A weekly personal finance newsletter to help you manage your money.

Cryptocurrencies & passive income

The Interest: Issue #5

The Interest: Issue #5

About 10 years ago someone had an idea for a new kind of digital money. The pesky thing about money is that you can’t be allowed to spend the same dollar twice. And the pesky thing about something digital is that it’s easy to copy over and over again. This new kind of digital money, called Bitcoin, solved that problem by making each unit of digital money impossible to copy. It uses cryptography to do it, thus the term “cryptocurrency.”

You might think “wait, I can buy things online — my money is already digital.” And, yup, you’re right. The trade off that’s being made (which isn’t even a trade off in some circumstances) is that to make yourmoney digital there has to be some trusted third party in the middle that keeps track of what you have and what you’ve spent (a bank, PayPal, Venmo, etc.). That’s the other innovation of Bitcoin, instead of a central third party maintaining the ledger (i.e. the database of transactions and resulting account balances), the ledger is maintained in a new type of database called a blockchain.

That’s where it gets interesting. Let’s say you’re of the mind: “meh — I’m OK with trusting a bank with my money, and, I’m actually perfectly fine with good old USD as my method of storing my savings.” That’s basically my opinion (and I think most people’s), with the caveat that I believe this new technology can replace the way we transact our money — doing away with the archaic credit card processing system. Anyway, let’s say you’re in that “meh” camp and thus eye roll at the Bitcoin craze. That eye roll may very well be justified, but to extend it to all of the other uses that this new technology enables, would, in my opinion, be a mistake.

What’s this got to do with personal finance!? There’s a point, I promise, and it’s not even investing in these currencies as speculation (I don’t think I’m allowed to give such advice publicly without a license).

The interesting thing about all of this to me, from a personal finance standpoint, is the potential for passive income to be earned via some of the new products and services that are being created using blockchains. It’s not just digital money — so many other digital services will be decentralized and made better for it, and regular old people will be able to participate in the verification processes necessary to run such services, and therefore get paid for doing so. I’ll whet the whistle by wrapping up this “blockchain intro” with one concrete example of a passive income opportunity, but I’m going to dive more into these in a part 2 to this piece, next week.

It’s necessary to understand a tiny bit more about how blockchains work. A blockchain is a public database. A transaction gets recorded in this database as long as there is consensus that it’s legit. The method of reaching that consensus is different from blockchain to blockchain. Some require the approval of only a small number of pre determined verifiers (booo). However most, including the most widely used blockchain, called Ethereum, reaches consensus in a more decentralized way. Ethereum, like Bitcoin, uses a complex method called proof of work.

Ok, an analogy. Let’s say there’s a contest to guess the number of jelly beans in a jar. A centralized approach to reaching consensus on who wins is to trust the person running the game. They’ve presumably counted the jelly beans ahead of time and everyone believes their answer and a winner is declared. No big deal at your neighborhood fall festival, but, what if the winner got $1 million. Then all of a sudden trust becomes an issue.

A decentralized approach would be to empty the jelly beans onto a table so that anyone can participate in the verification process, with the winner being declared as long as 51% of the verifiers agree (i.e. they reach consensus). In proof of work, in order to submit a verification individual verifiers have to prove that they spent the time/money necessary to count the jelly beans. In exchange for this they get 2 things: 1) an individual verifier knows whether or not the ultimate answer was correct, without having to trust anyone else; and 2) they get transaction fees for their efforts. Anyone playing in the jelly bean guessing game, but choosing not to spend the time/money to participate in the verification process, only has to trust that no one verifier was able to get more than 51% of the verifying power necessary to commit fraud. If someone with less than that amount of power tried to give an answer they knew to be wrong (so that they would win the jelly bean guessing game), all they’ve done is waste the time and money it took to submit a verification.

Ethereum is scheduled to switch their consensus method from proof of work to proof of stake, sometime in 2019. The rules for PoS are easier to understand than PoW. In PoS, all you need to do to become a transaction verifier is to stake (i.e. put on deposit) a certain amount of money. As long as you verify transactions according to the rules (that is, you let the software running on your computer verify the transactions without tampering with it), you earn transaction fees. If you try to submit a verification that the other verifiers in the network don’t agree with, then your deposit is “slashed,” which keeps everyone honest.

That’s passive income. Stake some money, let your computer run some software, and collect transaction fees. That’s interesting. With Ethereum specifically, it’s looking like you’ll need to stake “only” 32 Ether (the native cryptocurrency of the Ethereum blockchain) to become a transaction verifier once they make the switch next year. I say “only” because it was first thought to be north of 1,000 Ether, but the community decided that wouldn’t be decentralized enough. As of the time of this writing, buying 32 Ether would cost $7,328. I’m not advocating for doing so (again, not allowed to do that), but, now you know how much it’d cost to get in on this passive income opportunity in the future, and if you’re interested, you should go learn a bunch more about it first.

There are other opportunities as well — I’ll give a rundown of some interesting ones in part 2 next week.

Home energy efficiency 101

The Interest: issue #4

If you punch a hole in the side of your fridge, it will become less energy efficient. (What other personal finance newsletter is dishing out that kind of insight?). We can actually calculate how much less efficient. There’s about 0.5kg of air in an empty fridge and we’ll take a total guess that the hole would result in a full air replacement every minute. The task, then, is to cool 0.5kg of air from 70º to 35º 1,440 times per day. Doing it once uses about 0.002 kWh. Doing it 1,440 times per day for 30 days uses 86 kWh which at $0.10 per kWh would cost $8.64 per month. [Sidenote: the main cost of running a fridge is cooling the food, not the air — let those leftovers cool before sticking them in.]

By contrast, a closed fridge that’s never opened will heat up not through air exchange, rather by heat moving through the materials of the fridge. That’s called conduction (& radiation and convection, it seems, but I’m not the one to take us down that rabbit hole of science). The speed at which the temperature inside reaches the temperature outside will depend on how fast the materials in between conduct heat. Or in home energy building materials lingo: their r-value.

These same 2 principles (air exchange and heat conduction) dictate how efficiently your home is heated and cooled, and understanding them puts you well on your way to passing home energy efficiency 101. Minimize air exchange by determining the boundries of your “thermal envelope” and air seal them to the extent possible. Just like your fridge, cutting holes in your thermal envelope (for sockets, light fixtures, duct work, and poorly sealed windows and doors) will increase the amount of air replacements per hour in your home, meaning you’ve got to heat or cool more air.

You can’t live in a giant plastic bag, of course — you do need air ventilation for good old oxygen and other air quality measures, but unless the air sealing is taken to an extreme, it’s not likely to be something you’d have to consider. New construction homes purposely built to be extremely air tight use mechanical ventilators. There are even fancy ones that can limit the thermal impact of exchanging for fresh air.

After the house is air sealed, then it’s a matter of wrapping the surface area of the thermal envelope with high r-value materials, to the extent possible. Insulation, of course, is engineered to do just that. The r-value of a house can be computed by a simple weighted average of the surface area. If 50% of a wall is window with an r-value of 3 and 50% an insulated wall with r-value of 14, then that wall, overall, is r-value 8.5.

For the fridge, just sticking duct tape on the hole would do a lot of good. Assuming duct tape is air tight (of course it is, right? it’s duct tape!), it eliminates the air exchange and the only thermal impact is the fact that 5% of the fridge’s interior surface area is now very low r-value, effecting the weighted average proportionately.

When I was first trying to learn home energy efficiency basics, it was hard for me to understand the concept of the thermal envelope before I pictured the fridge analogy. Thinking about it that way , it’s obvious that air leakage is bad and, if air sealed, insulation slows down temperature equilibrium with the outside.

There are several other cans of worms to open, like window quality, roof strategies (ventilated or not, etc.), maximizing solar gain through positioning the house and its windows, the impact of appliances, and so on. Lots of fodder for home energy efficiency 201.

I’ll close with a note on lightbulbs.

LED lightbulbs are a total no brainer. Just 10 years ago they cost as much as $40 each, but, now they’re almost as cheap as “regular” bulbs, only use 9W to generate as much light as old 60W bulbs do, and they last much much longer. The ROI isn’t even close. 3 hours of use per day per bulb would cost $1.08 for the year with an LED bulb vs. $7.20 for the old bulbs. LED bulbs have a 10 year life span compared to 0.9 years for old bulbs (we’ll round up to 1 year). If you’ve got 30 bulbs in your house, we’re talking $3 * $30 = $90 investment and $324 in total electricity cost for all 10 years for a total of $414. Buying old bulbs would run you $1 * 30 * 10 = $300 and would cost $2,160 in electricity over 10 years for a total of $2,460. Plus, mother nature, you know? If you haven’t already, definitely switch to LED. If you’ve got CFL, those are close enough (14W for 60W equivalent light), so you can wait for those to burn out before switching.


P.S. those new iPhones! We’re switching to Xfinity Mobile (today). It’s only available for customers of Comcast Internet, but if so, it’s only $12/GB per line, all in. Or, $45/line for unlimited. We pay $138 right now for 2 lines on AT&T and this should drop our bill to ~$60, or worst case $90, and when the time comes to get kids their own phone (when is that time, btw??), it’s just $12/mo. They also have a promotion running through 9/30 for $300 in prepaid gift card per iPhone you purchase from them for new service. Good stuff. There’s reason to doubt Comcast’s ability to impress me with their mobile service, but the price is worth trying. I’ll report back.

Taxes are Simple. Mostly.

theInterest: Issue #3

Taxes are simple. Mostly.

I think most people should be able to roughly calculate their federal income taxes, fairly easily, on the back of an envelope. This is especially the case with changes to the tax code effective 2018. Being able to do a rough calculation is a skill that will help you be more aware of your money, better forecast your tax bill or refund, and to do some light weight tax planning.

The high level formula

income
- deductions
- adjustments
x rate
- credits
= taxes

Deductions (itemized OR standard)

The standard deduction is $12k for single filers and $24k for married filers. Unless your itemized deductions top that, this category is simple. This is where the meaty deduction are, such as mortgage interest, charitable contributions, property taxes, state and local taxes (all of which have limits), HOWEVER, you either itemize OR take the standard deduction. In 2018, the standard deduction got much larger (nearly doubled) meaning it’s going to be a lot more common to take it vs. itemizing. Yes, those charitable gifts and mortgage interest are most likely no longer saving you any money on taxes.

Adjustments (aka “above the line” deductions)

You can reduce your taxable income by a handful of things classified as “above the line” deductions, whether or not your itemize. Most commonly these are taken out of your paycheck, like health insurance premiums and retirement savings. For things not taken from your paycheck, the hardest part is just remembering if something is an above the line deduction or an itemized one. But you have the Internet for that and now you know what to search for. Here’s the list of above the line deductions (to arrive at “adjusted gross income”) straight from the source:

Tax rate

Your first portion of income is taxed at 10%, the next portion at 12%, the next portion at 22% and so on. It’s a common error to think all of your income is taxed at the same rate (whatever “your tax bracket” is), however that’s not true, it’s sliced into portions — everyone’s first portion of money is taxed at 10%, regardless of how much they make. Once you know your taxable income, figuring out your tax amount is a simple matter of multiplying by the tax rates for each portion or using a tax table.

Tax credits

*New for 2018* — as long as your income is less than $200k for single or $400k for married, you get a $2,000 tax credit per child under 17 via the Child Tax Credit. There are other credits, for education, low income, and other situations, but by far the most common is the Child Tax Credit.

Putting it all together

Let’s say you’re married with 2 kids, have $100k of income, contributed $3k to a retirement fund, paid $8k in mortgage interest, gave $5k to charity, and paid state local and property taxes of $8k.

$100k (total income)
- $3k (above the line adjustments)
- $24k (standard deduction)
= $73k taxable income
x tax rates (13,600 * 10% + 38,200 * 12% + 21,200 * 22%)
= $10,608 taxes before credits
- $4,000 tax credits
= $6,608 final tax amount (effective rate = 6.6%)

Notice the standard deduction was used instead of factoring in the mortgage, charity, and local taxes.

That refund tho

The amount you owe or are owed when you file your taxes is even simpler: your tax amount (the $6,608 above) minus what you’ve already paid via federal income tax withholdings from your paycheck throughout the year is what you owe, or, if that’s a negative number, it’s what they owe you. Withholdings tend to be conservative  — perhaps our example family of 4 paid $8k in taxes during the year, in which case they’d get a refund of $1,392 come tax time.

“Payroll taxes”

Also a federal tax, though not the income tax, are social security and medicare taxes, also called “payroll taxes,” also called “FICA” taxes. These amount to 7.65% (combined) for you the employee and another 7.65% for the employer. If you work for yourself you’re both the employee and employer, meaning you pay both (15.3%). 6.2 of that 7.65 is capped. For 2018, it goes away after $127k of income (per person). This tax can be more than the income tax, as is the case for our example family of 4. It gets less attention because it’s just a flat rate and doesn’t come along with deductions and maneuvers to minimize it.

Go flip that envelop over

This quick, rough, federal income tax calculation is, dare I say, pretty basic? Income minus 2 types of reductions, times tax rates, minus credits. It can get much more complicated, but, now you can back of the envelope it with confidence and be more one with your money.

How to Lease a Car Like a Boss

theInterest: Issue #2

Sometimes it’s better to buy, sometimes it’s better to lease. To figure out which is the case for the type of car you’re after, you’ve got to understand some basics, and how to score a great deal.

The basics

When you buy a car, you buy the whole thing. When you lease a car, you’re buying the difference between the negotiated sale price (including fees) and the predicted amount that it will be worth at the end of the lease term. Or using lingo: capitalized cost - residual value (RV). Counterintuitively, when the terms state “you have the option to buy this car for $X at the end of the lease,” you want $X to be as high as possible.

A $25,000 car might have a 58% residual for a 36 month lease term. Leasing it means paying $10,500 (or $291.67/mo) to have it for 3 years, plus interest.

The interest is determined by the Money Factor (MF). It’s not expressed like a typical interest rate, rather a shortcut value that factors in several things. The formula to calculate the interest is a little weird but understanding it isn’t important: (sale price + RV) * MF.

Using an example MF of .00100, we can calculate the interest portion of the payment for the example lease above: ($25,000 + $10,500) * .001 = $35.5, bringing the total monthly payment to $327.17. Factor in the sales tax rate in your neck of the woods and you’ve got your final payment amount.

Scoring a great deal

  • Money Factor: it’s not negotiable, however, sometimes you can buy it down by paying some money upfront which you get back at the end of the lease. Ask about this. Additionally, you’ll evaluate the MF when shopping around just like you evaluate interest rate.

  • Residual: it’s also not negotiable, however, to get a great lease deal, this is a key number. If the manufacturer is setting a high residual, that’s a time when leasing that car could be better than buying it. And even better, the residual % is applied to the MSRP of the car, not the final negotiated price, which leads us to...

  • The price: this is super negotiable, and doing so can score you a great deal if the dealership really wants to move the car. Because the residual is pegged to the MSRP, negotiations for a lease have more impact than when buying. If the amount you’re buying is $10,500 (like above) and you negotiate $1,050 off, you’re paying 10% less. Whereas if you negotiated $1,050 off of purchasing this $25,000 car, you’re paying 4.2% less. To negotiate this, zero in on it: move the conversation away from the “payment amount” and to the sale price of the car, and use the tip below to find market value.

  • Incentives: If the manufacturer wants to move the car, they’ll offer and publicize incentives. You don’t negotiate for these, just shop around and find the “offers” section of a manufacturer’s website. Like price negotiations, the great thing about incentives is that they lower the price without lowering the residual (which is calculated based on the MSRP), compressing the difference between the two.

  • Fees. Within the sale price (aka capitalized cost), there will be some unavoidable fees such as tag fee, title fee, doc fee, acquisition fee, and possibly others. The dealer has to show you the full calculation to sign-off on; don’t do so with any non explained fees in the mix. The only fee that’s common with leasing that isn’t there with buying is the lease disposition fee, usually a few hundred bucks. See if they’ll waive it, but you’ll need luck on your side.

Electric cars

I think electric cars are especially interesting candidates for being leased. First, for the most part the federal tax incentive of $7,500 per car is still in place and usually gets factored into the lease as an incentive. When BMW first starting leasing their i3, they had huge incentives, including this $7,500, and didn't really adjust their residual % much to compensate (it was a comparable residual to a “normal” BMW). I leased one in 2014 for 2 years. When I returned the car, I had the option to buy it for $33k, when the value at the time was more like $16k! That was a great lease, having only paid a fraction of what the actual depreciation was over that time. When it came time to renew, they had adjusted the residual and it just wasn’t a great deal, so I passed.

Also, battery technology is likely to improve rapidly over the next several years. I’m more comfortable committing to leasing a giant battery that might be soon outdated, vs. buying one for tens of thousands of dollars.

How to collect the right information

The RV and MF aren’t usually made public via car manufacturer’s websites. A great place to ask (or find other people asking) about these details is the Leasehackr forum. Use this to shop around for high residual %’s and low MF’s, and also to double check that the dealers quote is using the manufacturer’s numbers. If they’re trying to sneak in any premium for themselves, this will be the easiest component to negotiate. They’ll know you’ve caught them doing something semi-shady and will instantly adjust it for you once asked.

Leasehackr is also a great place to see the current chatter around which cars are currently “leasing well.” If you’re asking yourself, “is it really worth it to be part of this obsessive community while I’m car shopping?” — YES! you’re talking about a huge purchase decision and a little research can easily save you 4 figures in one swoop! 

For price negotiations, TrueCar and Edmunds are good places to identify what other people are paying. Don’t budge off of the low end of those fair market value ranges. If they start off higher, the sales person will eventually cave, after several trips back to see their manager.

Now go lease that car like a boss! Or better yet, ignore this entire post and just buy one a few years old for $10k.

Crowning a New Best Credit Card

theInterest: Issue #1

Adios, Starwood

Nearly 10 years (and 2 startups) ago I wrote a blog post comparing reward cards and declaring the Starwood Amex the winner. It’s been in my wallet ever since and the points have covered 2 free trips to Hawaii and several other hotel nights along the way. But Marriott bought Starwood and the almighty SPG point is no longer.

The new best card

After a bunch of research, I decided to replace it with the Citi Double Cash Card. It’s nice and simple: 2% cash back for all purchases, with no annual fee. We’ll use a $50k annual spending budget to make comparisons. That’d be a cool $1,000 cash back with the Citi Double Cash Card.

Why it’s better than other cash back cards

There’s no other card as high as 2% on all purchases, so it comes down to the math around cards that give 1% for everyday purchases and a higher percent for certain spending categories. I found 3 of them to be tempting:

  • Blue Cash Preferred Amex: 6% cash back on groceries (on up to $6k of spend), 3% on gas stations and select department stores, 1% everything else. Within that $50k budget, let’s assume you spend at least that $6k at the grocery store, $1,800 on gas (15k miles; 25mpg car; $3/gallon), and, $200 at “select department stores.” That’s cash back of $360 at the 6% level, $60 at the 3% level, and $420 at the 1% level, for a total of $840. Not good enough.

  • Amazon Prime Rewards Visa Signature5% cash back at Amazon and Whole Foods, 2% at restaurants, gas stations, and drug stores, 1% everything else. If you committed to Whole Foods for your groceries, and you do a bunch of your shopping on Amazon, it’s possible that you’d spend 25% of your overall budget (or, $12,500 of our example budget) at the 5% tier, and, if you go out to eat a lot and drive a decent amount, another $8k at the 2% level. That shakes out to $1,080 total cash back. But that comes with being locked into Whole Foods (which I’m not doing) and, those assumptions are perhaps a little aggressive.

  • Uber Visa Card: 4% back on dining (including takeout), 3% on hotel/airfare, 2% on online shopping and streaming services, 1% everything else. I’ll assume $6k/year on dining, $2k/year on hotel/air, $2.5k/year on online shopping. That works out to $240 + $60 + $50, in cash back respectively, + $395 in cash back on everything else, for a total of $745. If you never grocery shop and always go out to eat, maybe this is the card for you, but not having groceries as a premium category doesn’t give it a chance for me.

Another option is to get 2 cards. It compromises simplicity, but, it wouldn’t be too bad to get the Amazon card, hook it up to your Amazon account (and try to remember to use it for the occassional Whole Foods trip), and carry around the Citi Double Cash for everything else. We (embarrassingly?) spent $4k at Amazon last year and on pace for at least that this year. Increasing that spending from 2% to 5% cash back would mean a difference of $120+. I’m still considering it, but, think I might apply for this card too.

Why it’s better than a travel rewards card

The great thing about a travel rewards card is, with a little bit of luck, you can save big bucks on a flight or hotel stay by using points. 

Typically a miles card pays 1 mile per $1 spent and charges 25k miles for a domestic roundtrip flight — if the flight is over $500, you’re getting more than 2% cash back there. However, more likely those expensive flights will be higher miles to redeem and/or the $500 you could’ve got in cash back on that $25k spend would pay for most domestic flights with room to spare, plus you’re not locked to a single airline. 

With the Starwood card, “luck” with high quality hotel redemptions was more frequent. And, you could even trade 20k SPG points for 25k miles at an array of airlines — instantly making it better than any miles card, and points for gift cards at a 1% “cash” back rate, which was a nice fallback option. But it’s gone; oh well. Programs from Marriott, and Hilton just don’t live up — the value’s not there.

That leaves general purpose travel programs. The best of these is Chase Ultimate Rewards. With their best card (Chase Sapphire Reserve), you get 3x points on dining and travel and 1x points elsewhere. It has a $150 net annual fee (annual fee is $450 but first $300 of travel is reimbursed). If you book travel through their portal (kind of like their own version of Kayak), you get a 50% bonus on your points, making 1 point worth $1.50. You also get access to super fancy lounges at airports across the world (meh), and it comes with a great signup bonus, worth $750 in travel. That is nice, but, I think of a credit card as a decade long decision and don’t like to play the signup bonus game.

Overall, the rewards are good, but they still dont stack up to the boring old 2% card. The best you’re doing is 1.5% “cash back equivalent” on everyday purchases and 4.5% on dining and travel, and even if that didn’t come with the restriction of having to use their travel booking portal, we know from our analysis above that it isn’t likely to beat out “2% everywhere.” If you do travel a ton, and would enjoy fancy airport lounge access, this is a card to consider. But not for most of us.

Price protection, purchase protect, and extended warranty

Credit cards also have 3 under appreciated features. Some will refund price drops within 60 days of your purchase, some will repair or replace damaged items within 90 days of purchase, and some extend warranty coverage on certain purchases. Honestly, I don’t trust that I’d be diligent enough to take advantage of these, so they don’t factor into my decision. American Express by far does the best here, having all 3 features. Visa Signature cards do well too. The Citi Double Cash does have price protection (but not the other 2 features), and, apparently it’s automatic if they detect a price drop.

Summary

So long, Starwood Amex, hello Citi Double Cash. And I think Amazon Prime Visa Signature, as well. It has been nice to not have to dip into cash for big travel purchases — if I can avoid eyerolling at my own suggestion, I think we might funnel this cash back money into a separate account, and use that as our primary travel budget.

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