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Childhood Cash Convention in the Cafeteria

My credit management strategy is crazy to some. I’ve heard more than one person tell me I was making things hard on myself. However, if I didn’t perceive value in my method of financial management, I wouldn’t do it, nor would I recommend it to others – and when you get a great deal, you want to share it with others. Decide for yourself after considering the pitch below, keeping in mind that this site is not affiliated with any of the banks or creditors mentioned here.

When I was in second grade, a class assembly convened in the cafeteria. Our principal at the time, Dr. Gold, told us that someone from First Federal bank was there to help us set up bank accounts, if we wanted (and had our parent’s permission). This was greatly exciting to me at the time; frankly, the entire concept of savings and checking still is exciting to me. Alas, mostly only people in the banking industry share my still-above-normal level of excitement for consumer finance. My “First Start” savings account opened with a balance of about $100, and for years, I kept that account, watching my savings grow over time. Years later, Marine Midland acquired First Federal. Years after that, HSBC acquired Marine Midland. Throughout the name changes, the banks honored my First Start account terms, until I turned 18 and went to college where the account was converted to a free student checking account.

This also earned me the luxury of an HSBC MasterCard, allowing ATM and point of sale transactions, which previously were not possible with my First Start savings. HSBC’s student checking account offers “No fees” at HSBC ATMs, which would be very useful if HSBC had ATMs “in the wild”. If I wanted to have to go to a bank to use an ATM, I would be inclined to wait for a teller, depending on the level of crowdedness. The reality is that I would eventually use a third party ATM, though I didn’t know the true cost.

Typically, I use a credit card, so ATM fees are not an issue, but finally after years of avoiding it, the other day I withdrew money from an ATM at Hoboken Terminal so that I could buy a beer while waiting for my train. As an aside, I am not a huge fan of New Jersey Transit, but the fact that they let you drink on trains is amazing – much better than drinking and driving. Anyway, as I withdrew my beer money, the ATM announced it was going to charge me $1.50 through its monochrome, fixed-width terminal display that looked like it was older than I was. On top of this $1.50, when the transaction eventually posted to my account, HSBC slammed me for another $1.50, for a total of $3 in fees for access to $20 of cash that I already had in my account.

This is exactly why I use a credit card instead. If I didn’t even have that $20 in the first place, and instead charged $20 to my credit card, and then financed that over the course of an entire year, I might expect to pay $4 in interest at 20% APR. Noting that fees on a credit card cash advance are even worse than the ATM fees, this is not a practical solution to the cash dilemma, but merely illustrates the inordinate cost of cash access. Ironically, the credit card gives you time to pay without penalty, verse the ATM card that slams you for fees up front; this is covered in more detail later.

Bank fees have risen dramatically over the years, which might be contributing to the record profits throughout the banking industry. The largest source of profit on checking accounts is fees – as high as $29 per overdraft, even if the overdraft is as low as $.01. The consumer credit industry comparably derives a great deal of profit from late fees and over-credit-limit fees – many times also as high as $29 per incident. All this happens despite that many consumers assume their card will be declined at the point of sale if they have insufficient funds or insufficient credit. In fact, many banks make it a point to note that debit cards only let you spend money that you have, yet the same banks don’t advertise that this is not completely accurate for the majority of debit accounts.

At HSBC, the solution to this is to be very explicit in setting up the account to ensure it fits your expectations. HSBC is large enough of a bank that they offer a number of alternatives, one of which is right for just about everyone. So when I asked about avoiding ATM fees, I was told to switch to a “Premier” checking account, which was an interest-bearing checking account requiring a minimum combined bank balance of $10,000 – a little bit steep just so I could save a dollar or two in the rare instances when I need cash in a pinch. Not to mention this would still expose me to the $1.50 fee paid to the ATM owner. I decided to grin and bear it with my student checking account, figuring I would avoid the fees by avoiding ATMs as I always have. They key again is using credit cards instead of ATM cards.

I don’t see the perceived value of combined “credit/debit” cards for this very reason. If you select “credit”, you’re using a Visa or MasterCard, so why allow them to settle the balance immediately if they would otherwise send you a bill at the end of the month? On the other hand, if you select “debit”, your account is debited immediately (potentially over-drafting it), and you lose all the cardholder protections offered by Visa and MasterCard. In the third case, accessing cash at an ATM, at $1.50 per transaction, they’re charging 7.5% on $20 of your own money, and that’s not counting the fees of the ATM you’re using (since I paid $3 in fees, that’s a 15% service fee). Why pay a fee for having money, when a credit card not only allows you to avoid these fees, it lets you invest your cash in the meantime and earn returns on the cash you didn’t spend yet! I’ll show you how.

The Yield Curve, Yearly Return, and You

Enter the yield curve: a graph of yields on investment based on length of the investment. Typically, we expect that a short-term investment would yield a smaller annual profit than a long-term investment yielding a larger annual profit. After all, one would expect they would be compensated more for holding their investment longer. In today’s economic environment, this isn’t the case: the yield curve is inverted. Short-term investments are yielding more than long-term investments today. Some speculate that this is a sign of impending recession, considering that the only two other times in history that the U.S. economy had an inverted yield curve was in a period immediately before a major market correction. But tomorrow is not certain; today is. Therefore, if you have cash lying around, you might as well invest it in extremely short-term investments as they are currently paying considerable yields.

The demand for high-yield savings has exploded in the last two years, with the number of banks offering “online savings” accounts increasing daily. Offering online accounts is practically free for banks that already support the infrastructure to process both the online account access and transaction clearing. It can also significantly raise their cash reserves at that low cost, so typically the returns are astronomical compared to other accounts. HSBC’s Online Savings offer at the date of writing is 5.05% APY, although they recently had a brief 6.00% APY promotion. Note that even though this is a savings account, it has a higher yield than many CDs at traditional banks! The reason for this is, as the name implies, this account can only accessed online – you can’t do anything involving the account through your local branch, although you can perform some functions over the phone.

Also, this is a ultimately a savings account, so there are some federal regulations governing the use of your account. The most important is the withdrawal limit – you can withdraw six times per month (any dollar amount) without penalty. If you exceed six withdrawals within a month, HSBC will send you a warning letter explaining the limit and officially putting you on warning. If, within the next few months, you exceed the six-withdrawal limit again, HSBC automatically converts your account into a checking account. A withdrawal is any debit to the account, whether it is between banks or between HSBC accounts. Most people will not draw on a savings account six times in a month. I happened to hit this limit because I used the HSBC Direct ABA routing number, 022000020, and my account number as online “bill pay” account details with third parties. For example, I would log into my credit card company’s website, click “pay bill”, enter my online savings account details as if it were a checking account, and authorize the transaction. The account is debited as if a check were drafted – a very useful feature for a savings account! I simply made too many transactions and had to change my payment paradigm.

It’s time for an aside. Every check, whether it is a personal check, bank check – even postal money orders – has three sets of numbers printed on it. These numbers are printed in a font that looks like a computer font from the late 1970s. They are printed using a special magnetically resonant ink; this format is called MICR (short for magnetic ink character recognition). The three numbers are the ABA (American Bankers Association) number, also called the routing number, of the issuing bank, the account number of the check’s writer, and the check number. ABA numbers are always nine digits long; account number and check number lengths vary depending on the backing bank. Any account that can be credited or debited through ACH – the automated clearing house – can be credited or debited using the ABA number and account number. As an example of the risks involved here for both the consumer, bank, and collector, years ago America Online made a great deal of money by offering “free trials” of their internet access. Many accounts were backed by a checking account, such that when the free trial expired, the account converted to a paid account in which AOL was “authorized” by the user to automatically debit their checking account. Also, the movie “Catch Me if You Can“, based on a true story, prominently features Frank Abagnale‘s ingenious check counterfeiting scheme made possible because he acquired a MICR printer.

Deposits, on the other hand, are not limited. The account can be credited electronically just as it can be debited. Again, the key is that the online savings account works just like it was a checking account, for all ABA routing purposes. Consider now the typical employer-employee payroll relationship: the employee receives either a physical check or a direct deposit. Overwhelmingly, direct deposits are credited to checking accounts – but there is no rule that prevents one from registering a savings account instead. Many employers ask for a cancelled check, implying that the registered direct deposit account must be a checking account, however there is no reason you can’t register a savings account instead.

If you are interested in doing this, but your employer insists you give them a voided check, ask if your last bank statement would suffice. I recently switched jobs, and the new employer initially refused to deposit to my savings account since I couldn’t actually find a document that had the ABA number printed on it. However after I called payroll and insisted I had the ABA number correct, they took my word for it but added that I had better be right or I wouldn’t get paid. I was sure I had the numbers right and submitted that account anyway; sure enough, I got my money!

The online savings, by itself, still didn’t quite fill my needs since I still had the 6-withdrawal limit issue. However, I never closed my student checking account. Thus the combination of the savings account and checking account allowed me to move a single large sum out of the checking account at the end of the month (bill payment time). HSBC allows account-to-account transfers free of charge, and the transfers are practically instant, to boot. I could then draw on the checking account as much as my heart desired. The strategy then is: leave as much available cash as possible in the high-yield savings account, infrequently transferring funds into the checking account to disburse regular payments.

Now, considering my paychecks are directly deposited to my savings instead of my checking account, and the transfers between accounts are instant and on-demand, there is an interesting benefit. I earn interest immediately, even if my paycheck is only in my savings account for a day. Depending how long the money remains in the savings account, I may earn only pennies per check, but I may earn much more. In addition, there is no practical limit on access to my funds if I can withdraw six times per month, so I might as well take what I can get in the meantime!

Life insurance companies understand this quite well: consumers give cash now for cash later. Since a life insurance policy-holder gives cash now, but is paid later, the insurer invests the money for a return in the interim. Insurers call this float. From Wikipedia: “Float, or available reserve, is the amount of money, on hand at any given moment, that an insurer has collected in insurance premiums but has not been paid out in claims. Insurers start investing insurance premiums as soon as they are collected and continue to earn interest on them until claims are paid out.” In life insurance, float benefits the insurer and beneficiaries (not the policy holder), but float can also benefit you while you’re alive! Meanwhile life insurance is practically a license to print money: discuss.

The interest earned in the short period between a paycheck deposited into the online savings account and then transferred to the checking account to pay bills or otherwise is a form of float. You have cash now that may well be spent in the future, earning interest for an interim until it is paid out. Instead of looking at purchases as direct debits, look at them instead as accounts payable: overall, you may have the cash to cover the purchase, but if you can delay the payment while you earn a small return, you are still better off than had you not earned a return at all! This assumes that payments are not missed and that purchases are not financed at typical high-interest terms, instead being paid after some interest-free grace period.

Hold Me, Thrill Me, Kiss Me, Bill Me (Later)

This is where credit cards enter the picture again. Remember how I was charged $3 to have my $20? If instead I had charged $20 to my Discover card, a number of things would be grossly different. First, the $3 (15%) service fee is waived. Second, my account is not immediately debited as there is a delay between billing (when I am sent my bill) and payment (after the customary grace period to pay the bill). Third, I can pay the bill over time if I wished to (although I won’t). Fourth and finally, Discover offers 1% cash back on most items, and 5% on select promotional items! One percent may sound miniscule, and it is, but by combining interest free financing, float-return techniques, and cash-back, the returns accumulate.

Mind you, Discover engages in float techniques of its own. Discover (as well as Visa, MasterCard, and American Express) wants one of two things: cash now, or exorbitant fees later. When your debt is outstanding, each of these companies engages in a variety of complex structured finance techniques, such as issuance of credit-card backed securities, to ensure they both make money and mitigate repayment risk. These companies certainly don’t expect to collectively lose to consumers – but most consumers don’t take the time to maximize their personal benefit from these offers. Even when customers take full advantage of offers, and even if the creditors are ignorant to the concept of credit-card backed securities, the creditors still make money by charging merchant fees (usually about 3% after all hidden fees).

Remember, credit cards let you spend now and pay later. If you make a purchase at the beginning of a billing cycle, you wait a month for a bill. You then have a full month to pay the bill. Two months is one-sixth of a year, which at six percent, results in another one percent return. Combined with cash-back, you have now returned 2% of your purchase cost total. There are, however, a number of caveats with the Discover card method. Most importantly, Discover does both advertise and offer 5% cash-back on qualified purchases. Many times, these qualified purchases are made through retailers that have business arrangements with Discover card. Discover card is a truly ingenious marketing agency in this sense – many retailers are willing to slice 5% off their retail price to make a sale (however many aren’t; see the previous story!). These retailers often are not the best deal in the first place, so the 5% cash back offer encourages spending in a novel way. Another program that can help accumulate miniscule cash-back rewards offered by expensive retailers is Upromise, although Upromise is targeted more at helping parents save for college. Upromise gives back even less than 1% for the most part – after five years using Upromise to the fullest while still ensuring minimum spend to upscale retailers, I only recouped about $200.

But anyway, Discover, as with every other credit card issuer, sells their customer lists to other marketers offering everything from more credit cards to free razors on 18th birthdays. This is why I strongly recommend that if you get a credit card through any issuer, you look through the privacy policy for the “opt-out” instructions. Opting-out from creditor offers not only reduces your junk mail, it substantially reduces the chance you will be a victim of identity theft, by explicitly instructing your creditor not to share your personal information. Why are they sharing it anyway? Not for your benefit, but for their benefit – other creditors pay for leads – but who really knows where your information is going?

There are two other floating cash structures I have personally tried: “0% financing” at the point of sale, and “0% balance transfers”. Balance transfers are incredibly deceptive in my opinion: after combing Discover’s balance transfer policy, considering their 0% APY on balance transfers for the first six months, I figured I was getting a great deal. However, there was a fixed 3% balance transfer fee, that for 6 months, completely negated the 6% APY spread over 6 months (or, 3% return) that I floated. Discover refunded a Priceline.com transaction to me – which apparently is a miracle – but made sure to stick to their guns on the balance transfer fee. Alas there are many trade-offs to consider in personal finance strategies, so all actions should be carefully planned in advance.

On the other hand, “0% financing” offers are a much better deal, when they are used properly. Just like credit cards, retailers expect that a consumer will fail to pay their debt in accordance with the 0% financing terms. If the consumer misses a payment or fails to pay the full balance of a purchase within the 0% APR period, all the deferred interest is retroactively added to the next statement. In many cases on big-ticket items, this can amount to hundreds of dollars in finance charges, often 40% to 60% of the item’s original value.

The key to maximizing the benefit from 0% financing transactions is two-fold. First, only buy when you’re ready to buy – think of 0% financing as a means to an end and not a reason to buy. Second, keep the cash set aside in a savings account so that it earns a return for you while you are on credit at no cost. As long as you make your monthly payments, this can be a significant return. For example, on a $1000 item with 0% financing for two years, you might earn 5% on your saved cash, after making period payments, you may get over $90 back! And to sweeten the deal even more, if you use the HSBC online savings and checking accounts as I’ve described, you can deposit the money any time, then set up automatic transfers and bill payments so you don’t have to pay the bill each month manually. If you choose to do this, set the bill pay system to make the minimum monthly payment for the term of the 0% financing, then set the last payment to be a “balloon” payment that settles the remaining balance.

This may seem like a lot of work, but I find it to be completely worth it. It makes me feel good to get that extra 5% to 10% more out of my hard-earned money. This can really add up. For someone that spends $10,000 per year, who is able to recoup 5% of their spending through float-investment and cash-back, and who is able to get another 5% on their savings, this can amount to an extra $26,000 in savings after 25 years! Most people will spend far more than $10,000 per year, so if you’d like to explore how much you might be able to save, check out this compound interest calculator for floating savings (XLS) in an Excel spreadsheet.

Please remember that if you choose to do any of the things I’ve described here, make sure you can make payments on all your obligations, and make sure you have cash to cover anything you’re buying! Credit can be an incredible tool, but can also become a burden if used improperly. Happy investing!

If you are a bank or creditor, and are interested in having me review your product, feel free to contact me!