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Speaking Mathanese: The Annual Percentage Rate

What's your greatest fear about managing your finances? If you answered "math," you're not alone. Many folks fear they're not as smart as a fifth-grader about basic calculations behind everyday money moves. (Excellent ratings for Fox's TV show based around that very fear may prove them right.)

Fear no more. This "Motley Fool Mathanese" series will aim to tackle financial math myths and deconstruct the computations that make the biggest difference to your bottom line. In no time, you'll be smarter than that 11-year-old smart aleck down the street.

But first ...

... It's mathanese!
No, that's not a real word. I made it up when Foolish colleague and Motley Fool Green Light co-advisor Dayana Yochim and I were attending a Fool seminar about a year ago.

When it came time to calculate return on invested capital -- as complex of an equation as you'll find in the science of stock-picking -- I raised my hand. The exchange went something like this:

Me: "Um, that sounds like mathanese. Can you explain it again, please?"

Instructor: "Who are you?"

Actually, it wasn't quite like that. Just know that Dayana and I shared a good laugh. Like you, neither of us is great at math. We don't know much more than the basics. But fortunately, that's all that any of us needs to live a life of wealth.

The myth
Which brings me to this week's topic: the annual percentage rate.

How many of you think that's the annual interest rate you pay on debt? Correct! You're pretty good at this.

Now, how many of you think the APR is computed annually? Also correct! Creditors don't want to wait a year to collect interest. They prefer monthly payments.

Now, how many of you think the APR is computed monthly? Uh-oh. Maybe we should talk about return on invested capital? Nah, never mind.

The math
Creditors of all stripes, especially card issuers such as American Express (NYSE: AXP  ) , Citigroup (NYSE: C  ) , and MasterCard (NYSE: MA  ) , want to compound interest daily.

Take a look at the bottom of your last credit card statement. See the APR? Great! Now, look to the left. Chances are you'll see a line item called "periodic rate." A periodic rate is creditor-speak for "please pay us interest on this schedule."

Remember, most credit cards want their cut daily. The same goes for lenders like Wells Fargo (NYSE: WFC  ) and Washington Mutual (NYSE: WM  ) . How do you arrive at the daily rate? Glad you asked. Here's the math:

APR / 365

So if you pay 12% annually for a Citibank card on which you carry a $10,000 balance, it'd be simple to think you'd owe 1% of the total, or $100, in interest in May. But since the interest compounds daily -- at a rate of 12% / 365, or 0.0328767% -- chances are you'll owe a few dollars more than that. Or more precisely, by my math: $102.42.

Questions? Submit them here. Otherwise, I'll see you next week for another lesson in mathanese.

For more great money ideas, get 30 days of free access to Motley Fool Green Lightright now. There's no obligation to subscribe.

MasterCard is an Inside Value pick. Washington Mutual is an Income Investor recommendation.

Fool contributor Tim Beyers writes weekly about personal-finance and investing basics. Have a Foolish money tip? Tell him. Tim didn't own shares in any of the companies mentioned in this article at the time of publication. Tim's portfolio holdings can be found at his Fool profile. His thoughts on personal finance, Foolishness, and investing in general may be found in his blog. Forget Kermit the Frog; the Motley Fool's disclosure policy says it's easy being green.


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Tim Beyers
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Tim Beyers first began writing for the Fool in 2003. Today, he's an analyst for Motley Fool Rule Breakers and Motley Fool Supernova. At Fool.com, he covers disruptive ideas in technology and entertainment, though you'll most often find him writing and talking about the business of comics. Find him online at timbeyers.me or send email to tbeyers@fool.com. For more insights, follow Tim on Google+ and Twitter.

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10/23/2014 4:00 PM
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