My pal over at Chasing The Points has come up with a yet another crazy scheme for riches. Read the post here if you haven’t already: Jumping Into Debt To Manufacture Spend And Invest. We’ve met in NY a couple of times to talk blog, travel, finance, etc and I think he is one of the few innovators out there. Some of the projects that he is currently developing are very impressive indeed. I believe that when you are innovating you have to push the boundaries too far, else you will never know what you can achieve, and in this latest post, I wonder if he is pushing boundaries, or left them way behind.
The overview of the gig
Basic
- Obtain a student loan – use funds to invest in stock market.
Optimized
- Deducting Taxes from Loan, and using Evolve to pay it down at 5% cash back.
The costs
- 4.3% origination fee of loan
- 6.4-7.2% APR depending on when the loan is originated.
The Math
It sounds like madness to me, but could there be a method to it? Lets look at the math and decide. For the purpose of this example I will assume a loan of $10,000 and an effective tax rate of 35% (including city and state) CTP decided to use the 7.2% APR so I will too. Here goes:
$430 origination cost
Assuming they do not amortize the fee into the loan, a 10 year repayment plan would result in:
- Monthly Payments of $117
- First Year Interest Paid of $697
- Total Interest Paid of $4,057 to 10 year term (unlikely to occur)
Deductions
Student Loans are interesting… they are one of the few deductions that you can take without needing to itemize, this can be very useful, as the standard deduction is a powerful thing for many filers. In this case, in year 1 we could deduct $1,127.
It is very important to remember that a deduction is inferior to a credit when it comes to taxes. A deduction means your salary is reduced by that amount, and therefore to ballpark the value you have to multiply the deduction by your tax rate. We said 35% (arbitrarily) so the value of the deduction is $1,127*35% or $394.
What that means is total out of pocket cost is $1,127-$394 for $733
At this point, lets bring in the Amex Blue Cash, 5% cash back… this thing changes everything, the APR is meaningless in comparison. $10,000 will have a net cost of $733 in year 1, but at 4% net, you could earn $400 each month using the Blue Cash card (old style) kinda makes for an interesting equation you might think…
Here’s a problem though…
You can earn the $400 per month without getting into debt. The manufactured spending cycle is such that you can buy in and exit out of positions fast enough to pay off the bill before it hits, and pocket the profit. The deal that Chasing The Points is chasing has him not doing this, instead he is pulling the money out of the loop, and putting it into the stock market.
Is this smart? My initial reaction is hell no! But we need to think about this as not pure economics anymore, this is hyper economics – when you have opportunities to earn $400 per month from a credit card.
Got the Line, Got the float, but how can you liquidate?
The interesting aspect is the restriction to earning in Manufactured Spend is very rarely on the Line of Credit or Float side… in fact it is on the exit side. I could, in the time of Vanilla Reloads and CVS walk into a store and purchase $5,000 every day of these cards. My wife could do the same, so we could acquire $300K per month, paying fees of $2,370 and spinning off $15,118 in cash back for a net profit of $12,748.
Of course this is theoretical, and assuming that Amex didn’t get upset with us for earning $12,748 per month in profit… but it could hypothetically happen. The issue… what the hell to do with all the cards? The most obvious exit strategy was Bluebird or Serve, but only one per person means you have another $280K to liquidate each month.
Enter Evolve Money
Evolve Money is a bill pay partner of this loan – by originating it he is able to find another way to exit out his funds. Personally I never got on the Evolve bandwagon, I just don’t have the options, no debt service to make so I am kinda stuck.. which is annoying because I would like to be able to push through more money. I can see the desire to take on debt in order to open the payment pipeline. When you can earn $400 in a month it’s pretty enticing.
However- if you earn $400 in a month, then you have basically paid off that $10K loan, in two, and you are back to square one. What you have effectively done in this case is fund an investment account with a credit card. This is a neat concept, but you paid $430 and earned $400, so you got into the market for $30 of loss, plus annual APR. Of course, you can cycle the 10K many times over during a month, and generate a lot more from it than $400, but that is neither here nor there in regards to taking a loan, that is purely about credit lines and float. Alternatively you could fund the debt over the long term, with the short term inflows of Cash Back.
“Never fund long term debt with short term debt”
If you don’t have the funds capable to pay off the Student loan in month 1, then you are borrowing money to invest, this concept of leverage is nothing new, found in all manner of debts,from margin accounts to mortgages. The problem is that you have many moving pieces… if they move in the wrong way you can get trapped funding a long term position with a short term debt squeeze. Let’s run a worst case scenario, and see how bad it can be.
Doomsday Scenario
- Borrow $10,000, pay origination fee and incur annual interest – net cost in year 1 $733
- Evolve money stops payments to Student loan, or stops taking giftcards etc – exit route closes
- Stock market drops 20%
As you can see, despite the title doomsday, this is actually a reasonably viable, if somewhat pessimistic scenario. Anyone who is involved in the stock market should know it can easily drop by 20%. In fact I advise anyone investing in stocks to be OK with a 50% drop, else they shouldn’t be in the market.
The impact of this to net worth would be:
-$733 for loan
-$2000 for stock market loss
Or would it? Remember, one of the key points here is ‘taxes’, so the $2K loss wouldn’t be totally washed, if applied to ordinary income 35% would be reclaimed.
New total loss = $2,033 ($733+$1,300)
Or is it?
If one was disciplined, they could vow to pull the money from the market the moment that Evolve stopped being a bill pay partner – which might mean the miss the crappy stock day… so the new loss is $733
Or is it?
Well, if Evolve stops bill pay, and they pull the money out of the market, they could pay back the loan in full, meaning no annual interest payments, and the cost of the venture would be $430, which after tax could be $280.
If, then, else
There are series of outcomes that could occur – for example the stock market could keep on rising, the $10,000 could increase in value. The Evolve option may be there in perpetuity. If things start going awry if the scenarios are mapped correctly costs can be minimized. Without a doubt it is impossible to know when the market may drop 20%, so that has to be something that you are happy with. But the funny thing is, in the world of hyper economics, a 20% drop, or $2K in a month isn’t earth shattering. Due to the tax arbitrage between the Capital loss and a good month of earning in a tax free manner, the net loss on the $10K investment could be recouped in a matter of weeks.
With control, even an investment of $10K like this is actually manageable. There is downside risk, but there is upside too… as I run through the concepts and numbers I have to say I am more comfortable with the idea. However, I do happen to have one other variable that I am factoring in, I know the guy behind Chasing The Points, he is a smart cat, and he has a good job, so I think he can handle this. As a concept for people who I don’t know, I wouldn’t advise going near it.
“$10,000 will have a net cost of $733 in year 1, but at 4% net, you could earn $800 each month using the Blue Cash card (old style) kinda makes for an interesting equation you might think…”
Please “show your work” on the $800/month figure based on a $10.000 loan.
I’m not sure if it was expressed correctly. I was trying to say on the one hand you have $10K costing you $733, which some might say was wasteful, but on the other $10K through Evolve in a month = $800 profit. So I can see a draw to gaining the debt. The issue of course being that the loan would be paid off (essentially) and your exit pipeline closed.
Let’s see the math on how you get $800/mo profit on a $10,000 loan with a 4% net.
Would also be interested to know how you propose to jam $10k through the Evolve pipe through a single biller in a month.
Ah yes, a fair point, I was counting it double. Easy fix, I’ll edit the post, or you can cycle it biweekly 🙂 since I’m off the clock now I’ll let you do the latter! Good catch. Edit- fixed, reduced it to $400.
Quite an alternative for the source of gift cards is Macy’s at the moment where you may purchase a $500 for a total of $503, including the fee. That being said my wife’s $8K student loan might be paid off within let’s say a few weeks if we were to use Evolve of course. The same gift cards, on the other hand, could be cleared with a balance transfer offer (check deposited directly to our Citi account) from USBank that charges only 2% for the transaction. Her last year’s interest (6% or so) was much higher than approximate $160 we’d pay to USBank right now.
Evolve now limits payments to 4 each calendar month per unique biller. If buying vgcs and cashing out, that’s a paltry $2K.
Putting $10K into the market is nuts if you’re trying to earn extra cash by taking on debt. Especially Student Loan debt which isn’t extinguishable in a BK – stays with you forever unlike most other types of debt. Lots of idiots took out mortgage loans before The Crash and put it into “safe” investments in the market (like “safe Banks like BoA, Citi et al) trying to arbitrage the equity in “house rich, cash poor” homeowners.
I can think of some adjectives for Chasing The Points, but smart and savvy ain’t some of them…
We always read about these schemes when the market is frothy. Never fails. Nimrods buy in at the top when the easy money has been made and when smart money is selling and getting defensive.
As mentioned, I’ve not used Evolve – but the way I saw the rules the 4 payment concept didn’t apply to cash loads, like moneypak so it might be workable? Not saying it would be sustainable at all though.
I personally don’t like to borrow into the market either, but I do believe he is savvy and smart, and some of his latest ideas are top notch (and under the radar for now)
I believe it is possible to pay off the 10k debt in one month. But the profit is higher when paying this off in a month because the $733 was cost for an entire year. You don’t need EVOLVE to pay this off. You can send in money orders to pay it, evolve problem solved.
I think the entire post can be surmised to :
Choice 1 : Make $800 a month with no added complexity.
Choice 2: Take a loan for 10K and play in the stock market while paying $733 per year. Choice 1 is optional.
Both of these are independant of each other. Choice 2 is the same as taking a margin loan that is amortized over 10 yrs with 1st yr payment of $733.
Why would you mix both of these? They are mutually independant. Choice 1 is like a rich uncle saying that he’d give you 800 per month for 1 year. What you want to do with that 800 dollars is your whim. CTP should go for broke! He could go to Las Vegas and bet it all on red or buy mortgage backed securities/asset backed securities /derivatives to juice up the returns.
I don’t mean to be rude but this whole plan is disturbing on so many levels. The stock market is at all-time highs, in the 5th year of a bull run, and long overdue for a correction. If ever there were a time to “buy high” it is now. And unlike past market run-ups, this one is largely artificially manufactured by the Fed’s bond/buying/money printing/bubble creating activities – the very activities it has started to taper, BTW. By the time the bond buying stimulus effectively ends (this fall; that’s not a guess but a publicly announced fact) the market’s artificial legs will be gone. Remember the tech wreck of 2001? (Look at a 15-year chart of the NASDAQ for a reminder. ) That’s what a stock market bubble burst looks like.
Also, your calculations above ignore trading fees. $10k is a small enough sum that broker commissions would eat up a significant amount on a % basis. To be even moderately diversified a portfolio needs at least 10 positions so each position is a mere $1k on average. At $10 per trade you’re looking at 2% lost to fees right off the bat ($10 to buy + $10 to sell = $20 = 2% of $1k). That’s assuming a buy and hold strategy, not active trading.
I could be missing something, but this whole scheme sounds just mind boggling.
I like the way you are thinking, generally speaking… however we can’t time the market, it maybe at a top, but it has been at a top for 5 years as you say through the run. There has been one correction this year already.
I do believe in diversifying and protecting against downside risk, but the numbers in question probably are manageable in this case. I personally consider the ratio of investment to income (ability to restore by dollar cost averaging) and $10K that I used here is simple enough to do that.
Trade fees – great point! But you could get in the market with zero trade fees too, depends on how you do it. Glad you brought it up though.
Before I forget, congrats on the little one!
The market’s pullback this year was a blip but not a true correction (numerically defined as a drop of 10% or more; there hasn’t been a “correction” since 2011). I wasn’t suggesting timing the market (which is impossible) but saying it’s prudent to be aware of the environment one is investing in. Can anyone really deny we’re at a market top? Maybe not *the* market top, but consider that we’re likely in a bubble greatly inflated by a Fed policy which is ending (but has not yet ended). The Fed was printing $85 billion/month for most of 2013. That will be down to $25B/month in July and for all intents gone by Fall. Can the market rally after that? Possibly, but I certainly wouldn’t bet on it with my own money. More likely it will not only decline but correct, perhaps violently.
So someone initiating investment positions in this market is on very shaky ground. I’m making an assumption here so forgive me if it’s wrong, but someone who needs to take out a loan at 7% interest (and 4% in origination fees!!) just to obtain $10k is probably someone who can’t afford to lose much money. There are ways to mitigate risk (and even make money) in down markets, but they require tools that I don’t believe are readily available for zero-fee trading. If you’re buying stocks for no fees, can you even choose exactly when your trade executes (not a rhetorical question; I actually don’t know) let alone protect your position with options or even simple stop-loss orders? Brokerage firms are for-profit businesses so if they’re giving something free they’re making money some other way. (They *have* to, as a matter of responsibility to shareholders.)
Anyway, just my $0.02. Far be it for me to tell someone else how to manage their money 🙂
Two points:
1) The student loan interest deduction has a MAGI cap of $75,000 (See IRS publication: http://goo.gl/2otuot). Thus your tax rate is probably too high at 35% (city & state inclusive).
2) Forget any potential market volatility (just a quick note: over 10 years, he would probably be fine), but instead focus on tax law volatility. Who knows if the student loan interest deduction will be changed next year or the following year. Heck, the president may just write off all loans ever taken, so that ‘executive order’ would defeat the purpose of this exercise entirely.
Yeah, I first picked 30% then I changed it to 35% arbitrarily. I was ballparking both just for example purposes. The actual rate if one was at 75K would be 31.65%, so a touch generous.
2. Yes, I like that thinking a lot – that goes into the short term (risks) when funding long term debt, very relevant.
Isn’t the old Amex Blue capped at $6500 spend per year? If so, how could you earn $400 per month? Please, tell me how this is possible because I’d love to get in on that type of opportunity if it’s possible.
No- that’s the new Amex blue. The one I have is the inverse: it offers 1% for the first $6500 THEN becomes a 5% card at gas groceries and drugstores…. I kinda like it 🙂
I’d still like you to “show your work” on how you get to $800 a month. The math doesn’t work.
You are just going to have to read the post again and think about it a bit more.
Even at $400.
OK, if you don’t like it lay out some of your thoughts and lets discuss. Asking me to ‘show my work’ is something that a high school teacher might say to me, and I never liked high school teachers 🙂
Not sure what “thoughts or ideas” you’d like me to share. My thought is that there appears to be something wrong with the math. My idea is to look at the underlying calculations to determine where the error is.
Forget Evolve. Forget gift cards. Forget tax rates. To get $400/mo PROFIT ($4800/yr) you need to return $5,570 a year in order to cover the annual interest on the loan. I can’t seem to find where the initial $10,000 is going to return 48-57% annually. If you or your buddy can do that… you really shouldn’t be ****ing around with gift cards.
OK – well I don’t know what to tell you. It is absolutely possible to make that much annually from a 10K float, it is simply a case of cycle speeds. If you compare it to our milemadness tournament, we had people playing with $5K and a T+1 payment cycle who were earning a profit of about 3-4K per month.. And it very much involved ****ing around with giftcards.
Perhaps it would help our discussion if you let me understand a bit more about your own understanding of such things – you seem to know what you are talking about by questioning the evolve pipeline, then you seem to be surprised at a 40-50% annual return… it seems confusing to me.
How much are you currently cycling through MS in a month? That might help me understand where you are coming from better.
Maybe I misread the original post? I thought it was about getting those kinds of returns on a borrowed $10k in the stock market? Or (as I re-read it just now) are you countering that your buddy could/should generate greater returns by MS’ing, rather than ****ing around with student loans?
Last few months I’ve generated $50k in MS per month. This was a largely casual effort focused on hitting minimums for a bunch of new CCs. Family wants to go to Hawaii this summer.
As I mentioned in my first reply, perhaps it wasn’t the best constructed post- it’s been a busy week, became a dad 4 days ago and am moving house today… Lots going on!
Absolutely no way in hell I would suggest stock market returns like that- I tend to say 3 years or less be ready for a loss, 10 years or over perhaps an 8% average if you can keep fees low, harvest losses etc.
I was indeed trying to highlight how seemingly high aprs of those loans could be insignificant compared to the reruns from a 10k float, but I was also trying to say that the loan into the market wasn’t necessary for that- the only benefit of the loan to MS is that it opens up Evolve as an exit for people like him and me who have no other debt and therefore can’t really use it… Very obviously use it perhaps.
Post was clumsy, I can see that, but I’m going to have to ask for a free pass this time.
Enjoy hawaii-I’ve never been but it’s now on the list of places to see for us too.
Free pass granted!
Hawaii is highly recommended…