Credit Score: The Factors Affecting It

Credit scores are an important piece of your financial life. They affect the interest rate you pay on a car loan, home mortgage, and whether or not you are approved for a credit card.

Your particular score will depend on the credit bureau providing the FICO score. Equifax, Experian, and TransUnion are the three credit bureaus and they each have their own formula for calculating your score. Your score will range from a low of 300 to a high of 850 with a higher number being better.

The reason credit scores are tabulated is to predict your future credit success or failure on that specific date. Your score is not dependent on your income, employment or your assets. The bureau's look at the amount you owe on your most recent statements, making your available credit the most important factor. Having a lot of credit cards is not detrimental to your credit score as long as the total balance on all credit cards is low. In fact, about 30% of your FICO score is based on the total debt outstanding.

The most important factor in determining your score is timely payments. One late payment will stay on your credit report for up to one year, very late payments stay for two or three years, and collections and bankruptcies can last up to seven years.

Some people worry about opening checking accounts or looking at cars because they think their credit scores will drop. Some may look into your credit history so it is better to ask if they will do so and proceed from there. If you are looking for a new car or buying a house and have multiple inquiries, as long as they happen within a few weeks of each other, they will only count as one credit check. These credit checks will stay on your record for up to a year.

Index Funds Win Again

In October, Morningstar Inc. released a study between actively managed mutual funds and passively managed (index) mutual funds. The study found that active management loses on a risk adjusted basis.

Here are the details: Over the past three years, while nearly half of actively managed funds beat their benchmark index, only 37% beat the benchmark on a risk, size, and style basis. The results are similar when covering five and ten year returns.

Explanation: Managers take on greater risks with the purchases they make. Some risk comes in the form of buying stocks that are speculative or holding concentrated positions in a stock. When a manager takes on those risks the investor should receive a greater return. This is how bonds work where lower rated bonds with a higher risk of default pay a higher interest rate than high grade bonds with low risk of default. The study showed that investors are not receiving a higher return for the added risks on their money.

Another part of the Morningstar study emphasizes the benefit of using passively managed index funds. In absolute returns, over the past five years only two out of nine Morningstar style boxes had more than 50% of active managers beat their indexes.