Category Understanding the Mathematics of Personal Finance

DEFERRED TAXATION SAVINGS

The U. S. government offers several different tax deferral schemes for workers to use to build their “nest egg.” There are 401K plans, individual retirement accounts (IRAs), Roth IRAs, self-employed pension (SEP) IRAs, and so on. Each of these plans serves a different purpose/customer base, and each has its own rules about taxation, contribution, withdrawal, and so on. Many books have been written on this topic, and I couldn’t possibly do it justice in a few pages. What I will do in the fol­lowing pages is to walk through a hypothetical saving for a retirement example and show the potential value of a tax-deferred savings plan. I will be using my online spreadsheet Ch9Taxation. xls.

Г ’ rl begin using the Nest Egg tab on the spreadsheet...

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CREDIT CARD STATEMENTS

Each credit card company’s monthly credit card statement has a unique layout, so I can’t specifically explain your statement to you. Statements are similar, however, in having the following sections:

• a tear-off piece showing your name and address, the card company’s name and address, all or part of your account number, your account balance, the payment due date, and possibly the minimum payment due. This piece is returned to the card company with your payment;

• an account summary showing your previous balance, payments and credits during the previous month, finance charges for the previous month, and your new balance;

• a transaction summary detailing your purchases, cash advances, and payments for the month;

• a finance charge summary showing the different rates charged and...

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Annuities

A single clear, concise, definition of annuity is impossible to create, because there are two principal financial vehicles called annuities and an untold number of varia­tions and combinations within each of these two vehicle categories. A fixed annuity is considered in the United States to be a savings scheme with certain tax advantages and is regulated by the IRS. A variable annuity is considered in the United States to be an investment scheme, again with certain tax advantages, and is regulated by the U. S. Securities and Exchange Commission (SEC).

An annuity is a contract between you and an insurance company by which you give the insurance company money either in a lump sum or over time (the accumula­tion period) and then it starts sending you periodic payments...

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THE EFFECT OF INTEREST RATES ON PRESENT VALUE CALCULATIONS

The present value of amounts of money in the future, as the above calculations show, depends on the available interest rate. If interest rates are very low, then the present value looks essentially like the simple sum of all the payments. As interest rates get higher, payments far in the future become pretty worthless.

Table 7.3 shows the total present value of a 24 monthly payment account with $100 being deposited each month for different interest rates. As you can see from the table, the present value falls as the rate of interest increases.

One factor that’s very easy to model on a spreadsheet but very difficult to predict in advance is just what interest rates will be a few years from now...

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OPTIONS

Many types of “futures” products are available for the aggressive investor. I’m going to explain just one of them: options. A stock option gives the purchaser the right, but not the obligation, to buy (a “call”) or to sell (a “put”) a certain number of shares of a given stock for a preset price at any time up until the expiration date of the option.

That was a mouthful. Let me break it down, using the option to buy, or call, for an example. Widgetarama stock is selling at $28 (per sharei ) and I believe it will increase significantly in price over the next 90 days. I find that I can buy calls on Widgetarama stock for $4.00 with a strike price of $26 and an expiration date of 90 days from now...

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REGULAR SAVINGS

The other side of making regular payments to amortize a loan is making regular payments into a savings account so as to build up resources for your retirement, for a child’s college education, and so on.

Suppose you could start saving $350 a month regularly. Savings bank interest rates will probably vary, but just to get an idea of what will happen, assume that they

Table 3.10 A Savings Plan Spreadsheet Example

Start Month:

7

Start Year:

2005

Nr Mnthly Pmts

360

Rate

4.50%

Monthly Pmt

$350.00

Pmt Nr

Mnth

Year

Balance ($)

Payment ($)

Interest ($)

Tot Int/Year ($)

1

7

2005

350.00

350.00

0.00

0.00

2

8

2005

701.31

350.00

1.31

1.31

3

9

2005

1,053.94

350.00

2.63

3.94

4

10

2005

1,407.89

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