Manufactured Crisis

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There are many interesting questions in personal-finance.  And one of them is;  how much cash does one need for an emergency fund?

There are many schools of thought on this one.

  • Conventional wisdom seems to be that you should have six months living expenses set aside in an FDIC bank account.
  • Others argue that you need up to two years in an emergency fund to allow you to ride out a market correction.
  • Market backers will say that you should save a years worth of money in an emergency fund and then put it all into the market! The theory here is that it is rare that you will lose more than 50% of your assets in a market correction so you should be covered for six months in most circumstances.)
  • And some even argue that you should have an easily accessible line of credit, or low interest credit card for emergencies and just keep all of your money invested in the market all of the time so as not to miss out on any wealth building potential.

And you really can argue it any which way.

It all comes down to the essential qualities of cash (or money deposited in an FDIC insured bank account.)

As far as I can see, cash has one main benefit, and one main detriment.

The main upside of cash is that it is highly liquid. Meaning if you have your money in a bank account, it is always accessible to you in an instant. It is not subject to the whims of the market. And it’s value is relatively fixed.

The main downside of cash is that it doesn’t make you any money. In fact, it slowly and inevitably loses value to inflation. So tying up your capital in cash never really contributes to your building of net wealth.

And while considering the all of these various options today, I had an interesting question pop into my mind.

How much emergency cash could I generate in a year using only a single interest-free credit card, along with some juicy cash back cards, and the art of manufactured spending?

And here’s what I came up with.

Tools Required: 

1. A newly approved credit card with no balance transfer fees and an offer to keep a  balance interest-free for 15 months. For this example we’ll say that the card has a line of credit of $16,000.

This card would work pretty well: https://m.creditcards.chase.com/slate.aspx?

2. A few credit cards with 5% cashback category bonus opportunities. (this post highlights my current favorite)

3. An Isis Serve card for both me and my wife.

4. A PayPal business debit card for both me and my wife. 

And the whole cycle would look something like this.

Step 1:

Buy $10,000 worth of moneypak cards at drugstores with my 5% cashback credit cards. And load them onto my ISIS Serve cards.

Cost: 20 X $4.95 (purchase fee per $500 money pack card) = ($99.00)
Cashback: 5% X $10,000 = $500
Scoreboard: + $401

Step 2:

Buy $3000 worth of PayPal My Cash cards, with my 5% cashback credit cards and load them onto ISIS serve account with my payPal business debit card (1% cashback).

Cost: 6 X $3.95 (purchase fee) = ($23.70)
Cashback: 6% X 3000 = $180
Scoreboard: + $156.30

Step three: Online load $1500 onto both serve cards with a 1% cashback credit card.

Cost: zero dollars
Cashback: $30
Scoreboard + $30

Step four: Transfer Serve balances to my bank accounts.

Step five: transfer $16,000 of credit card debt from my cashback cards on to my new Chase Slate credit card where  the balance would remain interest-free for 15 months.

So at the end of these 5 steps I would’ve loaded $16,000 onto my cashback credit cards, transferred $1600 cash into my bank account via my ISIS Serve Cards, and netted $687.30 in cashback. (or an instantaneous 4.2% return on “investment.”)

And in doing so I would’ve effectively secured a $16,000 15 month interest-free loan.

It is also worth noting that this loan is scaleable. So If my wife also orders the same $16,000 credit limit, no fee, free balance transfer, credit card, we could just as easily borrow $32,000 for 15 months interest free.

And for all the of years preceding this putative emergency, the $16,000 (or $32,000) that I would not have kept in an emergency fund would have been earning market returns on its principal.

Try finding a better deal at your local credit union.

TKMaxwell desk_DW_122710

Hey, I like you.  I’d like to offer you an unsecured $16,000 loan at an APR of negative 4.2%…

But it is important to remember that there is no such thing as a free lunch. And the money that is being saved here, and made here, is as a result of 2 things: hassle and risk.

The hassle is not so bad. It’s probably about four hours worth of “work” in a single month, max.

But the risks are many and obvious and not to be dismissed.

Off the top of my head they are:

1. The risk of investing with leverage using potentially high interest loans.

If you cannot pay off your 16,000 in full within 15 months, you become subject to prohibitive interest rates of at least 12%. Yikes.

In other words, when you invest with your own money your most feared risk is the total loss of your investments. But when you invest with borrowed money your downside becomes compound interest in reverse, and even a negative net worth. Stockmarket risk becomes stockmarket risk on steroids.

2. The risk of bad timing.

Who’s to say that such a credit card offer will be available, or that you will be a candidate for such an offer even if it is available, when you need it?

3. The risk of depending on manufactured spending.

The manufactured spending landscape is constantly changing. And I would be very surprised if the approach described above is even feasible in 12 months. This is, admittedly, a shaky foundation on which to build your emergency fund.

4.  The risk of temporarily lowering your credit score.

As long as you have your $16,000  “loan”  sitting on your credit card, your credit utilization ratio will be increased, which will likely your credit score.  (Hat tip to reader Chris for raising this issue. )

And at the end of the day, these risks are just not worth taking (to me) in exchange for being able to earn market returns on six months worth of living expenses.

But here’s what this theoretical exercise does suggest to me.

  • The arbitrage skills required for manufactured spending are extremely adaptable and useful in the arena of personal finance.
  • The pursuits of early retirement, and of the miles game are perfectly complementary.
  • Knowing how to work the miles game is like having a wildcard in your back pocket. It gives you more options, and puts you on more secure financial ground without requiring even an additional dollar of net worth.

What say you? Is this another opportunity that is even better than sliced bread? Or are these merely the ravings of a madman?

alive-2
Why must they all laugh at my genius…

 

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6 Responses to “Manufactured Crisis”

  1. Robert June 15, 2014 at 8:57 am #

    I think the issue you raise in #2 is the problem: you wouldn’t be a candidate. Unless you lied on your credit card applications, you would have to reveal that you are unemployed. I suspect your lucrative credit card opportunities would be down the toilet at that point. Depending on the fine print of your contract, you might even be in default on your large loan (if you managed to get it before they learn of your employment status).

    • Miles Dividend M.D. June 15, 2014 at 11:23 pm #

      You could be right Robert. But you are seldom laid off without warning. And if this were the case then you could apply for one last churn of the appropriate cards during your last weeks of employment without lying about your income.

  2. Chris June 17, 2014 at 12:04 am #

    One note: this strategy could have real impact on your credit score depending on how much available credit you have, as you will be holding $16k of credit utilization before your month-to-month expenses on other cards…

    • Miles Dividend M.D. June 17, 2014 at 3:58 pm #

      Chris,

      You make an excellent point. I will add this to the risks section in the post.

      I do have a feeling that this effect would be minimal for a real churner, since the 16K would stay well below 10% of the total available credit.

      Also, as soon as the “loan” was repaid the effect on the credit rating would likely be mitigated.

      But your point is well taken, Thanks,

      Alexi

  3. Robert June 18, 2014 at 5:48 am #

    Saw this item today in an email. I’m skeptical they’d do this, but you never know. Worth thinking about for those who are using bond funds for diversification (classic 60/40 or whatever allocation you have) and who might be thinking of using it for emergency cash.

    “Own a bond fund? You might soon be subject to an “exit fee” if you want to sell.
    That too is under discussion this week at the Federal Reserve. “Officials are concerned that bond funds are becoming ‘shadow banks,’ because investors can withdraw their money on demand, even though the assets held by the funds can be hard to sell in a crisis,” according to this morning’s Financial Times.
    “Exit fees would seek to discourage retail investors from withdrawing funds, thereby making their claims less liquid and making a fire sale of the assets more unlikely.””

    • Miles Dividend M.D. June 18, 2014 at 8:55 pm #

      Why gild the Lily? The real issue is the inability of people to plan for their own retirement.

      Shouldn’t we just strengthen Social Security? It’s a very successful and valued social program. It works.

      Forced pensions are the way to go If you want to guarantee retirement security for the elderly.

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