2015-05-21

Stretch Your Emergency Fund with Puddle

Personal finance isn't just about building up net worth—it's also about making money available when you need it.  Just like a business, you have to worry about your balance sheet and your cashflow statement.  Having a lot of money locked up in investments isn't helpful when you need cash to cover expenses today.

This is the logic behind the emergency fund—hold a couple months' expenses in fairly liquid form, like a savings account or US Treasury I Bonds, to smooth over unexpected changes in expenses and income.  Establishing an emergency fund should be your first act before considering any other kind of investing.

How much money should you keep in an accessible place?  To make that decision, you have to balance two opposing forces: the risk and cost of having too little, and the cost of not investing in something with a better return.
  1. If your emergency fund falls short, borrowing money even for a short time can be very expensive.  Just watch John Oliver's bit on predatory lending to see how bad payday loan interest rates can be:



    As discussed in this video and a LOT of other media (1,2,3), payday loans frequently drag the working poor into a vicious cycle of high-interest borrowing.  To combat this, ideally your emergency fund would be as large as possible.

  2. The liquid assets in an emergency fund have generally poor returns compared to other investments.  You lose out on the gains you could have made elsewhere, and this is the opportunity cost you pay for that liquidity.  To combat this, ideally your emergency fund would be as small as possible.
So there is the tradeoff: a small emergency fund is inexpensive to maintain but may often fall short; a large emergency fund is expensive to maintain, and no emergency fund is big enough to cover ALL possible emergencies.

Emergencies are, by definition, rare events.  So why don't we get a couple people together to pool their resources?  Congratulations, you've just invented...


Accumulated Savings and Credit Associations (ASCAs)


In developing countries, villagers often band together to form accumulated savings and credit associations (ASCAs).  A typical arrangement might look like this:
  • Each member contributes as much as they want to the pool
  • Members can take loans from the pool
  • A member's withdrawal limit may be set by the amount and duration of their contributions
  • Loan duration and interest rates are set democratically by the group
To prevent problems, members of an ASCA should trust and respect eachother.  To make an ASCA a better option than a loan shark or payday loan, interest rates are low or zero.  An ASCA is a little bit different from an insurance contract, which typically allow withdrawals only for very rare events and doesn't require you to pay back the money you withdraw.

It's very important to note that while a well-run ASCA can help its members deal with temporary liquidity issues, this arrangement will NOT fix a broken balance sheet or long-term cashflow issues. All members should be 'good for the money' in the decided-upon loan duration!

If you have a small group of friends and family, all you need to set up your own ASCA is a trustworthy treasurer, a spreadsheet, and the ability to quickly and easily exchange money.  And time!  Time to debate with them and agree upon a set of rules.  Will the interest rate be zero?  Should the loan duration be two weeks or six months?  Can anyone withdraw as much as they want, or is the withdrawal limit dependent on how much they've contributed?  What do you do if a member can't or won't pay back a loan?

My ideal ASCA agreement looks something like this:
  1. No interest on loans.
  2. A loan duration of two months.  Liquidity issues should be fixable by next paycheck.
  3. Non-paying members are ejected and socially ostracized. Family and close friends only!
  4. Withdrawal limits according to a formula like this:
    • the time value of the contributions, times some multiplier
    • a withdrawal limit cap proportional to contributions times some multiplier
  5. New members are sponsored by two existing members, who each agree to take on 1/3 of the new member's liability in the event of default; the group absorbs the other 1/3
The new member vetting clause can help assuage trust-related fears and allow an ASCA agreement to function between people who don't all know eachother.

Sounds complicated, but it's easy to implement!



The DIY ASCA


Creating your own ASCA can be a little or a lot of work, depending on your requirements.

For small-scale efforts, you might trust one person to be the 'treasurer'.  The treasurer holds the group's contributions, disburses loans, and updates the group on repayments.  Simple!  On the downside, the treasurer has a lot of responsibilities and transferring funds for loans might be slow.

For larger-scale efforts, you might consider opening a shared bank account for the group and issuing members a debit card to make withdrawals.

 → PayPal

One potential way to do this is to open a no-cost PayPal Business account and give your group members access as 'employees'.  To make a withdrawal, group members can log in, transfer money to their own PayPal accounts, and then cash it out into a bank account or use a no-cost PayPal debit card  (they'll also need to establish a no-cost PayPal Business account, but this is not a big deal) to draw on the funds.  It may be possible to issue the group members their own debit cards to draw on this money directly without first transferring it to their own accounts, but I haven't looked into this.

Downsides: you have to trust every group member implicitly, as there is no treasurer overseeing every transfer (maybe PayPal has a setting for requiringan administrative sign-off on transfers, but I haven't yet found it).  You have to deal with PayPal, which has a long history of arbitrarily freezing accounts and generally screwing people over.

 → Credit Unions

Credit unions are like banks, except they're staffed by reasonable people who don't necessarily want to screw you.  You may be able to open a bank account for your merry band of ASCA participants and issue debit cards to allow them to draw on the funds.

I called my lifelong bank, Penn State Federal Credit Union, and they were very helpful in helping me how to figure out what I would need to do.  In short: I'd need to register the ASCA as an 'unincorporated association' with the state to receive a DBA (Doing Business As) name, then register this DBA with the IRS to obtain a Tax Identification Number (TIN).  The IRS TIN process is entirely online and takes all of five seconds, but I suspect the state registration is going to require filing some sort of organizational charter, a list of officers, etc.  With a basic business credit account, the money won't earn any interest and there's no need to also file for IRS 501(c) nonprofit status.  If you're up for a challenge and you do want that tax-free credit union interest, perhaps look into organizing under 501(c)(8) as a "Fraternal Beneficiary Society or Association".  I'll look into this when I have more time (which, at the rate I'm adding projects, may be when I'm retired...)

Downsides: most credit unions have membership requirements.  At Penn State Federal it appears that all members issued a debit card would need to be members of the credit union, and would therefore need to meet those requirements.  Some credit unions may be more open than others, so your mileage may vary.

If you have any experience in this or ideas for other ways of implementing a DIY ASCA, I'd love to hear about it!

My research notes on this topic are available on the Social Saving and Borrowing page on the AHS Wiki.


Puddle, the ASCA-in-a-Box


I learned about the ASCA concept through Puddle, financial technology startup that's trying to bring the ASCA concept to the US.  By linking to your Facebook account and perma-banning people by social security number, Puddle hopes to filter out the troublemakers and make public ASCAs a thing.  The Puddle team includes the cofounders of Kiva.org, and they have received money from Google Ventures.

(The individual ASCAs in Puddle are also called puddles, but I'm gonna call them pools because I like that better.)

You can take your chances in the public pools or start your own public or invite-only pool.  I haven't really done anything in a public pool, so I can't comment on them.  You can also 'trust' other users to share your contributions, but how your share responsibilities in case of a 'trusted' member's default is not entirely clear to me.  I am a pretty smart guy (finishing a PhD in chemical engineering in a year or so), so the fact that I don't entirely understand the system is a little unsettling.  Puddle could really benefit from a series of simple, clear, case-study-based articles to explain the mechanics.  With input from the developers, I'd be happy to write these articles!

By default, pools allow loans of three or six months with a monthly fee proportional to the amount you borrow:

$ borrowed    APR
$7017.1 %
$20012.0 %
$6008.3 %
$10008.0 %
$98007.6 %

Keep in mind that those are annual percentage rates, while the max default loan duration is 6 months.  These rates are better than most people will get on a credit card, but still rather high.  Late payments are displayed to everyone in the pool and assessed an additional fee.  The FAQ explains that interest payments (and maybe fees?) are fed back into the pool to help cover money lost due to defaults, but the exact way this works (and Puddle's cut, if any) is unclear.

Concerns aside, I crashed forward and created my own hidden invite-only pool:


By default, pool contributors can borrow 5x the amount the they contribute, but the new pool creation dialog says:
Leverage is set to be 5:1. Please contact us if you want to customize this setting after your group is created.
'Customize' is my middle name, so I contacted support and asked to leave the maximum leverage at 5x and change the interest rate to 0% and the maximum loan duration to 2 months.  They obliged!

Our pool is coming up on a year old, and we've had three people borrow so far.  All repayments have proceeded uneventfully and everyone involved has been pretty happy with the system.  Barring discovery of a better alternative, we're planning to increase the number of members and the amount of money in our pool.

Puddle recently redesigned their interface and fees to make it simpler for financially unsophisticated users to get started, but I think this limits the appeal to power users like myself.  What is Puddle's long-term plan?  Could Puddle disappear tomorrow and take all of your money?  Not likely with industry veterans and Google Ventures backing, but the lack of powerful management tools has motivated me to explore the DIY alternatives described in the previous section.  The DIY options have serious drawbacks, so maybe actions speak louder than words: for now, we're sticking with Puddle!

If someone from the Puddle team would like to comment on any of this, I'd love their perspective!

Puddle in the News

Forbes - Creating A Line Of Credit With Friends: The New Trend In Finance
Collectively.org - This DIY Lending Company Trying To Disrupt The Broken Credit Industry


ASCAs Have Promise


Much has been written about how, when you're poor, you're always one step away from financial disaster:
With the right implementation, ASCAs could help people in the US as much as they've helped people in developing countries.  Will Puddle be the implementation that succeeds?  We'll have to wait and see!

2015-05-03

Earn 5.12% APY on $5000 in a Savings Account

Yesterday, I got together with five fellow Mr. Money Mustache fans at Lake Merritt in Oakland to talk about money and life.  This was the latest Bay Area Mighty Mustachian Meetup (BAMMM) event, which is to say I sent out an email on the Google Group list, posted in the MMM forum, and created an event in a Google+ Community and some people showed up.  If you'd like to hear about (or better yet plan) future events, tap into one of those channels or (NEW) follow me on Twitter at @BC_ChemE and watch for stuff tagged with #BayAreaMMM.


IMPORTANT  
I don't do affiliate links, so you can be sure I'm not linking this to make a buck.

The 5.12% Savings Account


One thing we discussed was the pain of holding cash in "high-yield" savings accounts that return, at best, 1% now.  I used the opportunity to pitch US Treasury Series I Bonds, which I've always liked for emergency funds because they at least keep pace with inflation.  Another attendee recently became financially independent (dunno if he wants to be publicly outed and not sure if he has a site) and had a more liquid solution with a better rate: a savings account associated with a prepaid debit card company called Mango Money.

The vital details, culled from the AHS Wiki page that serves as my open notebook for these projects:

2015-04-07

Guest Lecture: Personal Finance 101

This morning I had the opportunity to give a forty-minute presentation about personal finance basics to a Penn State freshman seminar class.  One of my (many) long-term goals is to fix the lack of personal finance education at the high school and college level, so I jumped at the chance and dragged myself out of bed at 3AM to prepare a presentation.

I gave and recorded the presentation using Google Hangouts On Air:



The presentation is here and the spreadsheets referenced in the video are available here.

Unfortunately the audio on the other end wasn't working, so I was not able to do the question-and-answer session that I had planned.  In lieu of that, I'll follow up with the students using a Google Form to collect their questions and I'll post the answers here.

I have been subscribing to a lot more YouTube content lately, and I like the concept of preparing a series of short personal finance videos to add at the top of my posts here.  These videos could give the tl;dr version for people who prefer the sound of my voice to my writing style (what a choice!).

My public speaking needs work, but to be fair this was 6AM my time...

2015-04-04

Save Your IRS Tax Transcripts

Have your taxes from previous years?  Archive them!  Collect all of your forms for each year, digitize them, and make sure they're backed up to the cloud—Google Drive, Dropbox, whatever.  The IRS can audit three to six years into the past and you can file a corrected return up to three years back, so make it a habit to keep this information organized.

Pieter Brueghel the Younger's The Tax Collector's Office, 1640.  I bet the IRS looks like this too.
If you're missing a year, or if you'd like to see what information the IRS has on your earnings for this or previous years, you can download tax account, income, and tax return transcripts online.  Just head over to the IRS transcript website and make an account!  Transcripts are free and can be downloaded immediately.  When you're doing your taxes for this year, this is an easy way to verify that you have all of the W-2s and 1099s that the IRS does.

2015-03-22

Save Money on Electricity with Alternative Pricing Plans

Knowledge is Power


If you know how electricity prices vary over time, you may be able to use this to save money.


The Theory


The electrical utility system is designed with a certain base output power that is sufficient to meet the demand for electricity almost all of the time.  On hot and humid August afternoons when everyone is blasting the AC on high, electricity demand may spike above what the base capacity can supply.  The utility company then has a couple options:

0) Do nothing.  The grid line voltage will drop, a state called a 'brownout'.  This may successfully reduce power consumption, but it could also cause some types of equipment to malfunction or sustain damage.

1) Manage demand with rolling blackouts.  Demand is pruned by cutting off power to some areas of the grid; which parts are shut down is 'rolled' on a schedule, announced ahead of time if possible.

2) Supplement the base supply with additional power by activating 'peaking plants'.  These power plants may use designs that are less efficient and cost-effective than the base supply plants, but they can be quickly switched on and throttled, like a jet engine, to match fluctuating demand.

And last, but not least:

3) Manage demand with good old economics.  If the utility company can collect time-of-use data with a smart meter and consumers are informed ahead of time that the price of electricity will be higher on certain days ('critical peak pricing') or at certain times of day ('time-of-use pricing'), they may adjust their behavior and temper peak demand.


In Practice, with Pacific Gas & Electric


If you are one of Pacific Gas & Electric's 5 million+ electricity customers, you can take advantage of two peak demand reduction programs: the SmartRate Add-On and the Time-of-Use Base Plan.  I started taking advantage of these last year and it saved me 30% on my summer power generation costs.

SmartRate is a 'critical peak pricing program' for reducing electricity demand during peak demand periods. You receive a 23% discount on your May to October electricity rate in exchange for accepting a 320% rate increase on hot summer days (9-15 days per year) that are predicted to seriously stress the grid's capabilities. These peak demand 'Smart Days' are announced ahead of time and you can be notified by text or email, so you can plan to curtail consumption as much as possible.

What if you switch and you end up paying more?  Your first year comes with free bill protection, so you'll only owe the lower amount.

On the Time-of-Use base plan, the price of energy changes depending on the time and the season:

From November to April, you receive an 18% discount on weekends and weekdays
except from 5-8PM on weekdays, when you receive a discount of 6%.

From May to October, you receive an 18% discount on weekends and weekdays
except from 10:00-21:00, when the price increases by 24%
and 13:00-19:00 when it increases by 85%.

If your schedule means that most of your electricity usage happens off-peak, you can save a lot of money with this plan!  You can even stack the Time-of-Use base plan with the SmartRate add-on for even more savings.  Everyone wins: you save money on electricity and the utility company saves money on expensive peak power generation and storage systems.

If you don't have PG&E, call your utility company and ask them if they offer alternative pricing plans for their residential customers.  These plans require the utility company to collect time-of-use data with a smart meter, which have only been rolled out in certain markets.