The Motley Fool: Credit score cautions

Q. Will it really hurt my credit score if I close some credit card accounts? — P.S., Anchorage, Alaska

A. Sorry, but yes. The FICO score is among the most commonly used, and about 30% of your FICO score is tied to how much you owe relative to your available credit.

If you have five credit cards with a total credit limit of $50,000 and you owe $25,000, you’re using 50% of your available credit. But if you close two accounts and your total credit limit drops to $30,000, you’re suddenly using most of your available credit, and a bank might not be eager to lend you more.

Meanwhile, 15% of your FICO score is based on the length of your credit history. If you close out cards that you’ve held for many years, that can lower the average age of your accounts, which also lowers your score.

Q. What’s a shell company? — A.D., Conway, Arkansas

A. It’s a generally legal structure that can have a legitimate purpose, such as when it’s a special purpose acquisition company (SPAC) formed to acquire another company.

But shell corporations have a shady reputation. The Corporate Finance Institute minces no words: “A shell corporation is a business that is formed that has no actual business operations. They are mostly created for money laundering. … They do not employ anyone or provide any services. Shell corporations are created in tax havens to avoid paying taxes and to hide the identity of the owner. If an individual is involved in an illegal activity, a shell corporation can be a platform to hide money.”

Shell companies are often established in countries with very business-friendly laws or low tax rates (such as the Cayman Islands or Switzerland).

To be an effective investor, you’ll need to use a little math from time to time. Here are a few examples of investing-related math concepts to understand.

First, imagine buying into the Home Surgery Kits Co. (ticker: OUCHH) at $50 per share and seeing it rise to $100. The share price doubled, and some refer to that as a “two-bagger” gain. Note, though, that when something doubles, it grows by 100%, not 200%. A 200% gain reflects tripling, and a 300% gain quadrupling.

Now, remember that when OUCHH rose by $50 to $100 per share, that was a 100% gain. But if it rises another $50 to $150, that’s a 50% gain — because $50 is 50% of $100. Another $50 gain, from $150 to $200, would be a 33% gain, as $50 is 33% of $150.

Here’s some more math that might surprise you: Imagine that the Two-Legged Stool Co. (ticker: OOOPS) falls in value from $80 to $40. That’s a 50% drop — the stock price was cut in half. You might assume that it needs to rise by 50% for you to break even, but no: Once it falls by 50%, it needs to grow by 100% to get back to the starting price. Once it’s at $40, it needs to grow by another $40 to reach $80. If the stock drops 75%, from $80 to $20, it will need to quadruple, gaining 300%, to get back to $80. Even a more modest 20% drop in value will require a 25% gain to recover. As the drop gets bigger, the required return for a recovery gets much bigger. That’s good to understand when you’re waiting for recoveries. If you no longer have much confidence in a stock, don’t wait for a recovery — move what’s left into an investment you do have faith in.

Remember to focus on how you expect a stock to perform in the future, too, without thinking too much about how much it has risen or fallen. What matters now is how it’s likely to do from this moment on.

One of my regrettable investments happened decades ago. I got tired of watching my Ginnie Mae mutual fund drop from well over $15 per share to $14.60. Against some advice, I sold my shares and bought a certificate of deposit paying 3.55% in interest. And then the Ginnie Mae fund started rising again. — P.B., Dallas

The Fool responds: Investments do often fluctuate in value. If you were looking for some that would grow in value rapidly, like some stocks, those investments wouldn’t.

Ginnie Mae (short for the Government National Mortgage Association, or GNMA) is wholly owned by the U.S. government, with the mission of helping Americans buy homes. A Ginnie Mae mutual fund therefore offers access to securities backed by the U.S. government, making them quite safe.

Of course, safer investments tend to offer lower returns. Consider the Vanguard GNMA Fund, about which Vanguard says: “The fund primarily invests in GNMA securities, which are backed by the full faith and credit of the U.S. government and typically offer a higher yield than U.S. Treasuries.” Since inception in 1980, the fund has averaged annual gains of more than 6%, but over the past decade, gains have averaged less than 1%.

Ginnie Mae funds aren’t likely to soar in value, but they do offer income; the Vanguard fund recently yielded a solid 3.4%, for example. Income from certificates of deposit, meanwhile, simply reflects prevailing interest rates.

I trace my roots back to 1922, when 25 U.S. Army officers, meeting in San Antonio, agreed to insure each other’s vehicles. A year later, Navy and Marine Corps officers were added. By 1931, I had 30,000 members. By 1946, with new automated office machines, I was a technology leader. I launched a savings bank in 1983 and welcomed enlisted personnel in 1996. In 2009, all those who served — and their families — became eligible to join me. My membership tops 13 million people now, and I employ more than 38,000 worldwide. Who am I?

I trace my roots back to 1886, when a traveling book salesman started recruiting women to sell fragrances he mixed. My first name was the California Perfume Company, and my current name debuted in 1929. I began selling jewelry in 1971. Thanks to my catalogs, in 2005 I was the second-largest publisher in the U.S. (after TV Guide). I’m a longtime champion of gender equality and women’s well-being and have donated more than $1 billion to women’s causes. Today I’m owned by the Brazilian business Natura & Co, which also owns The Body Shop. Who am I? (Answer: Avon)

Dividend stocks have historically been excellent investments. Over the last 50 years, dividend-paying stocks in the S&P 500 have outperformed that broad market index: According to data from Ned Davis Research and Hartford Funds, they’ve averaged roughly 9.2% annually in total return, compared to 7.7% for an equal-weighted S&P 500 index fund.

Meet Enbridge (NYSE: ENB), a Canadian energy infrastructure giant that has delivered 28 straight years of dividend growth and has plenty of fuel to keep that streak going. Its dividend recently yielded a whopping 7.6%.

Enbridge is methodically transitioning its business to lower-carbon energy by using some of the cash flows from its fossil fuels businesses to invest in infrastructure to support a clean energy future — such as European wind energy farms and a renewable natural gas (biogas) platform. That’s making its dividend more sustainable, while ensuring it has the power to continue increasing its payout.

CEO Greg Ebel recently stated: “Our business is stable, and we remain committed to delivering predictable cash flows. The balance sheet is strong and remains a key priority.”

Enbridge isn’t likely to be a rapid grower, but it’s likely to keep growing — and raising its dividend, too. It should appeal to those seeking both income and upside potential. (The Motley Fool owns shares of and has recommended Enbridge.)