Budgeting Basics
You’re creating a zero-based budget and want to save for a vacation in 6 months that will cost $1,200. Your monthly income is $2,500, and your fixed and necessary variable expenses total $2,200.
How much do you need to adjust your budget to hit your vacation goal without using credit, and what budgeting strategy would help you do that?
You need to save $1,200 ÷ 6 = $200 per month, which means you must reduce your spending from $2,200 to $2,300 - $200 = $2,100.
A good strategy is the “pay yourself first” approach automatically setting aside the $200 in a separate savings account each month before spending anything else.
Explain the difference between a Roth IRA and a traditional IRA in terms of tax benefits, and under what financial circumstances someone might prefer a Roth IRA over a traditional IRA.
A Roth IRA is funded with after-tax money, so withdrawals in retirement are tax-free. A traditional IRA uses pre-tax money, reducing taxable income now, but withdrawals are taxed later.
Someone expecting to be in a higher tax bracket in retirement might prefer a Roth IRA, locking in today’s lower tax rate.
You have three credit cards with balances of $1,500 (22% APR), $800 (18% APR), and $3,000 (15% APR). You can put $500 per month toward paying them off.
Using the avalanche method, what’s the order you should pay them off, and why?
With the avalanche method, you pay off the debt with the highest interest rate first while making minimum payments on the others.
So the order is:
$1,500 at 22% APR
$800 at 18% APR
$3,000 at 15% APR
This saves the most money on interest in the long run.
A freelancer earns $60,000 a year but has no taxes withheld from their income. They qualify for $10,000 in business expense deductions.
If the effective tax rate is 20%, how much should they set aside for taxes, and what tax form must they file quarterly?
Taxable income = $60,000 - $10,000 = $50,000
Estimated tax owed = 20% of $50,000 = $10,000
They should set aside $10,000, and file Form 1040-ES quarterly for estimated taxes.
Define liquidity in financial terms, and explain why having highly liquid assets in an emergency fund is more important than assets with higher returns but lower liquidity.
Liquidity is how quickly and easily an asset can be converted into cash without losing value.
For emergencies, high liquidity is critical because you may need funds immediately. Assets like savings accounts or cash are ideal; assets like real estate or stocks may take time to sell and could lose value.