A lot of people, even relatively experienced investors, don’t know what a financial calculator is, what it does, and why using one is a good idea.
Simply put, a financial calculator is a specialized calculator that helps you to solve certain types of problems relating to money (thus the term financial calculator).
Most financial calculators can do lots of things including statistical analyses, merchant-related calculations (cost/price/markup/margin), and others, but the most common type of calculation they’re used for is called a ‘Time-Value of Money’, or ‘TVM’ calculation.
Most people are familiar with simple TVM scenarios, even if they don’t know them by that name. Any kind of loan with regular payments is a simple TVM scenario, such as a car loan, a mortgage, or a student loan. A financial calculator can also handle more complicated TVM scenarios, in which the payment amount changes over time, but this will focus on the simple scenarios, which are the most common type of calculation people do with financial calculators.
In every TVM scenario, there are five major pieces of information:
- How much time passes from the beginning to the end
- What is the interest rate of the loan or the rate of return of the investment
- How much money changes hands at the beginning
- How much money changes hands at the end
- How much money changes hands every month* between the beginning and the end
What the financial calculator does for you is fairly simple: If you know any four of these pieces of information, it will tell you the fifth.
This means, for example, that you can find out how much money is owed on a mortgage after a certain number of payments has been made. The four pieces of information you would need are: 1) how many payments have been made (i.e. how much time has passed), 2) the interest rate, 3) the original amount of th eloan (how much money changed hands at the beginning), and 4) the monthly payment. Once you have those 4, you can calculate the 5th which is the money still owed after those certain number of payments have been made.
… or you can find what the payment on a car loan would be.
… or you can find out what rate of return you’re getting on an investment you make.
… and so on.
This is just the tip of a very large iceberg, but it’s really the first thing you need to know as you set out to evaluate investments with a financial calculator.
* Most investments are evaluated with monthly payments, but the financial calculator can handle annual, quarterly, bi-weekly, or other types of periods