plow their money into fixed-interest-bearing securities such as treasuries, certificates of deposit or savings accounts. The Fed is expected to increase interest rates at least 3 times in 2017. The FOMC will convene again on Wednesday, 1 February, but no rate hikes are expected at this juncture.

While analysts will be cautioning market participants about the impact of rising interest rates (the federal funds rate), many opportunities exist for gold traders in the futures market. Analysts point to important educational resources such as CreditLoan.com for didactic insights into accessing credit in a tightening economy. Interest rates are expected to rise by upwards of 0.75% by the end of 2017, and this will have far-reaching implications for commodities like gold, home loans, personal loans, and overall economic activity. When the costs of capital are higher, the money supply diminishes. It will be interesting to see whether the current long-term trajectory of gold continues and the precious metal continues to lose value.

Advanced, Current Events, Guest Posts, Other Guides

The Travel Money Market in Perspective

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Travel Money

People buy foreign currency for many reasons. You may wish to purchase Forex as a hedge against depreciation, or because you are traveling abroad. Many people buy foreign currency to send to someone else who is living abroad. Whatever your reasons for buying or selling Forex, you will always want to pay the lowest possible charges.

Banks have been found to be the most expensive way of buying foreign currency. Not only do banks levy high charges on sending/receiving domestic or international wires, they also charge premium rates for converting currencies.

As such, currency exchange companies have sprung up all over the world. These companies effectively reduce or eliminate wire transfer fees and associated high commissions, and offer travelers the best possible rates on currency exchange. There are many options available to you when taking currency abroad. Experts advise travelers to use credit cards with no foreign transaction fees. It is ill-advised to use such cards at automatic teller machines (ATMs) since extortionary charges will be levied by the foreign bank ATM and your home bank. Cash advances will quickly eat into your capital and erode it away.

What Is the Problem with Conventional Currency Transfer Services?

Forex

When you order foreign currency through your bank, you are going to be hit by fees, commissions, and other costs. If you choose to go via banks, do it online. In-bank currency purchases are more expensive. Banks have the added advantage of preferred borrowing rates since they deal with huge sums of money daily. They can get currency for their customers at better rates, but again they tack on many additional charges that you won’t be paying elsewhere.

If you withdraw cash from your bank’s branches overseas, you will also be hit with fees in the region of 1% – 3% if it is an in-network ATM. For these reasons, you will want to compare travel money rates before you part with your hard-earned cash. You may also need to pay international transactions fees which will necessitate fewer trips to the ATM and bigger withdrawal amounts each time. This is a security risk and a costly option.

Why Is the UK Leading the Way with Currency Exchange?

The United Kingdom is the epicenter of the Forex market. The City of London in particular is where the bulk of global Forex trading takes place. As such, the UK has many top-tier money transfer services available. These are highly regarded and oftentimes provide far superior service than the big banks. It is always a good idea to research the money transfer providers available on the market.

These include John Lewis Travel Money, Travel FX by Global Reach Partners, TorFX, FairFX Travel Money Rates, The Currency Club Travel Money Rates, Covent Garden FX Travel Money Rates and many other reputable providers. The providers in the UK operate under the rules of the Financial Conduct Authority (FCA), and HM Revenue and Customs. As such, clients can rest assured that all operations are legitimate with these reputable service providers. Outside of the United Kingdom, banks typically run the show. This is quickly changing in the United States and Canada where many alternative money transfer services are now available

What Is the Best Way to Exchange Money When You’re Going on Holiday?

The tide has shifted from banks to reputable money transfer providers. In the UK, there are a myriad of highly regarded providers that offer better services and rates than banks. Banks typically buy currencies at the best rates, but charge customers much higher rates. This is pure profit. The wire transfer fees for incoming and outgoing wires at banks are extortionary. As such, your best bet is to evaluate the rates at top UK providers, and compare them based on your preferences.

Money transfers for personal use such as going on vacation are going to be smaller than for setting up a new business. Therefore, you will want to ensure that your currency exchange rate is favourable, and that’s where flexible currency purchases by money transfer providers beat the banks. They will wait for you to get the best rates before initiating currency purchases. Banks simply purchase the currency as soon as you seal the deal. Shop for the best rates before you consider going to banks.

Updates

New items added to assignments!

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HowTheMarketWorks is growing – and the list of great educational articles you can include in your class assignments is growing too!

creditcard

Last week we added 3 new Personal Finance and Investing articles, plus one great new personal finance calculator!

New articles

New Calculator

We add new articles to the Education Center every week, but when we add new items to the Assignments, you know they are special!

Articles we add to Assignments can be integrated with your HowTheMarketWorks contest – you can assign these as reading to your students, and track their progress. These articles have been written to cover topics that are part of the National Standards for Personal Finance and Economics, part of the Common Core curriculum.

Click Here to learn more about assignments!

Popular

Student Poll: Majority Favor Trump in Presidential Race

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2016 Presidential Poll of College Students

Presidential Poll of College Students Trump Leads by 3.4%

Presidential Poll of High School Students Trumps Leads by 19.1%

Stock-Trak Inc., the leading provider of educational stock market simulations for the high school and college markets, posted polls on its websites from November 1 to November 3 asking its users for whom they would vote.  Participation in the polls was optional, the strategy was admittedly unscientific, but the the results were amazing.

Our www.StockTrak.com site is used in over 1,100 college finance classes and by 75,000 students each year.  The demographic tends to be slightly more males than females, and roughly 75% undergraduate students, 23% graduate students, and 2% other.

 

Our www.HowTheMarketWorks.com site is used by a mix of middle school, high school, college and adults clubs that want to learn about the stock markets and practice trading.  The middle school classes using HowTheMarketWorks.com tend to be Math or Social Studies; the high school classes are mostly Economics, Personal Finance, and Business; and the college classes are mostly Finance or Economics classes.

Based on the self-reported age, users over 18 years old were directed to one Presidential Poll and users under 18 were directed to another Presidential Poll.

During the 3 days of November 1 to November 3, 2016 9,467 users 18 years old and over completed one poll and 11,885 students under 18 years old completed the other poll.  The 2 results are as follows:

StockTrak.com and HowTheMarketWorks.com 2016 Presidential Survey

(for users 18 and over)

Democrat – Hillary Clinton: 3,363 votes or 35.5%

Republican – Donald Trump: 3,678 votes or 38.9%

Libertarian – Gary Johnson: 857 votes or 9.1%

Green – Jill Stein: 453 votes or 4.8%

Other:  996 votes or 10.5%

The “Other” votes included responses such as Bernie Sanders, Me, Romney, Paul Ryan, Dak Prescott, and ‘Thankfully not American!.’  Watching the voting throughout the day revealed an interesting trend.  During the day when the stock markets were open, Trump seemed to stretch his lead.  However, the evening and overnight votes pulled Clinton back closer.  “This was a consistent trend for each of the 3 days,” said Mark T. Brookshire, Stock-Trak CEO and Founder.  “Perhaps this pyscho-demographic trend suggests that the students who were actively managing and monitoring their portfolio during market hours leaned Republican while the more passive investors leaned Democrat.”

 

 

 

StockTrak.com and HowTheMarketWorks.com 2016 Presidential Survey

(for users under the age of 18)

Democrat – Hillary Clinton: 2,935 votes or 24.7%

Republican – Donald Trump: 5,207 votes or 43.8%

Libertarian – Gary Johnson: 948 votes or 8.0%

Green – Jill Stein: 576 votes or 4.8%

Other:  1719 votes or 14.5%

The “Other” votes for this age group were what you might expect with answers ranging from Bernie Sanders to Obama to Mickey Mouse.  “I was amazed that so many students would voluntarily take our Presidential Poll, but I am at a loss to explain why our poll of users under the age of 18 would be so strong for Trump,” says Mr. Brookshire.  “Perhaps its because of the strong selection bias of our high school users being from Economics, Personal Finance and Business classes.”

 

For  more information, please contact Mark T. Brookshire at Mark at StockTrak.com or 770-337-7720

Contests

Back To School Challenge

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Our Back To School Challenge is now finished, we had tens of thousands of trades placed to fight for the top spots! See the winners below! If you want a shot at a cash prize yourself, join our next contest!

Click Here To Join The Next Contest!

Stock Trading Contest Result

  1. Fractals7                                                     
  2. Namburiv
  3. Catspaws
  4.  Igorski123
  5. MichaelGebhart

See The Trading Strategies From This Contest!

Janene’s March Trading Strategy - Contest: March Trading Contest Final Portfolio Value: $131,022.78 Trading Strategy For This Contest I’ve watched the market as it fluctuates, learning to buy and short gold as it adjusts. I tend to go with my gut instinct when buying stocks. Sometimes it works, sometimes, not so much. The best thing you can do, to help you Read More...
Vicky’s March Trading Strategy - Contest: March Trading Strategy Final Portfolio Value: $101,169.24 Trading Strategy For This Contest Trading Strategy: Investing for the first time in the stock market is very overwhelming; even if it is done with virtual money. I’ll start saying that implementing a strategy takes a lot of practice and patience. You must begin understanding some of Read More...

About The Challenge

We held trading contest from September 5 through September 30, 2016, with over 4,000 traders joining in! We gave prizes to the top 5 finishers. This was the fourth prized contest of 2016!

Prizes

  • Top 5 Finishers Each Win $100

Rules

  • There will be a full audit at the end of the investing contest on all winners to verify any corrections due to stock splits, dividends, or any other corporate action our team may have missed. Only legitimate portfolio returns will be counted in the ranking.
  • Each person is allowed only 1 entry. Users with multiple portfolios in the contest will be disqualified.
  • The usernames of the winners will be made public, but not their actual first name, last name, nor email address.
  • No member of the HowTheMarketWorks Team is eligible for any prizes

Other Prized Contest Results

Fall 2017 Challenge - Win prizes in our stock market contests! Find all of the information for any stock contests with prizes we are currently running here! You can also find information on past contests and their winners. Register Here To HTMW Fall Challenge Who can join? Anyone can join! Joining our stock market contests is completely free, so Sign Up Read More...
Back To School Challenge - Our Back To School Challenge is now finished, we had tens of thousands of trades placed to fight for the top spots! See the winners below! If you want a shot at a cash prize yourself, join our next contest! Click Here To Join The Next Contest! Stock Trading Contest Result Fractals7                                                      Namburiv Catspaws  Igorski123 Read More...
Stock Market Contests April Trading Contest - Our April Trading Contest is now finished, we had tens of thousands of trades placed to fight for the top spots! See the winners below! If you want a shot at a cash prize yourself, join our next contest! Click Here To Join The Next Contest! Stock Trading Contest Result TJack43 EddieB18  Housemanager  brucehaan wolforda17 About Read More...
March Trading Contest - Our March Trading Contest is now finished, we had tens of thousands of trades placed to fight for the top spots! See the winners below! If you want a shot at a cash prize yourself, join our next contest! Click Here To Join The Next Contest! Stock Trading Contest Results MichaelGebhart  +53.77% wpeldiak  +50.55% Janene  +31.00% Read More...
stock trading contest join February Trading Contest - Our February Trading Contest is now finished, we had tens of thousands of trades placed to fight for the top spots! See the winners below! If you want a shot at a cash prize yourself, join our next contest! Click Here To Join The Next Contest! Stock Trading Contest Results almater1  +44.59% Housemanager  +43.9% Michael  +35.1%% Read More...
January Stock Trading Contest - Our January stock trading contest is now finished, we had tens of thousands of trades placed to fight for the top spots! See the winners below! If you want a shot at a cash prize yourself, join our next contest! Click Here To Join The Next Contest! Stock Trading Contest Results smithjj5  +30.19% blowke  +28.64% qtran12203 Read More...
December Stock Trading Contest - Our December stock trading contest is now finished, we had tens of thousands of trades placed to fight for the top spots! See the winners below! If you want a shot at a cash prize yourself, join our next contest! Click Here To Join The Next Contest! Stock Trading Contest Results smithjjj5 – +36.28% Return mchung37 Read More...
November Investing Contest Results - Our November investing contests are now finished, we had tens of thousands of trades placed to fight for the top spots! See the winners below! If you want a shot at a cash prize yourself, join our next contest! Click Here To Join The Next Contest!   First Weekly Contest blowke +15.56% Second Weekly Contest brendanriley +15.41% Read More...
October contests October Stock Contest Results! - The October stock contests are finished, with over a thousand participants from all over the world! We had hundreds of thousands of trades placed, and already gave away almost $1000! See who won below! First Weekly Contest The Top 5 performers by portfolio value were: hoabidebay +16.94% kingsalman+14.36% brucehaan +14.08% daniellopez +10.16% Housemanager +9.83% The Read More...
free stock contest September Monthly Million Challenge! - The September Monthly Million Challenge is the first in our Monthly Million series, with over a thousand participants from all over the world! The rankings were fierce, with the HowTheMarketWorks team scattered throughout, but you’ll be surprised who won! The Top 5 performers by portfolio value were: AngelRivera +30.81% Janene+23.14% wkaraman14 +18.15% puttno2 +12.63% smithjjj5 Read More...
A - G, Beginners, Personal Finance

Credit – Using Borrowed Money

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What Is Credit?

“Credit” is when you have the ability to use borrowed money. This can come in many different forms, from credit cards to mortgages. There is a wide range of ways to use credit, which means that it is often a challenge for beginners to learn all the different ins and outs of using credit.

Basic Credit Terms

Before diving in to how each piece works together, you should know some of the basic terms that come up a lot with credit.

Principle

This is the amount of money that you need to re-pay. This includes the amount you originally borrowed, plus any extra interest.

Interest Rate

This is how much you are charged for the right to use borrowed money. This is an annual interest rate.

Credit Limit

Your credit limit is the total amount you are allowed to borrow.

Grace Period

This is the time between when you borrow money and when interest begins to be charged on the principle.

Minimum Payment

This is the least amount you can pay back per month before your credit card company considers you defaulting on your debt. This is a percentage of your total principle balance.

How Does Credit Work?

Credit works based on trust. You, as the borrower, ask a lender for a “line of credit”, or the ability to borrow money to use for your own needs, and you promise to pay it back. The lender will agree, with certain terms and conditions. These terms are generally based on what you intend to buy, how likely you are to make all repayments on time, how trustworthy you have proven yourself in the past with borrowed money, your income, the overall conditions of the market, and a few other factors.

At the end of the day, the more trustworthy you have proven yourself to creditors, the better terms you can get when borrowing money, because they see it as a lower risk. If creditors do not see any reason to think you’re trustworthy (or if you have proven yourself untrustworthy in the past), you will get worse terms.

What Are My Credit Terms?

Your credit terms refers to how much you can borrow, and how expensive it is to borrow. Having “Good Terms” generally means higher credit limits (meaning you’re allowed to borrow more money at a time), lower interest rates (making it less expensive to borrow), and other perks like cash back and flight miles. For beginners, focusing on lower interest rates should be your biggest concern when shopping around for credit cards or car loans.

How Can I Improve My Terms?

Since your credit terms are determined by trust, the best way to improve your terms are by using credit and reliably paying it back. This shows creditors that you are able to manage regular payments and will very likely be able to pay back your borrowed money on.

From a creditor’s point of view, every time they lend money it is an investment. Their return on investment would be the interest rate you are charged to borrow money, while their risk is the likelihood you are not able to pay back on time, or not at all. If you have shown that you can reliably make your payments, they believe you’re a safer investment, and so you get better terms. If they don’t have much credit history, or (worse) a credit history with lots of late or missed payments, they see you as riskier, so they charge more to use the service.

Creditors use credit reports to share information with each other about who does, and who does not, pay their bills, so you won’t be able to get out of a bad credit history by switching to a different lender.

Credit In Practice – A Credit Card

When you use your credit card to buy something, say a television at $300, you open a new principle balance for $300, which you borrow from the credit card company. You can only borrow up to your Credit Limit, we will assume your credit limit is $300 in this example so the TV used it all up.

The credit card company then gives you a Grace Period, or time between when you first make the purchase and when they start charging you Interest. The grace period is usually 3-4 weeks, but this can vary a lot depending on your credit card company [rich]The Grace Period is another important term to know when shopping between credit card companies![/rich]

After the Grace Period ends, the credit card company will start charging you an Interest Rate. The interest rate is a percentage of the principle balance that is added as a charge – this is the primary cost of borrowing money. The Interest Charge is added to your Principle Balance.

You will need to make at least your Minimum Payment every month in order to remain in good standing with the credit card company. The minimum payment is a percentage of the Principle Balance, but beware – if your minimum payments are less than the amount being added by interest and fees, you will never fully pay off your debt. Many young people have been stuck paying off relatively small credit card debts for many years by only making the minimum payments, meaning they ended up paying many times extra in interest more than they originally borrowed! You can always pay more than the minimum payment.

As you make payments to reduce your principle balance, you can use the difference between your principle balance and your credit limit to continue making extra purchases on your credit card.

Once your principle balance is zero, no more interest will be charged, and you will be back to the beginning. To see how this works out, check out our Credit Card Payments Calculator.

Credit In Practice – A Mortgage

house

If you need to buy a house or property, you will have a mortgage. The biggest difference between a mortgage and a credit card is that with a mortgage, you are borrowing the money for a very specific purpose, usually to buy a house. The house you are buying then becomes collateral in the loan, meaning that if you fail to pay back, the creditor can take your house.

This risk of losing your house works both ways – it also means that your creditor has a lot lower risk in lending you the money, since they are able to claim something back if you aren’t able to repay. This means that with a mortgage, you will have much higher credit limits and better interest rates than a credit card, even with the same credit score and credit history.

Otherwise most of the mechanics are the same as a credit card – minimum payments, interest and principle all work the same.

Unlike credit cards, there are two types of interest rates used with mortgages, Adjustable and Fixed.

Fixed-Rate Mortgages

Fixed-Rate mortgage is how it sounds, the mortgage interest rate is fixed for the entire duration of the mortgage. This means your rates and payments will be predictable for the entire duration of the mortgage. As a trade-off, fixed-rate mortgages might be (on average) slightly higher than adjustable.

Adjustable-Rate Mortgages

With an adjustable-rate mortgage, your interest rate can move up and down over the term of your mortgage based on the overall market rates. Lenders prefer these – it means they can increase or decrease how much they’re charging based on prevailing market rates.

For lenders, you lose some predictability in your payments. However, to compensate, banks generally offer lower average adjustable rates than fixed rates (but this may not always be the case).

What Else Impacts My Credit?

There are a lot of other factors besides your credit history that will impact your credit and payments. The biggest of these can be the “Extra fees”, or money credit card companies charge for using certain services. These can be tricky and add up fast.

[rich]The most common extra fee is to receive a paper statement in the mail rather than by email. You might also be charged a “service fee” even if you don’t use your card.[/rich] Fees vary widely, both in type and amount, between credit card companies, so should definitely be on your list of things to check when shopping around.

Other factors are more mundane, like your income and the general market. If you earn more money, you will likely have higher credit limits and lower interest rates, since creditors see that you have a greater ability to pay. If interest rates in the overall market are low or high, this will also play a significant role on the rates you get.

Another hidden cost could be your interest rate calculation. Some creditors will make one calculation per month, others will charge per day. These differences can make a big impact on how your payments work- if there are monthly calculations, you benefit by making a big payment once per month right before the calculation. If it is daily, you benefit most by making many smaller payments throughout the month.

Building Credit From Scratch

Watch this great video from Bank of America showing how to start building credit from scratch.

Beginners, Glossary, Personal Finance

Credit Reports

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Credit Reports are basically a report that contains your credit history – both the good and bad. If you watch late-night TV, you have probably seen a few commercials offering free credit reports, so you might know that these are important. Most people, however, don’t know just how big a role a credit report can play.

What is a Credit Report?

question file

A credit report, at its core, is a document that keeps a record of (most) of your regular bill payments. There are three main organizations that provide credit reports in the United States: Experian, TransUnion, and Equifax.

Each of these organizations is specially licensed to collect information on all individuals in the US related to their credit and payment history, criminal record, bankruptcies, and lawsuits. Your “Credit Report” is basically your file that they have on all of these activities for the last 7-10 years.

Companies and organizations from whom you are requesting credit can then ask one of those 3 agencies for a copy of your credit report to help them assess your application for credit. This would include any time you want to open a credit card, take out a loan, get insurance, or renting a home. Sometimes even potential employers might request a copy of your credit report, although in this case you need to provide consent.

What is the difference between a “Credit Report” and a “Credit Score”?

Your credit report is a complete credit history, meaning the bills you have paid (or didn’t pay), and their amounts. A “Credit Score” is a single number.

Since a credit report can have a lot of different information from different sources, this is consolidated by using what is called the “FICO score”. The “FICO score” basically distills all your credit history down to a number – the bigger this number is, the more likely the credit agencies think you will pay your bills on time. If you have a clean credit report you will have a high credit score. On the other hand, if you have a poor credit score, you probably have a lot of late payments or complaints in your credit report.

https://youtu.be/wt0z89tYvfE

Your income does not impact your credit score, but repeated requests to review your score do have a negative impact, since the credit rating agencies assume that if you are trying to get a lot of different credit from a lot of different places, your financial position might be unstable.

credit score
Source: Bank of America – Better Money Habits
 

Why Do I Need To Care?

Your credit report, and credit score, are important, and can have a huge impact on your financial life. Anyone who would need to assess your financial trustworthiness will probably be looking at your credit report, so it is absolutely in your best interest to keep it looking good.

Applying For A Credit Card

credit card

The first time your credit report might come up is when you apply for a credit card. Based on the length credit history (meaning the total size of your credit report), your credit score, how well you have kept up with any previous payments, and your income, you will have a very wide range of credit options available.

Generally speaking, people with a poor credit history have lower spending limits, higher interest rates, and less likely to get any leeway with their credit card company with late payment forgiveness or credit card perks. On the other hand, if your credit report looks good, you will have a wide pick of different credit card companies offering increasingly attractive terms to attract your business.

Applying For A Mortgage

If your credit history is poor, you might have trouble securing funding for a home at all. When you want to buy a house, you will see the same kinds of terms as when you apply for a credit card, but with much higher stakes. This means more banks and lenders willing to lend to you in the first place, better interest rates (which can save you tens of thousands of dollars over the life of the loan), and more flexible down payments.

Renting an Apartment

When you rent an apartment, your potential landlord will probably look up your credit report. Renters often use the credit report to compare different candidates and determine the size of the security deposit. Remember – a person renting an apartment is primarily concerned with making sure the rent is paid on time. If you have a poor credit report, they might rather wait for the next applicant than take a risk.

Getting Insurance

While it might not play as large a role as direct lines of credit, insurers also look at your credit report when they determine your premiums and deductibles. This is because they want to make sure all of their clients are paying on time. The entire idea behind insurance is that the insurance provider is taking in at least as much money from premiums as they are paying out in claims, so they need to make sure all of their clients are paying their premiums on time.

If the insurance company suspects that you will lapse on your coverage, just to start catching up right before filing a claim, they will likely charge you higher premiums to make up for it.

Applying For A Job

apply

More and more employers are requesting the credit history from potential job applicants. This trend first started in the finance and banking industry, but has been spreading to other sectors as well. Potential employers see your credit history as your overall professional trustworthiness, particularly if you have a long history of late payments.

What Exactly Is In My Report?

Your credit report follows your basic payment history to creditors. This includes:

  • Credit Card Payments
  • Cell Phone Payments
  • Cable/Internet Payments
  • In-Store Financing For Large Purchases
  • Unpaid Parking Tickets
  • If You Have Been Sued
  • Any Other Outstanding Debt
  • Mortgage Payments
  • Rent
  • Utilities (Gas, Phone, Water)
  • Car Payments
  • Unpaid Taxes
  • If You Have Declared Bankruptcy
  • Pay Day Loan Payments

Items in your credit report do not stay there forever, so even if you make credit mistakes when you are young, you might not need to suffer from them forever. Generally speaking, missed bill payments, collections, and most other items expire after 7 years. Bankruptcies and other civil judgments (like unpaid taxes) usually have a longer expiration, up to 10 years.

credit report
Source: Bank of America – Better Money Habits

How Does This Information Get In My Credit Report?

Generally speaking, the more a company uses credit reports as part of their decision to do business with you, the more likely they are to provide information that will be included in future reports.  The three credit reporting agencies get all of this information from your creditors, meaning everything in your report was given to them by someone you did business with (or sued you). Not every creditor supplies this information. For example, if you rent an apartment, the payments might not appear in your credit report unless your landlord makes a point to report it. This is sometimes unbalanced, since landlords might not always report timely payments (or even late payments), but almost certainly will report judgments and collections.

Your creditors report this information, which is linked to you through your Social Security Number and your address. The Social Security Number is the main way it is linked, but they address is also used to help prevent fraud and identity theft.

The Fair Credit Reporting Act

All of these details so far have been helpful for creditors and employers, but you also have some control over your credit report that comes from the Fair Credit Reporting Act. This is a law that gives all consumers certain rights to their credit report, along with restrictions on businesses on what they can include in the report (and how they can use that information).

Consumer Rights

The most fundamental right you have is that each person can get a free copy of their credit report from all 3 of the main agencies once per year. This is done through annualcreditreport.com. Once you have your credit report, you can also dispute any claims on it if you feel they are not legitimate. This means you can call the agency who provided the report and file a “dispute”. You also need to contact the lender who made the report to ask them to issue a correction if it is inaccurate. If the claim was because of an error, it will be removed from your report.

inspect

Even if a claim is not an error, you can contact the business who filed the claim and try to get it removed – if the person who files the claim withdraws it, it also is removed from your report. This is most often the case when people move out of their home without paying the final utility bills. If you contact the utility company and pay the outstanding bills (plus a fee), they may withdraw the claim entirely from your report. If you do have any such claims, it is always in your best interest to find them and take care of them as soon as possible, since it will impact your overall ability to obtain credit. For more information on disputing claims, visit http://consumer.ftc.gov.

If a potential employer wants to see your credit report, they need to get your written permission, only use it for the purposes of hiring you (and tell you what those exact purposes are), give you a copy of the report if they decide not to hire you (or fire you), and give you an opportunity to dispute any outstanding claims before they make their final decision.

If you get denied credit (or a job) because of the contents of your credit report, you also have the right to get a free copy for your own reference.

User Responsibilities

Businesses who order credit reports also have limits on how they use them. Generally speaking, a business who orders a credit report must:

  • Only use the report for deciding the terms of your financial agreement
  • Notify someone if something in their credit report affected their final decision
  • Tell the consumer which company they got the report from so the consumer can verify it.

Data Provider Responsibilities

People and businesses who provide the data that is included in credit reports also have their own responsibilities. The most important of which is to make sure all the information they report is accurate and up-to-date.

This means that if you file a dispute, the data provider has 30 days to verify that the claim is accurate, or else it is removed from your report until they do so. The data provider must also take some safeguards to prevent against data theft. This is why they require both a social security number and an address, so these items can be cross-referenced to check for identity theft.

The data providers also need to tell consumers before they file a claim and give them a chance to resolve it before it appears on their credit report.

Fixing Mistakes

Watch this great video from Bank of America showing how to find mistakes on your credit report, and get them corrected.

The Bottom Line

Your credit report is important, so don’t forget about it. You get one free look at your credit report each year (note – this report does NOT include your credit score), so you should take advantage of it. Some studies have shown that up to 30% of credit reports have some inaccurate information, and it is always in your best interest to have these resolved as soon as possible.

Mobile assignment preview
Updates

Assignments Have Gone Mobile!

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Mobile assignment previewHave you ever been working on a trading assignment on HowTheMarketWorks, only to be frustrated when you want to check your progress on a mobile device?

Not anymore!

Mobile Assignments Are Here

Whether you are trading on an Android tablet, Windows smartphone, or Apple Watch, you can monitor your assignment progress from anywhere!

As always, no software to download, app to install, or other restriction between you and your portfolio. Just log in to HowTheMarketWorks from any mobile device, and select “Assignments” from the main menu!

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Advanced, Advanced Trading Strategies, Charts and Patterns, Guest Posts, Technical Analysis

Trading Forex with Technical Indicators: A Guide

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When it comes to currency trading, there is a vast range of different strategies you can adopt to generate trading profits. For example, you could pursue an event-focused strategy, where you place trades just after large market-moving macroeconomic or political events. Alternatively, you could put on medium to long-term trades based on your view of countries’ economic fundamentals and how they will affect their currencies in the next 6-12 months. You could also become an expert in selected particular currency pairs and focus on your trading activities around those. On the other hand, you could also adopt a technical indicator-based strategy to trade currencies, which new research shows works particularly well in ‘hot’ markets. This is the strategy we will discuss in the article.

Popular technical indicators

There are a substantial amount of technical indicators focusing on different areas, such as volume, momentum, volatility, and trend following. However, it is important to note that using just one single indicator will not help you generate a trading profit. If you want to trade forex using chart analysis and technical indicators you must always combine complimenting indicators to generate trading signals.

blue chartPopular technical indicators include the Moving Averages, the MACD (Moving Average Convergence Divergence), the RSI (Relative Strength Index), OBV (On Balance Volume), Bollinger Bands, the Chaikin Oscillator, and the William %R. The list goes on as new indicators are created as the popularity of chart analysis tools rises. In fact, Mark Priest Head of Index & Equity Market Making at ETX Capital stated that “traders are increasingly demanding more sophisticated tools to trade forex and a large part of that is developing improved chart analysis tools to accommodate this demand.”

Combine indicators to create a trading strategy

As I mentioned above, if you want to trade forex using chart analysis the key is to combine complimentary technical indicators to generate strong trading signals. An example of a trading strategy that you could apply to your chosen currency pairs would be to combine the MACD (Moving Average Convergence Divergence), the RSI (Relative Strength Indicator) and Bollinger Bands.

Combining these three indicators you can gauge price movements based on moving averages, momentum, trend, and volatility. The way to turn these three indicators into a trading strategy is to trade when three out of the three indicators say buy (or sell) then you buy (or sell). This would be a strong signal. If two out of the three indicators give you a trade signal, you could also trade, but it would be a less strong trading signal. If only one or no indicator indicates you should execute a trade, you don’t trade.

Let’s look at how these indicators work in combination. We will use the EUR/USD as an example.

On the chart below we can see the Bollinger Bands overlaid on the candlestick chart for the EUR/USD and we can see the Relative Strength Index and the MACD below the price chart. The three indicators used actually show a buy signal for the EUR/USD on a medium term basis.

The Bollinger Bands, which are volatility bands placed above and below a moving average, show the price moving through the moving average from bottom to top during a low volatility phase (as indicated by the tight bands around the moving average). This would indicate a price increase. The RSI, which shows the momentum of the price movement, is close to pushing through the centerline indicating a change in trend towards a price rise.

white chart

Finally, the MACD shows three, albeit weakish, buy signals. Firstly, it shows a signal line crossover of the fast moving average through the slow moving average (the black line crosses through the red line). Secondly, it shows the trend line moving towards the zero line and, thirdly, it shows the divergence between the two signal lines increasing.

Judging by the trade signals from these three indicators we should be buying EUR/USD. However, the trade signals, especially from the MACD, are not as strong as they could be so it would now depend on your risk profile whether you would want to buy EUR/USD or hold off and wait for clearer trade signals from this strategy.

Furthermore, it is important to back test technical indicator-based trading strategies using historical data. That way you can check how accurate your chosen indicator combination is at determining profitable trade signals for your chosen currency pairs.

teach personal finance
Teacher Resources

TeachPersonalFinance.com: Resources for Educators

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teach personal financeTeachPersonalFinance.com is a new resource for teachers that opened in the last year. It is a collection of recommendations, resources, and suggestions from a veteran personal finance teacher with over 30 years of experience.

There is a “Personal Finance Toolkit” of recommended resources and supplements for teachers (including HowTheMarketWorks!), along with the best ways to add both free and paid supplements to any personal finance class.

There are also recommendations for setting up personal finance-focused after school programs, crash courses for teachers, textbook recommendations, and much more.

Click Here To Visit Teach Personal Finance

 

Updates

Real-Time Rankings Are Here!

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rankings

Frustrated with the delay between the updates in your portfolio value, and how fast you move on the rankings page?

Not Anymore!

Real Time Rankings on HowTheMarketWorks

In the past, we needed to check everyone’s account and revalue them in a loop to update the rankings page – a process that could take up to 2 hours! We sped this up a few months ago by only showing people who have placed at least 1 trade, but get ready for true high-speed competition!

The value showing on the rankings page now updates every time you place a trade, and your position with it. This means every buy, sell, short and cover can move you up or down in real time. Users who don’t log in or trade are still updated every hour.

This also means we are now including every participant in every contest in every ranking – a feature teachers have been dying for, so now it only takes a second to see who is – and who is not – correctly registered in your contests.

More new features coming soon!

economics
A - G, Economics

What is Economics?

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Definition

“Economics” is often called the Dismal Science – it studies the trade-offs between making choices. The purpose of economics is to look at the different incentives, assets, and choices facing people, businesses, schools, and governments, and see if there is any way to improve outcomes.

This is done by looking at how supply and demand are related throughout the economy, exploring different allocation methods, and investigating how to change (and what impacts there are from changing) the distribution of wealth.

Examining Costs and Benefits

The central problem in all economics is exploring different costs and benefits of choices made by everyone in an economy. This is not just the dollar cost of an action, but also what is being given up.

Every time a road is built in one place, that means there are not enough resources to build it somewhere else, so governments need to carefully plan construction to make sure each project gets the most possible benefit given all available alternatives. Likewise, if a school decides to build a new computer lab, they cannot use that money to hire a new teacher, do renovations on classrooms, or improve the school lunch menu.

Every choice made is a balancing act – trying to make sure the benefit you get from one action is greater than the benefit you would get from any other alternative.

Supply and Demand Throughout The Economy

At a bigger scale, when there are many people making the same kinds of decisions all at the same time, the economy as a whole also needs to balance everyone’s choices. This is how “Supply” and “Demand” appears, and how prices are determined.

For more examples on how prices are determined through Supply and Demand, read our full article on Supply and Demand Examples in the Stock Market.

Supply and Demand together are called “Market Forces“, large trends that result in one market outcome or another (such as the price of a good, and how much pollution is made in the production of those goods). When the supply and demand result in a particular number of goods to be produced and sold at a certain price, this is called a “Market Outcome“.

Market Outcomes

[econ]If you have tried to divide your HTMW cash between different stocks, you have tried resource allocation! It can be difficult to decide the best way to use limited resources.[/econ]Just like how different Market Forces can produce one Market Outcome, all of the different Market Outcomes in an economy will result in different “Resource Allocations“. Resource Allocations refers to everything from how many people work in coal mines, to how long (on average) students stay in school, to how much workers earn, and everything in between.

This means that all of the Market Outcomes are related – if a change in supply or demand cause the price of a good to go up, the people who make that good will earn more, and more people will start making it. This means that the income of those people goes up, which means the goods they like will have an increase in demand, and the cycle continues. The specific market outcome, and resource allocation, depends mostly on the total resources available (all raw materials, all available capital, and the entire work force number and skill level), previous market outcomes, and government policies.

Not Just Prices – Different Allocation Methods

Using “Prices” is just one of many possible ways to allocate the total resources available. Depending on what market outcome we are focused on, a different allocation method might be better or worse. Economists often try to determine what the best allocation method is for particular goods or services to try to improve market outcomes.

Market Prices

“Prices” let individuals measure their own individual level of demand against a prevailing market price – how much they have of a good or service depends on how much others are willing to make it, and how much everyone else values it.

Auctions

Auctions are commonly used when there is a large imbalance between the number of potential buyers and sellers of a good or service, and the quantity available is limited. Economists spend a lot of time analyzing auction systems

For sellers, individual goods or services are left for potential buyers to “bid” on. This means that the person who values the good or service the most (in this case, who is able to pay the most) will get the good, and the seller gets the best possible price.

Auctions can also go in the other direction – a buyer could ask for sellers to “bid” to sell their good at a particular price, and the buyer will take the offer of the seller who can offer the lowest price. This is generally the case when a government hires a contractor to build a road – many competing companies provide “bids”, and the government makes its choice based on the bid price and the expected quality of the work.

Entitlements

Entitlements is a different allocation method – everyone gets a certain amount of a good or service, which is then paid for by taxes. This allocation method is generally used for “Essentials”, or otherwise things where it is impossible to charge someone based on their usage. The availability of public parks, drinking water, and clean air all use an “Entitlement” distribution system. Certain levels of basic housing and food is also generally provided as an Entitlement.

Price Controls

Even in a normal supply and demand system, price controls can be put in place by the government if a society is not satisfied with the pure market price allocation. This can be things like adding extra taxes to increase the price, giving subsidies to decrease the price, or telling sellers they can’t sell a good or service above or below certain prices.

Changing The Distribution Of Wealth

The distribution of wealth is more complicated than just how much the top 1% earn compared to the bottom 99% – it also examines how wealth is distributed between industries in an economy, how much different skill levels are worth relative to others, how taxes are paid and collected, and much more. When economists look at changes in the distribution of wealth, it is usually by making subtle changes to these smaller factors which add up to changes on a bigger scale, rather than trying to find a single way to transfer wealth from the “Rich” to the “Poor”.

Taxes and Transfers

[econ]These are also called “Robin Hood Taxes”. There is a huge amount of debate as to how much they help – or hurt – the poor in the long run.[/econ]Taxes and Transfers refers to the last point – taking money directly from the rich through taxes, and refunding that money directly to the poor through a subsidy or other transfer. This is the most blunt way to change the distribution of wealth, but it also has the largest implication for the total market allocation in an economy.

For example, the Rich use most of their income for investment, while the Poor use almost all of it for direct consumption. This is because the rich generally don’t get much benefit out of an extra $100 worth of groceries in a month, but that might be a very large boost in living standards for the poor.

By giving a single rich person an extra $10,000 in taxes, and using that revenue to give $100 directly to 100 people, those 100 people will almost certainly be made much better off than the one rich person was made worse off. However, that means that $10,000 would not be invested to help new companies grow, which in turn means fewer jobs are created to help build new wealth. A central problem of economics is trying to balance the consumption and benefit of people today against taking measures to help more growth for the future.

Government Spending

[econ]Economists use interest rates to try to compare present benefits against future benefits. For example, you might give up $100 today for $120 dollars a year from now, but maybe $101 is not worth the wait.[/econ] Economists also try to influence the distribution of wealth through government spending. This includes things choosing to use government money between giving grants to start-up businesses to create new jobs, or using that money to give scholarships to students to get a college education. Both outcomes are directed towards growth, but it is challenging to determine how to balance different spending alternatives to encourage different kinds of growth.

Another example comes from direct government spending – some countries spend a large amount of money on biotechnology research to build a new sector of their economy, while other countries spend more on building more public housing connected to public transit, to try to help the poor get better jobs in economic sectors that already exist.

Every part of economics is measuring these trade-offs – the benefits and costs of one choice versus another.