Jeff Lancaster SAN FRANCISCO • SILICON VALLEY

“Frugal Ain’t The Word” Series at all department stores (whatever those are). I’ve got two teenagers and I buy a lot of groceries, so 6% cash First Up: Optimizing Credit back is a slam dunk. Cards With the Amex I pair a new VISA card with a new sponsor. On the VISA I get 1.5% cash back until I’ve spent $15,000, and then it’s 2% cash back after that. So I use the VISA for everything except gas and groceries. A back of the envelope calculation shows that if I spend $12,000/year on groceries, $5,000/year on gas, and $31,000/year on every else (for an average of $4,000/month on the credit card) my cash back will be $1,415, or almost exactly 3%. Even people who travel frequently and might prefer

points or airline miles will seldom get this kind of value, Jeff Lancaster, CFP® although with very careful planning and an enduring Principal enthusiasm for Gershwin it’s possible. The sad truth is

that blackout dates and other ticky tack rules mean that For the past many years I’ve used a VISA credit card frequent flyer miles are seldom worth as much as they that gave me 2% cash back for everything I purchased. seem, which is why airlines are usually happy to sell This was the best deal going, and so when I got a new them. My sense is that people who prefer miles to cash card in the mail a few months ago announcing that the either don’t know what they’re missing, or they like the card had a new sponsor, I quickly called the associated “mental accounting” that makes that occasional ticket 800 number. The person on the other end of the phone seem “free”. For those who want guaranteed, nothing- addressed my “benefits” question by telling me about to-do, stress-free, in-the-bank savings, go for cash back. accident insurance, travel insurance, rental car insurance, so on and so forth, before I cut her off and The credit card game gets better for those who choose to asked about the 2% cash back. “That, unfortunately, is play above the rim, though added complexity is coming to an end,” she said. “It’s going to be 1% going involved. For instance, about once a year I seem to need forward.” Because I put everything on a credit card, to buy something reasonably expensive at Sears, or some going from 2% cash back to 1% cash back was going to place like that. Every time I do this the person at the be a costly proposition. counter tells me that if I open a new credit card account I’ll get a 10% discount, 7% more than I would get by Fortunately, a quick search under “cash back credit using my Amex. I always open the department store card” and a bit of reading identified a more rewarding if account. When the bill comes a month later I pay it, and somewhat more thought-requiring process. I now carry I include a short letter telling the company to cancel the two credit cards. One is an American Express card, a account. You can do this once each year with pretty card I’ve never had before because I don’t like paying an much any of the card shilling merchants. It’s possible annual fee and it isn’t accepted in as many places as your credit score might be dinged modestly, but if you VISA. What’s terrific about the American Express card, aren’t buying a house or refinancing in the next year or though, is that I get 6% cash back on all grocery two, it’s worth considering. purchases (except at warehouses, like my beloved Costco,) 3% cash back on all gasoline purchases, and 3%

Another strategy that I’ve read about but haven’t yet tried involves those “grocery store” discounts. It seems possible that I can go to Safeway and buy a VISA gift card (I’m still going to buy most of my groceries at Trader Joe’s) and get 6% cash back. The gift card is essentially cash, and I can therefore transform virtually any purchase with the gift card into the magical “groceries” category. Cha-ching. Finally, it goes without saying that the interest rates and late fees require that the credit card gets fully paid each month. With the “bill pay” feature, however, I’m not going to stumble and pay late: the credit card companies pull money from my checking account automatically each month, the day the payment is due. How to put yourself in the position of the credit card company and lend money to others at mid-teen rates of interest will be the subject of a future “Frugal Ain’t the Word.”♦ Email Jeff at [email protected]

Jeff Lancaster SAN FRANCISCO • SILICON VALLEY

“Frugal Ain’t The Word” Series tape measures, a salad spinner, rechargeable batteries, a Weber barbecue, dishwashing detergent, furnace filters, Shopping Online at Amazon and a lifetime supply of incandescent bulbs that are apparently bad for the environment but also actually

allow me to read. Can you imagine how much time and money, and parking lot and Mariah Carey anguish all of this would have required? And yet with Prime you simply “Buy with 1 Click” and, poof, it’s on your doorstep. Even though I’m a long-time Amazon enthusiast, I’ve held off on buying their $79 e-reader, the Kindle. (As I write this Craigslist shows a new one for $40.) This is because I already have an iPad and it works fine when I Jeff Lancaster, CFP® need to get my hands on a piece of literature instantly. Principal In addition to preferring the physical book to the electronic version, I also find the cost savings of ebooks There’s nothing inherently frugal about shopping online. disappointing. My most recent physical purchase, The Search engines may help ensure that the price you pay Sense of An Ending, was $16, while the download will be competitive, but by the time shipping costs (and would have cost me a not-that-much-less $12. Amazon delays) are factored in, that trip to the mall may seem has always had free downloads but the selection is like a reasonable, if painful alternative. That tradeoff pretty limited. Free or not, I’m not reading Tale of Two doesn’t need to be weighed, however, if your online Cities again, and neither are you. shopping experience begins with a subscription to the sublime Amazon Prime. The key benefit is rather simple The Kindle purchase has become more enticing now that but the bells and whistles are nice too. Amazon has offered up a “lending library” to Prime members who own Kindles. (An iPad won’t cut it here: For an annual fee of $79, a subscription to Amazon Amazon wants you to buy a Kindle.) The library Prime means that most anything you buy from Amazon provides access to thousands of contemporary titles. A ships for free. This is true for the things you want quick survey shows books for which I recently paid full shipped to your house and also for the things you want price, including The Finkler Question and The Big Short. shipped to other domestic addresses. Even more If these were still on my “want to read” list, remarkable is that Amazon Prime merchandise arrives “borrowing” them at no cost would be tempting. in two business days. For an additional $4 you can receive next day delivery. Just looking at your car costs I hesitate, despite the fact that the students in my more than $4. household may find electronic books rather useful. If someone you know was recently asked to write an essay Free shipping for an entire year makes sense in on Turgenev’s attitudes towards the romantic, a quick proportion to the frequency of shopping of course, and download of Fathers and Sons followed by a search for this runs across the grain for those who seek to shop the word “romantic” is tough to beat. cautiously. But if you imagine that Amazon is only about buying books, you’re not spending enough time “But there’s more!” say those cheesy infomercials, and on the site. A review of things I’ve purchased in the past indeed Prime also comes with “instant video” access to several months includes books, yes, but also soft fabric thousands of movies and television programs. Most of

Jeff Lancaster SAN FRANCISCO • SILICON VALLEY

the content is awful, but there are some gems. In the past few months I’ve streamed Man on Wire, Office Space and Food Inc. People are always bad-mouthing bacon, but I’m going to keep eating it. With essentially unlimited free delivery of merchandise, books and video content, you might think Amazon loses money on the deal. According to their CEO, they do. The state of California is unhappy, too, because Amazon customers don’t have to pay sales tax at time of purchase. (Of course, you already knew that the “use tax” attributable to purchases at Amazon and other out of state sellers is reportable on Line 95 of the California state tax return.) Surely before long, Amazon will stop subsidizing Prime, and California will be able to hit you for the sales taxes up front; but even then it’s still going to be a great deal. ♦

Email Jeff at [email protected]

Jeff Lancaster SAN FRANCISCO • SILICON VALLEY

“Frugal Ain’t The Word” Series warned that these sites are as compelling and addictive as fantasy football. Hundreds of small scale borrowers Peer to Peer Lending tell their story: why they need the money, why they will be able to pay it back, and over what time period (three

and five years are most common.) While there are an endless variety of needs stated by borrowers (a new car, a new business, an engagement ring), the most common reason stated, by far, is the desire to pay off existing credit card balances. The lending sites don’t merely examine this activity from afar; instead, they use a variety of factors to assign each loan a grade. Exactly as is the case in any lending market, borrowers deemed most reliable can borrow at fairly low interest rates, Jeff Lancaster, CFP® perhaps 6% or 7%. Borrowers deemed dodgiest may Principal have to pay as much as 20% or 30% interest. The sites then do the math for you. For instance, the loan to the Recent articles in the Wall Street Journal and elsewhere person with poor credit who wants to do a drug rehab in have highlighted the rapidly growing phenomenon of Hawaii may offer a 25% yield, but, with the likelihood of so-called “peer to peer” lending. Popularized by default shown at 14%, the loan’s estimated return to the companies such as Lending Club and Prosper, these creditor nets out at 11%. companies and their web-based platforms offer Just as no life insurance company would insure just a individual investors the tantalizing opportunity to play single life, the law of large numbers is a big part of the the role historically performed by credit card companies, reason lenders are willing to provide unsecured loans to lending modest amounts of money to lots of strangers at strangers. Imagine you would like to open a new surprisingly high rates of interest. Below we explain account and fund it with $10,000. If you wish, you can how peer to peer lending works. We also offer up a send the entire $10,000 to the person on his way to variety of considerations readers may wish to weigh Hawaii. But if you consider yourself an investor and not alongside otherwise enthusiastic media stories. a gambler, you might likely prefer to lend money only to The premise of peer to peer lending is that online those with good credit. Indeed, these sites will happily platforms can cut out banks’ onerous branch cost slice that $10,000 like an onion on your behalf, and with structure and efficiently connect investors (or a few clicks your money can be parceled out in $25 “creditors”) who seek to lend money with borrowers increments to 400 different borrowers. A basket of loans who need cash fast. From the perspective of the creditor, in a more familiar environment might go under the a successful relationship is one in which a loan is re-paid name of “bond mutual fund“. And, assuming the loans and at an interest rate deemed competitive. From the you prefer to make carry an average 8% yield and have borrower’s perspective, the loan works so long as the an anticipated default rate of just 2%, you might cost of capital, defined as the interest rate on the loan, is “expect” to earn 6%. This kind of high quality yield is lower than what might have to be paid elsewhere, most especially attractive when compared to the 1% yield often to the credit card company. earned by owners of 5-year Treasury bonds, to say nothing of the 0.01% yield available in money market A quick visit to the informative and easy-to-navigate funds. peer to peer lending sites sounds like a good idea, but be

Jeff Lancaster SAN FRANCISCO • SILICON VALLEY

As part of our investment committee’s effort to research loans continue to be counted as recoverable until the higher yielding alternatives to investment grade credit, moment they are written off. I prefer to assume a late about 18 months ago I in fact opened my own accounts loan is going to sour, which experience has borne out with Prosper and Lending Club to see if they might more often than not. really work as well as seemed not just possible but in Finally on the negatives, while it must be said that an fact probable. To cut to the chase, over the past 18 annualized return in the neighborhood of 7% over the months, taking into account loans still current and those past year and a half is quite good, over this same time already gone bad, these accounts have earned an period a typical (taxable) BOS bond portfolio has earned aggregate total return just below 7%. This is an attractive almost as much, and that’s with much less risk and far rate of return if one chooses to compare the performance greater liquidity. Were the economy to weaken going of peer to peer loans with high quality bonds. forward, we can imagine that the default rate on As the companies’ web sites both rightly note, however, unsecured credit card loans would rise. Conversely, peer to peer loans are risky and, as such, are more investment grade debt might prove quite resilient as appropriately compared with junk bonds. Lots of investors sell stocks and buy bonds. In short, while peer borrowers default –sometimes without making so much to peer loans likely exacerbate portfolio risk during as a single month’s payment -- and there’s not a thing periods of adversity, investment grade bonds might well the investor can do once a borrower proves unable or rise in value while stocks are falling. unwilling to stay current with note payments. These negatives notwithstanding, we remain intrigued Another substantially negative aspect of peer to peer by the evolution of peer to peer lending. We are lending is the lack of liquidity. Unlike the person who committed to continuing our research in this rapidly needs cash and decides to sell a bond mutual fund maturing market. While we know that the investment today, peer to peer loans are much harder to move at a history of those who have reached for yield in fair price in a secondary market. Whether it’s sand state frustrating environments is seldom pretty, we don’t real estate or auction rate paper, investments that are intend to dismiss peer to peer lending as insufficiently falling in value are especially frustrating for those who attractive for BOS clients. We intend to keep following want to sell but can’t find anyone to take the other side this market carefully.♦ of the trade.

Other negatives must be noted, too. On the tax side, Email Jeff at [email protected] interest on good loans is reported on Form 1099-OID (original issue discount) and is taxed at marginal rates while bad loans are reported on Form 1099-B and show up on Schedule D as capital losses. That’s an irritant, and explains why Prosper and Lending Club promote IRAs as good vehicles for these accounts. It’s also irritating that the web sites calculate rates of return for you but don’t do a very good job of it. One company with which I have an account estimates my rate at about 9% and the other says it’s closer to 10%. Somebody’s way off here and, frankly, it’s not me. The problem apparently relates to the way non-performing

Jeff Lancaster SAN FRANCISCO • SILICON VALLEY

“Frugal Ain’t The Word” Series change the motor oil, rotate the tires, or deal adequately with the dog’s muddy paws. There’s no big sales tax hit, The Frugal Scores a Sweet either, because you never buy the car. Unfortunately, all New Ride, For Free! of this is taken into account by the bank loaning you their car. They know they have to continue paying most

of the onerous costs associated with ownership, and so they price leases accordingly. Real deals are rare, and it seldom makes sense for an individual to lease a car unless it can be written off as a legitimate business expense. If you use the car to deliver pizzas or visit clients then you may not have a problem, but if you mostly use the car to haul groceries and schlep kids to school and piano lessons, good luck with that.

Without negating any of the above, the good news is Jeff Lancaster, CFP® that there are yet other financial planning principles that Principal allow for the prudent acquisition of a new ride. I confirmed this by carefully running the numbers before One of the first rules of optimized financial planning is, signing up for a three-year lease of what is now “my” “don’t buy a new car.” New cars depreciate rapidly, new Fiat 500e all electric car. scheduled maintenance is costly, sales and personal Among these important rules is “capture government property taxes are outrageous, insurance costs are high, subsidies,” and indeed the State of California’s Clean and the nice smell goes away as soon as a wet dog or a Vehicle Rebate Project just mailed me a check for $2,500 large order of fries works its way to the back seat. to reward me for signing an electric car lease. They also Perhaps it is for many of these same reasons that sent Fiat a check for $7,500. Had I purchased the car, the psychological studies confirm that the pleasure derived entire $10,000 would have been mine, but with that from buying and operating a new car is ephemeral. Of would also have come all of the financial baggage noted course, even remotely calculating people know all of above, to say nothing of fears of technological this. Seemingly unlimited automotive industry obsolescence. advertising budgets are therefore required to retard our otherwise sound judgment. As was discussed in a prior newsletter piece regarding Amazon’s wonderful if mysteriously priced-to-lose- There is a way to get around many of the financial money “Prime” program, another valuable planning disadvantages associated with buying a new car: you rule is “acquire high quality goods and services from can lease. A lease is a surprisingly complex financial businesses willing to sell at a persistent loss.” The lease arrangement, but basically a lease is a loan. A bank lets certainly applies here, with Fiat’s own chairman you drive their car for a few years and then you have to lamenting that his company loses about $10,000 per give it back. In exchange, you give them some money up electric vehicle, even after the government rebates. You front –typically thousands of dollars- and you also make might ask: why would Fiat produce money losing monthly payments throughout the duration of the lease. electric cars? As it turns out, they have no choice: due to On the plus side of this equation, rapid depreciation is California environmental mandates, large automakers no longer a worry since, again, it’s not your car; neither have to sell a percentage of zero-emission cars in order is it necessarily your long-term problem if you neglect to to sell regular gas guzzlers.

Jeff Lancaster SAN FRANCISCO • SILICON VALLEY

Even given that this is so, how are they pricing the lease rental car companies to get me one. You probably such that they still lose so much money? I paid virtually already guessed: that’s free, too. ♦ nothing down, and even with license and registration all of those ticky tack closing costs added up to just $1,265. The car itself is just $215/month (I could have chosen a Email Jeff at [email protected] less attractive color for $199) and there’s another $18/month of taxes on top of that. When I put all of the costs on a spreadsheet and subtract my clean vehicle rebate, the total cost of the car (including the customary end of lease “disposition” fee) comes to $7,575, or about $210/month out the door. As the cheesy infomercial says, “but there’s more!” and indeed there is. Specifically, gasoline is a lot more expensive than electricity. I’ll forego all of the detailed inputs (email us if you’d like a copy of the spreadsheet) but if I continue to drive about 800 miles each month, my PG&E bill will go up about $74/month but my Chevron bill will go down by about $195/month, a savings of about $120/month in fuel costs. Because a regular plug works fine, I didn’t choose to install a high speed electric vehicle charger, although if I had there’s a 30% Federal tax credit for that, too. In addition, because I sold my prior car (on Craigslist – a piece of cake) I estimate that I will save at least $1,000 per year in depreciation costs. I also estimate that I will save at least $500 per year in maintenance I would have done on my old car but won’t do on the bank’s car. It’s nice to drive somebody else’s great-smelling car without a care in the world regarding depreciation or maintenance. The bottom line? I calculate that relative to the costs of continuing to drive my 12-year old car, the next three years in the Fiat will likely cost me -$322. That’s right: due to the munificence of California taxpayers and the frustration of Fiat management, I’m getting paid to upgrade to this nimble, quick, parks-on-a-postage- stamp, pleather-seated, satellite-radio-equipped new car. The free white sticker means I can also drive in carpool lanes even when I don’t have any passengers. And for those weekend trips when I might need a gasoline powered car with normal range, Fiat has a deal with