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!


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!