Browse Month

October 2018

The Problem of the Golden Basket

Somewhat related to the previous post on paydays, I had lunch and then coffee with another friend, and for some reason our discussion turned to personal finance as well. Unlike the last time, I was the one starting with the view that deviates from conventional theory this time.

Suppose you have a choice between two savings accounts. One account pays 2% AER and the other pays 1% AER – so £10000 invested for a year would earn £200 in the first account but only £100 in the second. Should you allocate 100% of your savings to the account that pays 2% AER?

In general, if all other things were held equal, there probably isn’t much of a reason not to allocate everything to the 2% account. However, the standard for all other things has to be high. In practice, I can see quite a few scenarios where there may be legitimate reasons to allocate some money to the 1% account.

One possible reason could be terms of access. Clearly, if the 2% account is a fixed rate bond only allowing access to the money after some amount of time while the 1% is an easy-access account, that provides a clear reason. If one wishes to maintain an emergency fund, for example, the fixed rate bond is probably best avoided even if it pays higher interest. Some savings accounts, while not having a fixed term, place restrictions on withdrawals in terms of frequency or advance notice in exchange for higher rates – again, be careful about using these accounts to park an emergency fund.

Another reason could involve how the accounts compound. The annual equivalent rate (AER) refers to how much money one will have after a year. However, if one wants the funds together with some interest before one full year, then precisely how the accounts pay interest becomes significant. If the 1% account compounds monthly while the 2% account compounds annually only, then between one month and one year after the start date the 1% account has more withdrawable interest. This is a variant of the access problem, though this focuses on access to interest as opposed to the principal. This may seem a little short-term minded, but could be interesting if one is engaging in stoozing or has other pressing financial commitments.

The amount of money one has is also relevant. Financial institutions can fail; in this case, the UK’s Financial Services Compensation Scheme (FSCS) guarantees up to £85,000 per depositor per authorised bank/building society. There is thus certainly a case for keeping not more than that amount with each bank; if one was fortunate enough for one’s savings to exceed £170,000, finding a third bank seems reasonable. I’ve never seen cash as doing the heavy lifting as far as growing my portfolio was concerned. I’d collect interest as available, but would prioritise safety. If the accounts were held with the same provider, of course, then this argument falls down – even if one has multiple accounts, the FSCS limit is on a per-bank basis. In fact, one has to be careful as some bank brands do share authorisations – meaning that an individual will only get the protection once even if several of these banks fail.

In general, the inconvenience that might be caused by failures is something worth considering as well. The FSCS compensation only applies if the bank is suitably authorised; even if one’s balance is fully covered by the FSCS, claims can take one to four weeks to process. I think I’d be much more comfortable having at least a nontrivial amount in a separate account (two to three months’ expenses, ideally) if possible.

Customer service is another factor. I’d probably prioritise that more significantly for more complex products – however, for a savings account it would still be useful.

Furthermore, there are other principles which individuals might find important. MoneySavingExpert on its savings account best buy tables has a section for highly-rated ‘ethical savings accounts’. The criteria Ethical Consumer (which MSE works with) include concerns like tax avoidance and funding of climate change, though I don’t necessarily agree with all of them (“excessive director’s remuneration”, in particular – if someone is that valuable it seems unethical to me to artificially depress their salary). Similarly, Islamic banking is necessary for adherents, since interest is forbidden in Islam.

To conclude, there are quite a number of reasons why one might not actually want to put 100% in the higher interest bearing account. Of course it makes sense ceteris paribus (if all other things were held equal), but that seems unlikely in practice. The standard for all other things being held equal here is high – the access conditions, compounding conventions and bank account provider all need to match (and that isn’t even an exhaustive list).

Moving Cash Flows

I met a friend for a meal on the weekend, and among other things my friend mentioned that at his company, there was an internal debate over whether payday should be moved forward. This wasn’t a debate on the financial ability or willingness of the company to do this, but was instead focused on individual workers’ preferences.

My initial reaction was a bit of surprise. I wondered why this was even a debate, as I believed the answer should almost always be yes. This reminded me of the standard time-value-of-money question that I wrote about just over a year ago; being paid the same amount of money slightly earlier, mathematically, seems like an outright win. The UK hasn’t had negative interest rates yet – and even in a place like Switzerland where bank rate is negative, this isn’t typically passed on to most depositors.

Cash flow might be a problem if one considers the dollar-today-or-more-tomorrow question; however, this shouldn’t be an issue in this set-up. Valid cash-flow scenarios remain valid even if payday is brought forward. In a sense, an early payday creates additional options; it shouldn’t invalidate any existing ones.

With a bit more discussion and thought, though, we found that there were indeed valid reasons as to why one might not want payday to be shifted forward.

First, although the mathematical argument makes sense, there are some edge cases around tax liability. If one’s salary is close to a marginal rate change and a payment is pushed across a tax year boundary, the amount of tax one pays might change (and can increase). 

Also, although we speak of interest as an upside, how much benefit an individual can actually realise may be significantly limited. Some bank accounts pay interest based on the lowest balance on any day in the month, meaning that being paid a few days early yields no benefit. Even if interest is based on the average daily balance, the upside is also in most cases small. For a concrete example, 2017 median UK post-tax earnings would be about £1,884.60 per month. If one was getting paid three days early and storing that into a high-interest current account yielding 5% APR, the additional interest wouldn’t be more than about 30 pence.

Moving away from purely numerical considerations, there are many other plausible reasons too. Clearly, departing from an existing routine may affect one’s own financial tracking. I find this alone to be a little flimsy (surely one’s tracker should be adaptable to variations arising from December and/or weekends?). That said, if one is unlikely to derive much benefit from the money coming early (and it seems like in most cases there indeed wouldn’t be much benefit), the change would likely seem unnecessary.

Another scenario could be if one has many bills or other payments paid by direct debit, and cannot or does not want to pay all of them. In that case, deciding precisely where the money goes could be significant – for example, if one is faced with a decision to lose fuel or premium TV in winter. This is probably not the right system to handle a situation like that, but if one wishes to only make some payments then an unexpected early payday could mess the schedule up. Somewhat related might be joint accounts in households where there are financial disputes.

Taking advantage of an early payday also requires self-control. Consider that if one is living paycheck-to-paycheck, while an early payday might ease financial pressure, it also means that the time to the next paycheck is longer than normal (unless that is also shifted forward). This needs to be dealt with accordingly.

If you’d ask me whether I’d like payday to be shifted forward, I’d almost certainly say yes. Our discussion went to a further hypothetical – would you take a 1% pay cut to have your entire salary for the year paid on January 1st?

From a mathematical point of view, you would be comparing a lump sum of 0.99N dollars paid now, or (for simplicity) twelve payments of N/12 dollars paid 1/12, 2/12, \ldots, 12/12=1 years from now. Assuming that you can earn interest of r% per month and using monthly compounding, after one year we have

Value_{\text{LumpSum}} = 0.99N (1+r)^{12}

Value_{\text{Normal}} = \sum_{i=1}^{12} \left( \frac{N}{12} (1+r)^{12 - i} \right)

If we set these two to be equal and solve for r, we get a break even point of r = 0.00155. This computes out to an APR of about 1.87\%. This is higher than best-buy easy access accounts at time of writing (MoneySavingExpert identifies Marcus at 1.5%). You can beat this with fixed-rate deposits, and probably beat this through P2P loans, REITs and equities – though more risk is involved.

I think I could see that being a yes for me, though I’m not entirely sure I’d have the self control required to manage it properly!

Chips on the First Floor

Every so often, I spend some time filling out a crossword puzzle. There are quick crosswords where only definitions of terms are given, and cryptic crosswords which include both a definition and some wordplay. Especially for quick crosswords, these clues can be ambiguous – for instance, Fruit (5) could be APPLE, MELON, LEMON, GUAVA or GRAPE; OLIVE if one wants to be technical, and YIELD if one wishes to be indirect.

To resolve this ambiguity, about half of the letters in a quick crossword are checked. This means that their cells are at the intersection of two words, and the corresponding letters must match.

With a recent puzzle I was attempting, I had a clue with a definition for ‘show impatience (5, 2, 3, 3)’. I didn’t get this immediately, but with a few crossing letters in the middle I quickly wrote down CHOMP AT THE BIT. This was fine until I had a down clue with definition ‘problem (7)’ which was D_L_M_O. This should clearly be DILEMMA. It was a cryptic crossword, so I was able to check CHAMP AT THE BIT with the wordplay part, and it made sense. (The clue was “show impatience in talk about politician with silly hat, I bet” – which is CHAT around (an MP and then an anagram of HAT I BET).) The “original” expression is actually CHAMP, though I’ve only heard of the CHOMP version before.

I sometimes have difficulty with crosswords in the UK (and sometimes with crosswords from the US as well) owing to regional variations in English. Singaporean English follows the UK in terms of spelling. However, in terms of definitions, things vary. For example:

  • Common with UK usage:
    • Tuition refers to additional small-group classes (like in the UK), not the fees one might pay at university (US).
    • A biscuit is a baked good that’s usually sweet (like in the UK) and probably shouldn’t be eaten with gravy; an American biscuit is a bit more scone-like.
  • Common with US usage:
    • Chips are thin fried slices of potato (same as US). The word refers to fried strips of potato in the UK (which themselves are fries in both Singapore and the US); the thin slices are called crisps in the UK.
    • The first floor of a building is the ground floor (same as US); in the UK that’s the first floor above ground (which is the second floor in Singapore and the US).

Without venturing into Singlish (which incorporates terms from Chinese, Hokkien, Malay and several other languages), there are also terms that aren’t in common with either American or British English. Some of these pertain to local entities. Economy rice is a type of food served in food courts, and the MRT is Singapore’s subway network – though I’ve heard several uses of it as a generic term, much like Xerox for copying.

Others seem a little more random. Sports shoes refer to trainers specifically, and don’t refer to water shoes or hiking boots which are used for sport. The five Cs refer to cash, cars, credit cards, country club memberships and condominiums – five things starting with the letter C that materialistic Singaporeans often chase.

I’ve been resident in the UK for around six years now. This is obviously fewer than the number I’ve spent in Singapore (about 21), though the years in the UK are more recent. I’ve gotten used to the British expressions, especially for life in the UK (I generally like chunky chips more than crisps, and correctly distinguishing the first and ground floors is important for getting around). I don’t think I’ve had too many issues with remembering the correct versions of terms to use when in Singapore or in the US – having had to deal with these inconsistencies has helped here.