Handling Finances

It’s been a while since my last post largely because I’ve been super-busy playing in a musical and what little free time I had was spent relaxing or spending time with my wife.  During that time, I noticed that the money I’d been repaid on some of my Prosper loans had topped the $50 it takes to start a new loan.

This led to a dilemma.  I could either take the money and transfer it to an interest-earning account, or fund a new loan.  A quick calculation showed that I’d earned just over 4% over the last six months with no defaults and an 8% return on my investment is definitely not bad!  On the other hand, even though I stick to loans with some of the lowest credit risk, interest rates have been dropping as the economy slumps so the risk is higher for every dollar I invest.

Since the loans run for 3 years and I only have $500 invested in Prosper loans, if one loan defaulted I would likely lose around 9% of my investment bringing my 3-year earnings down to around 4-5%.  That’s still far better than current CD or money-market rates, but probably worse than CD rates in a year or two.  This actually strikes me as a pretty reasonable risk, though I do fear that my understanding of the risk is minimal.  I hate to invest in something so new and untested, but at the same time, I think it’s well worth a small experimental portion of my savings.

For the near future, then, I have decided to continue reinvesting loan payments in new loans.  I may even increase my investment once we’ve managed to purchase a house in six months or so (when less of my cash is needed within a year).  I’m not hugely supportive of P2P lending, but with what I know now, I’m still coming to the conclusion that there is a place for P2P lending in a regular guy’s investment portfolio.  Especially for smaller loans under $10,000 or so, for lenders with low debt and good credit, the default rate can be as low as 2-3% according to lendingstats.com which tracks Prosper loans.  Of course, the data is significantly skewed as some of the first loans are only now starting to be fully repaid, but even a 5% default risk is acceptable to me given the amount I’m investing and the return I’m getting.

I have a friend who was recently caught by a rather questionable policy in the credit card industry of changing billing due dates.  By moving the due date around by just a week or so, they hope to catch people who try to pay at the last minute each month and simply assume that the due date will be the same from month to month.

It’s easy to solve this problem — pay bills when you get them and not when they’re due!  I totally understand if you run out of money to do this once or twice, but if you’re waiting for your paycheck to clear before you pay your bills, you need to change your habits.  Always keep one paycheck of funds in your checking account and live off your previous paycheck, not your next paycheck! This might be hard at first if you’re used to spending every penny that goes into your checking account, but it’s certainly not impossible!  Unless you’re reading this from your local library you might start by canceling your internet account if you can’t think of any other ways to save money to get started on this.

Anyway, my friend was particularly resistant to paying early because he didn’t want to give his credit card company even one day extra interest on the money.  This is silly — the credit card company is already giving you an average of half a month with the cash interest free, and that’s before they even send you the bill.  In essence, you’re getting an interest-free loan for a month and a half, so while you might want to hurt the credit card company by a few pennies of lost interest, it’s not worth the amount of effort it takes to avoid late payments if you’re trying to nail the deadlines.

Don’t just pay your debts on time, pay them ASAP and you’ll reduce your stress, miss fewer deadlines, and even if your checking account pays money-market interest rates, the pennies you might lose just isn’t worth the trouble!

When I traveled to London, England recently, I found that my money was only worth half what it was in America.  In other words, I got half as much as the same money would have purchased at home.  That got me wondering what my money is actually worth.  My bills claim to be “legal tender for all debts public and private” but what does that mean and why does the same dollar buy half as much (in terms of both goods and British Pounds) in England?

A Brief History of Money

Early currency was simply representative of various goods.  Precious metals were used to represent things like grain or livestock.  The first coins allowed for easier transactions and let merchants travel and do business without having to carry around all their goods.  Coins also allowed for the first accounting system and allowed people to store wealth more easily than maintaining and guarding large caches of food or large herds of animals.  In Europe, gold, silver and copper were used as currency because there was a fixed amount of each metal in the civilization.  A person could be reasonably sure your gold would be just as valuable next year since it wasn’t being mined and so inflation wasn’t much of an issue with the basic coins (though of course commodities would fluctuate in value according to supply and demand).

Coins were a huge innovation, but they were still rather difficult to haul around and trade in large quantities.  Banknotes were issued in China around 1000 AD and were redeemable for coins or goods on a regional basis.  A more universal Chinese currency was introduced around 1250 AD o make long-range trading easier.  At the same time, paper currency and many financial constructs like savings accounts and exchange rates were being developed independently in the Islamic culture.

In Europe, paper currency was somewhat less orderly as governments had a tendency to print more money than they had resources.  In other words, if everybody redeemed their currency, the government would run out of coins and goods promised on the notes.

So what are dollars worth now?

Ever since the United States ended its agreement to convert dollars to gold in 1971, American dollars have been worth only what two parties are willing to exchange for American dollars.  Of course, since the US government only accepts US dollars as payment of taxes, the US dollar will be good to get the IRS off your back as long as the IRS exists (and keeps the current policy).  This is known as a ‘fiat currency’ as the US dollar’s value is defined by fiat.  That’s no small thing, and the perceived stability of the US government is a large part of why many other world currencies are pegged to the dollar and many markets (even overseas) do business in US dollars.

If the US government wanted to spend more money, they could simply print more bills, but the more they printed, the easier it would be for people to get their hands on bills to pay taxes and as with any situation of supply vs. demand, the value of each dollar would decline resulting in inflation.  If the government were to print way too many bills (as in Germany after WWI when huge reparations exceeded the amount of money they could take in in taxes) the bills can become totally worthless as citizens find that their cash is worth more as toilet paper fuel for heating fires than as currency.

It seems weird in a way to be dealing with money that is only representative of future taxes.  While it legally must also be accepted for debts in America (like credit card debt or to settle a resturaunt bill when you pay after you eat) there is no legal reason a supermarket would have to accept cash as payment for food.  Yes, they’ll lose a lot of business if they only accept gold bullion or Euros, but it’s at least possible.

It’s a funny world where we go around exchanging little green pieces of paper, but it’s better than lugging around piles of gold coins.  It’s also much easier to control the supply of US dollars than it is to control the supply and demand of a precious metal like gold when gold can be found and dug up much more easily than in midieval times.  I suspect that in the far future, we’ll do away with paper and coin money altogether and move to an entirely electronic financial system.  We might even end up pegging our monitary system to something that’s useful to everybody — like energy (what good would cashing in your dollars for gold REALLY do you)?  Until then, we’ll just have to keep doing business in our governments’ future taxes and simply be thankful we don’t have to carry around wagons full of wheat, chests full of gold, or strings of rare seashells when we go shopping!