How I'm thinking about money these days

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Personal finance and travel hacking in the United States are almost always linked through the intermediary of credit cards, which unlike in most civilized countries are allowed to charge lightly-regulated fees which they rebate to customers in the form of cash, cash-equivalents, or alternative loyalty currencies.

These schemes are usually devised with the concept of “stickiness” in mind: you can offer almost anything to customers in the short term if it’s so hard to switch financial providers that they continue to give you business for years or decades after the initial “acquisition cost” has vanished off your balance sheet.

What travel hackers know is that nothing is as sticky as people think it is, so in fact they don’t need to change their spending habits at all in order to trigger many of the benefits financial providers think will lock in their business in perpetuity.

With all that said, here’s how I’m thinking about investment options these days, keeping in mind just how low those barriers really are in practice.

Rewards checking accounts

Rewards checking accounts typically offer above-market interest rates on balances up to a certain limit, as long as direct deposit and monthly transaction requirements are met. I usually search for the highest-earning accounts on depositaccounts.com, but here are the three I’m currently using:

I primarily use Consumers Credit Union as a current account to manage payments and for ATM withdrawals, since it has a lower limit on the maximum interest rate but also rebates third-party ATM fees; I don’t mind if my balance falls below $10,000 on any given day, in other words.

Two other options I’ve looked at closely are the FitnessBank and Orion Federal Credit Union accounts, which offer 6% APY on up to $25,000 and $10,000, respectively. The FitnessBank requirement of linking a step-tracking device and walking an average of 10,000 steps per day feels too fidgety for me, although if you’re already tracking your steps and know you’ll easily meet the requirement then it seems like a fine option. The Orion FCU requirement for both $500 in deposits and $500 in debit card purchases would be easy to automate, but with such a low limit on the 6% APY balance it hasn’t been a priority for me to set up an account there yet.

Round-up savings

Blog subscribers knows about my long-standing affection for round-up savings accounts. Unfortunately, my 10% APY round-up savings account is no longer available to new members; in fact, the credit union that offered it no longer exists, although I was grandfathered into the old account structure during the aquisition.

I have experimented at length with this account, and as far as I can tell, I can make exactly 29 deposits per day in round-up transactions, which I plan to until the account reaches the $250,000 insurance limit or is closed for deliberate and flagrant abuse — whichever comes first.

Peer-to-peer installment lending

Peer-to-peer lending emerged in the 2000’s during the first wave of what today we’d call “distributed finance.” The idea was that instead of borrowing from the big banks you’d borrow from your fellow citizens; instead of putting your money in the anonymous stock market or a local savings account, you’d invest in individual home improvement projects or weddings or hospital bills. At the time, the two most prominent platforms were Lending Club and Prosper, joined by a few minor platforms like Fundrise and Kickfurther (and, I’m sure, many others I’ve forgotten or never heard about).

Lending Club and Fundrise have both pivoted into more straightforward banking and investment operations, but much to my surprise, Prosper is still chugging along letting you buy shares of individual promissory notes in increments as low as $25.

Unlike the high-interest accounts described above, lending through sites like Prosper comes with risk. Even worse, it comes with unknown risk. At the individual note level, there’s individual risk, but this is negligible: if you buy thousands of $25 loans, some of them will default simply because you’re exposed to the individual life histories of thousands of people, and shit happens even to healthy, employed, home-owning borrowers.

At the institutional level, Prosper’s credit-rating system might be fundamentally flawed: you might expect a 5% default rate from “AA” borrowers (Prosper’s highest rating), but the true number is 15% because some unaccounted-for variable skewed Prosper’s ratings too high.

Your borrowers may be also be exposed to an economy-wide risk, like a nationwide fall in housing prices, or a shooting war with a rival power, which eliminates the advantages of diversification: all of your borrowers might default at once if they’re drafted to go save Taiwan, whether they live in California or Oklahoma.

But these peer-to-peer platform loans have another risk, the financial solvency of the platform itself. In the case of Prosper, you are not actually lending any money to borrowers. You are buying a repayment-contingent note from Prosper, which originates and owns the actual loan to the borrower. As long as the borrower makes their payments, and Prosper pays its bills, then Prosper will transmit the borrower’s payments to the owners of those repayment-contingent notes. But if Prosper itself files for bankruptcy, the value of the loans will be assets of the bankruptcy estate, and lenders will be left with unsecured claims against that estate.

I personally used to consider this the main risk of lending through Prosper. I thought people would happily lend through them until the first economic calamity came along, then Prosper would be wiped out, the notes would be worthless, and the whole peer-to-peer lending experiment would come to an end.

That isn’t what ended up happening, and Prosper has survived and continued to both issue loans to borrowers and sell notes to investors. The website remains very primitive and it still takes me several clicks to find the simplest settings, so automating investments is essential.

I’ve found the easiest way to invest with the platform is not to use their “Auto Invest” feature, but the confusingly- and similarly-named “Recurring Order” function. The recurring order function allows you to specify loan characteristics to filter for (I chose “AA” and “A” graded loans, with yields above 10% APY) and then as those loans are added to the platform it will automatically buy them in the increment you specify (I chose the minimum, $25).

The platform seems to have a lot of loans, so the recurring order function hasn’t had any trouble finding qualifying loans for me to buy, but at some volume there presumably is a trade-off between loan quality, interest rate, and purchase size: if you are fixed on quality and rate, then you might have to buy more than $25 per loan in order to meet your demand for volume. I doubt I will ever hit that point and I don’t spend any time worrying about it.

Stocks, flows, risk, and compounding discipline

To the best of my knowledge, I coined the term “compounding discipline” to refer to the need to make sure that if you rely on your interest compounding over time, then you have to put in the work to make sure it actually is.

A $25,000 balance at Andrews FCU will earn about $120 per month at the Kasasa Cash rate of 6% APY. But a balance of $25,120 will also earn about $120 per month, because the last $120 earns only 0.5% APY. You can earn $120 per month forever, but if you want your savings to compound, then you have to exercise compounding discipline and move that $120 each month into the next vehicle you have available.

The way I’ve formalized this discipline is to split my savings into two broad categories: I invest bigger and faster in safe assets and lower and slower in risky assets; the returns generated by the safe assets pay for the investments in the risky assets. I’ve used the example of Prosper peer-to-peer lending, but I don’t think they’re better or worse or more or less risky than bitcoin or real estate or reselling on Amazon. If one of those is more attractive then you should do it instead. The point is simply to make sure you have somewhere to put the next interest payment so your assets keep compounding at the right mix of risk and return for your situation.

Conclusion

Sharp readers may have noticed I’ve left out the only savings vehicles most Americans have: their individual retirement accounts and workplace-based 401(k) and 403(b) savings accounts. I’ve also ignored the tax implications of the various investment vehicles available. The omission is deliberate: I don’t think about these at all.

If you maximize your annual contribution to your IRA and workplace retirement accounts, and select a low-cost, stock-heavy mutual fund, and make sure your dividends and capital gains are set to reinvest, then you’ll die a millionaire. There’s nothing to think about and it’s not especially interesting to talk about. Once you’ve got all the settings configured right in your payroll software (not always easy!) it shouldn’t take more than 15 minutes a year to make sure everything’s on track.