Ten Basic Personal Finance FAQs
What is a credit score? What is good debt? What is an IRA? What type of debt is OK? These are some personal finance questions that come to have crossed our minds at some point in our life. Some are basic terms that remain unchanged. However, others depend on the market and its changing trends and norms.
We bring you answers to ten of the most basic personal finance questions.
Answers to Ten Personal finance Questions
Finance is a complicated landscape for most of us, especially youngsters who have just started taking care of their own finances and budgets. They have to learn new ropes on how to start good and lay a solid financial foundation for their future. So we must all familiarize ourselves with these basic FAQs of the finance industry.
WHAT IS A CREDIT SCORE?
A credit score is a rating system that creditors can use to assess any borrower’s risk while making a decision to lend them any money. The credit scores used mostly in the market by creditors is from FICO. Your credit rating is defined via various parameters such as the amount of debt you already have, whether your utility bills are paid on time, the number of credits cards you already have, and if you have any outstanding or unpaid bills etc.
The credit score affects almost all financial decisions made by creditors or lenders, and its range falls within the range of 300 to 850. Whether you want to buy a car or rent a house, opening a new line of credit and getting a loan or mortgage will require a review of your credit score by all lending companies, banks and private investors.
WHAT IS A 401K?
A 401K is a retirement plan that is offered to all employees by their employer. It allows the employees to take advantage of their paychecks and put aside an amount for their retirement. However, it is up to the employee to decide how much money he wants to put aside every month. The company will usually invest this money on your behalf into various bonds and stocks so that your saved and invested money can help create more money.
You get to choose your investments, which can be direct investment, or you may get a chance to pick a mix of different investment opportunities. However, it is dependent on how much risk you are willing to take and feel comfortable with. The investment money that is contributed or deducted for your 401K gets taken from your monthly paycheck before taxes; it means it helps reduce your taxable income.
WHAT IS AN IRA?
IRS stands for “Individual Retirement Account” or “Individual Retirement Arrangement.” It is a place to put or save your money away for retirement, which will be invested on your behalf. Your IRA can be utilized along with 401K in a combination, or it can be used as an alternative to 401K if your company does not offer the option of 401K. Somewhat similar to 401k, your money is invested across a variety of bonds and stock packages. Of course, you get to choose the bonds and stocks, but the primary purpose is to grow your money over time.
However, IRAs come with contribution limits. For example, in 2019, you could put a total of $6,000 annually into your IRA with an exception to put an additional $1,000 if you are over the age of 50.
In traditional IRAs, the money usually put into people’s traditional IRA account is tax-deferred. It means you only pay taxes on your IRA amount when you withdraw it. It is nothing like a Roth IRA, meaning no matter the amount of money you make, a Traditional IRA will allow you to make contributions to a maximum applicable limit.
WHAT DOES INVESTING MEAN?
Investing actually means pouring your money into a project or a venture – that can be a form of commodities, companies or real estate. The idea is to make more money from your existing money. The easiest way to get into investing is, to begin with, one’s retirement account. However, remember that there are various ways to invest, and contrary to the common misconception or opinion held by the masses, you do not need tons of money to start investing.
WHAT IS ‘GOOD DEBT’?
The answer to what is good debt depends on your circumstances. You can ask some personal or general questions to yourself in order to assess what kind of debt is worth it. However, it is totally up to you to determine whether any specific debt is good or bad for you.
HOW MUCH SHOULD I PUT IN AN EMERGENCY FUND?
It all depends on how much you think about the cost of your life. There is neither a hard-and-fast rule nor a specific number that can define one formula that applies to all. The best and safest way is to have at least three to six months of your total living expenses such as food, rent, monthly bills and transportation saved aside for emergencies.
This way, if you come across a situation where you have lost a job or fall on hard times for any reason, you can continue to meet your minimum financial commitments and maintain a lifestyle without stacking on any additional or substantial debt.
WHAT IS A BUDGET? DO I NEED ONE?
A budget is just a basic plan or understanding of how much you make vs. how much money you spend. And Yes – it is absolutely important to budget; however, it comments in various forms. While you can be rigid about what your expenses are and fix strict allowance, you can also be relaxed in some aspects. Either way, it helps you keep control over your money and expenditure.
HOW MUCH DO I NEED FOR RETIREMENT?
The answer to this question depends on multiple variables, such as how old you are, how much you have already saved in your retirement account (if you have saved any). What are your annual income and the level of comfort you want when you retire? However, there are tons of retirement calculation tools out there to help you determine the approximate amount you need to consider retirement.
HOW MANY CREDIT CARDS SHOULD I HAVE?
Well, it is totally up to you and what your credit scores and ratings are. It will also depend on how responsible you have been with your existing credit cards? Where having an assortment of credit cards can help you strengthen your credit scores, it can also be asking for trouble.
If you find yourself neck-deep into debt from multiple credit cards, then do not think about opening another one. However, if you are a great money organizer and knows how to handle your credit and finances and have been great with your cards so far and looking for a better deal, then go for the one with better rewards.
WHAT IS APR? HOW DO INTEREST RATES WORK?
APR stands for “Annual Percentage Rate.” It usually comes into play if you are unable to pay off your monthly credit card bills. APR is generally an interest rate a lender charges on any owed amount that you did not pay clear in full.