C.R.E.A.M.

The bigger the bill, the harder you ball
Well I’m throwing mine, cause my money long

Wiz Khalifa, “Work Hard, Play Hard” (2012)

Well, my money’s not long yet — which is why I’m writing this. Before we begin, the usual disclaimer applies:

This is an opinion and is for informational purposes only. You should not construe this information as legal, tax, investment, or financial advice. This is not a solicitation to buy or sell securities. You should consult your own legal, tax, investment, or financial advisers before engaging in any transaction.

W-2: Wages

Every employer engaged in a trade or business who pays remuneration […] for services performed by an employee must file a Form W-2 for each employee.

Internal Revenue Service, “About Form W-2, Wage and Tax Statement”

Thanks to the largesse of Uncle Larry, my net worth peaked this summer, exceeding five figures for the first time. My gross (pre-tax) wages for the summer were just a tad less than $40,000, the most money I’ve ever seen in my life, and after withheld taxes, I took home about $25,000.

Looking at the $15,000 of taxes that my employer withheld and thinking: taxation is theft? Google computed my tax bracket on the basis of my employment for a full year. I could have filled out a Form W-4 to reduce my withholding, but since I’m taking a year off from school and plan to work more, I elected not to. But if you are working over the summer only, the IRS urges you to take another look.

I took AP Economics back in high school, which wasn’t much, but it was enough to know that assuming the Fed hits its target of 2% annual inflation, every day, my earnings are losing 0.005% of their value. In more concrete terms, what I can buy for $100 today will cost $102 next year.

To mitigate this depreciation, I needed to put my cash to work, ideally in something that returned at least 2%: so that my $100 today would be $102 in a year, and I’d still be able to buy the same amount of stuff.

1099-INT: Interest

File Form 1099-INT for each person […] to whom you paid [interest] of at least $10.

Internal Revenue Service, “About Form 1099-INT, Interest Income”

All of my birthday money from the past nineteen years was in a savings account offered by my hometown credit union, and every month, I’d get a few nickels of interest. Once I got my first paycheck, I realized just how much I was losing to inflation: the annual percentage yield (APY) on the account was 0.15% (and the national average is hovering around 0.09%), far below the 2% that I needed to maintain my assets’ value. So, where to put my money to work?

Stocks and Bonds

My first thought was to plow it all into the market. The S&P 500 has historically had 7-10% annual returns, and as a young person with high risk tolerance (and enough time to weather a few downturns before retirement), it made sense for me to go for a riskier portfolio allocation, such as 90/10 stocks/bonds or even 100% stocks.

Easy enough, right? Unfortunately, this wasn’t money I was saving for a far-off home purchase or retirement — I likely needed to draw on this money soon, relatively often, to pay for rent in San Francisco, public transit, and other nice things. I couldn’t afford to weather a bear market and I wasn’t necessarily ready to put this money away for the long term and wait a downturn out. If the stock market tanked next month, that could mean significantly less runway for my plans. I wasn’t even sure if I had enough cash for the six-month emergency fund typically recommended by financial planners.

Furthermore, over the summer, there was a lot of CNBC squawk about the yield curve and (at the time) its recessionary implications, which made me a little wary, so given that I didn’t have much cash to begin with, I came to the conclusion that while I’m moving towards financial independence and building up principal, I should hold off on dealing with the stock market and keep my money in lower-risk, higher-liquidity vehicles.

Treasury Bills

One of the fundamental tenets of investing is the delicate balance between risk and reward: if you make a riskier investment, you potentially can make (or lose) a lot more money. Similarly, if you make a less risky investment, your potential for gain (and loss) is less. What about an investment with zero risk? In finance, the rate of return of this theoretical zero-risk investment is known as the ”risk-free rate.” While no investments have truly zero risk, the yield of Treasury bills — short-term debt backed by the full faith and credit of the United States government — is often quoted as the risk-free rate, and barring nuclear war, it generally suffices.

A common cash-parking strategy is to build what’s known as a “t-bill ladder.” Essentially, you divide your cash into four equal piles, and every week, for four weeks, use one of those piles buy a four-week treasury bill. On the fifth week, your first bill will mature, you’ll get paid, and you can use those proceeds (i.e. your first pile, with a bit of interest) to buy another four-week bill, and so on. Four-week treasuries are currently yielding (annualized) about 1.6% (as of November 15th, 2019, a four-week bill is yielding 1.59%), and unlike other bonds, gains are exempt from state and local taxes. You still need to pay federal income taxes, though, which based on my highest marginal federal bracket of 22%, makes the effective yield 1.24%. According to the Bureau of Labor Statistics, inflation for the 12 months ending in October 2019 was 1.8%, so unfortunately, this strategy is still trailing inflation by 0.56%. And if I wanted to withdraw, it could take up to 4 weeks (waiting for the last bill to mature) to get all my cash back. Because of these caveats, I wanted to look into other options.

High-Yield Savings

In the middle of the summer, someone told me about the Wealthfront high-yield savings account, which at the time was offering 2.57% APY, one of the highest rates on the market for an essentially risk-free product (by splitting deposits among multiple banks, the account is FDIC insured up to $1 million). After taxes — in this case, all of federal, state, and local — the account had historically seemed to still yield a bit more than treasuries, and it was also the most liquid option, with the money always ready to be withdrawn (usually within a day via ACH).

Because of these factors, I ended up moving most of my money to Wealthfront’s savings account, putting more into the account as I got paid throughout the summer. Changes in the target federal funds rate in the months since July have lowered the yield on the account to 1.82%, but given the current rate environment, it’s still pretty solid (albeit not as good as some competitors, like Marcus, which currently offers 1.90% — but yields change and in a few months Wealthfront — or Betterment — could be offering more, so I’m not sweating it). At the current rate, and based on my highest marginal state (California’s 6%) and federal rates (22%), the Wealthfront savings account yields 1.31% after taxes, so it’s still (barely) beating T-bills, by 7 bips.

We’re still losing to inflation of 1.8%, so one question you may be asking is why even bother with this at all. In my mind, firstly, it’s better to be losing 0.49% a year (buttressed by the savings yield) than 1.8% (by just keeping the cash in a checking account or under my mattress). Second, part of why yields are being squeezed so much is because of the recessionary fears I mentioned earlier. By cutting the federal funds rate (three times, in fact, between when I started saving in the summer and now in November), the Fed is making it more costly to save and easier to borrow and consume (via lower interest rates), in the hopes of expanding the economy. Consequently, it’s making putting money into the stock market more attractive for those who want to beat inflation.

We are in the middle of the longest bull run in history, and if there’s anything consistent about the past, it’s the boom and bust cycle of the macroeconomy. Whether it’s student debt, corporate debt, or emerging market debt dealing the fatal blow, I’m still not entirely convinced that this run can last forever unscathed, so, at least for now, I’m continuing to keep my money in a savings account.

The macroeconomic situation can (and will) change, though. I’m anticipating working more (and saving more) over these next few months, and I have an item in my calendar set to April 2020 — hopefully once I have enough of an “emergency fund” and can start saving and investing with a bit more discretion — to put some cash into stocks if the contraction never manifests (or buy the dip if it does). Perhaps my money will be long soon.

1099-MISC: What Else?

File Form 1099-MISC for each person to whom you have paid during the year […] at least $600 in […] other income payments […] cash payments for fish […] or any fishing boat proceeds.

Internal Revenue Service, “About Form 1099-MISC, Miscellaneous Income”

When I do buy stocks, I’ll likely want to keep them in a tax-advantaged retirement account. I haven’t thought too deeply about retirement yet, but I’m planning on starting out with a Roth IRA — a retirement account where I pay normal income taxes on money I contribute (i.e. deposit) but in return don’t have to pay taxes on investment gains when I withdraw (which I can only do after age 59 ½ as part of the conditions of the account). The alternative is a traditional IRA, where I defer taxes when I contribute but pay taxes on gains when I withdraw (again, after age 59 ½). There are a few other subtleties — most importantly for me, in the off chance that I want to withdraw early (before age 59 ½), with a Roth IRA, I can take out my contributions (i.e. the money I put in) without paying any taxes or penalties, while with a traditional IRA, I need to pay taxes (at my income bracket at the time of withdrawal, which will probably be higher) and a 10% early withdrawal penalty. So at the current time, the Roth is not only more flexible with withdrawals but also has advantages from a tax perspective that can’t be achieved with a traditional.

In terms of asset allocation, since I’m so young, I plan to have an aggressive — 100% or close to 100% stock — portfolio since I can weather a few downturns before retirement. And even if I retire early, as someone in the tech industry, I think most of my money — at least for the next few years — will come from working rather than investing, so I’d rather keep my retirement accounts focused on the very long term and only retire early (i.e. before age 59 ½) if it’s possible to without dipping into those accounts.

A home is perhaps in the (long-term) horizon too, and as I’ve become more and more financially independent — buying my own meals, paying my own rent, and booking my own plane tickets back home — I’ve opened up a student credit card to build a credit history. I’m currently using the Discover It Student Cash Back card which offers 2% cash back in the first year with no annual fee. It’s a solid first card, but after the first year (upon which the card will revert to 1% cash back) I’m considering opening a new credit card with better benefits. A few friends have done well with the Chase Sapphire Reserve, but it has a $450 annual fee that I’m a bit wary of, and given my short credit history it’s unlikely I’ll be approved anytime soon. I might just end up getting a solid fee-free cash back card (perhaps the Apple Card) instead of a points-based one with a complicated fee structure. Regardless of which card I get, though, I plan to keep my Discover card open (I just won’t use it) to preserve the length of my credit history, since a longer credit history contributes to 15% of my credit score.

The benefit of having a strong credit history is that it’ll help me get a better mortgage rate — the idea is if you have a higher credit score, you’re a less risky borrower — and although I have no current plans to buy a home, having this credit history has already proven useful. My new landlord in San Francisco requested my credit score before renting to me, and I was very happy that I already had one and could provide it.

Despite all this preparation, with all this positive cashflow, it’s admittedly been a bit more difficult to stay frugal. I usually avoid expensive clothing, but I ended up buying not one, but two Patagonia vests in June (to be fair, they’re quality gear and I intend to keep them for a while, but still, I don’t usually spend that much). I still take public transit as much as I can, though, and wait at least 48 hours before making online purchases. But as my cash pile has grown bigger, staying lean is definitely something I’ve had to keep at the forefront of my mind a bit more deliberately.

A lot of the stuff I’ve outlined above won’t have benefits as immediately, though — for the most part, I’m sowing the seeds for a far-off financial future. I’ve had to do a lot of reading to understand all of this, and this is how I’ve been managing my assets, but once again:

This is an opinion and is for informational purposes only. You should not construe this information as legal, tax, investment, or financial advice. This is not a solicitation to buy or sell securities. You should consult your own legal, tax, investment, or financial advisers before engaging in any transaction.

I know about as well as anyone else where the market’s headed and I’ve only been seriously handling my finances for a few months now. Read the sources, look at the data, and come to your own conclusions about what to do with yours. There’s nothing like skin in the game to make something like this exciting — that, I know for sure.

Planning on getting a credit card? Use my Discover referral link and we’ll both get $50 (or not, and we’ll both get $0).