Get Rich Real Slowly

Cross-posted from Pu­tanu­monit.

Some of you have read Get Rich Slowly and thought: no, this is not slow enough. The dizzy­ing pace of 6-7% an­nual re­turn is too much. You want more safety and less volatility, some­thing to­wards the bot­tom-left cor­ner of the effi­cient fron­tier.

Con­crete ex­am­ple: you have $10,000 to­day, and you may want to spend them some­time in the next 2-3 years on a car, a mini-re­tire­ment, or just an emer­gency. You would like there to be more than $10,000 when you need the money, but what you re­ally want is to be con­fi­dent that there wouldn’t be any less than that. Emerg­ing mar­ket stock in­dex funds can turn $10,000 to $15,000 in two years, or to $6,000. You just want there to be $10,500.

This post will briefly cover the ba­sics of low-risk-low-re­turn sav­ing, with gen­eral prin­ci­ples and par­tic­u­lar ex­am­ples. With apolo­gies to my in­ter­na­tional read­ers, the ex­am­ples are all USA-spe­cific. The gen­eral ap­proach, how­ever, should be eas­ily trans­ferrable – and you’ll know what scams to watch out for.

“Risk-free” rate

The bench­mark for the re­turn rate on low-risk in­vest­ments is the fed­eral funds rate, which is cur­rently set by the Fed­eral Re­serve at 2.5% [1]. This is the rate at which big in­sti­tu­tional banks bor­row dol­lars [2] from each other and from the cen­tral bank overnight. This num­ber also tracks very closely the rate at which the US gov­ern­ment bor­rows money for one year.

The chance of any bank go­ing bankrupt overnight or the US gov­ern­ment de­fault­ing on its debt within 1 year are both very close to zero, which is why the fed­eral funds rate is of­ten referred to as the “risk-free rate of re­turn”. Of course, noth­ing is ever truly risk-free when fi­nance is con­cerned. “Risk-free” is a eu­phemism for “this won’t blow up un­less the en­tire rest of the fi­nan­cial sys­tem blows up as well, and at that point, you should care about your stocks canned food more than about your dol­lar sav­ings.”

So, big banks can bor­row and lend “safely” at 2.5%. Let’s see what nor­mal schlubs like us can get when we go to the big banks our­selves.

Check­ing and Sav­ings Accounts

There are roughly 70,000 re­tail bank branches in the United States. A third of them be­long to the biggest 5 re­tail banks: Wells Fargo, JP Mor­gan Chase, Bank of Amer­ica, US Bank, and PNC. Either one would be happy to open you a check­ing ac­count – a sim­ple ac­count where your money is in­sured by the gov­ern­ment, ac­cessible from any ATM and on­line, and earns 0% in­ter­est.

When the bank sees that your pock­ets are bulging with 100 Ben­jam­ins, they will offer to open you a sav­ings ac­count as well. Sav­ings ac­counts usu­ally have limi­ta­tions such as a min­i­mum bal­ance needed to open, a cap on monthly trans­fers, and fees. On the plus side, your money will earn an as­ton­ish­ing in­ter­est rate of… 0.03%.

That’s right, at the end of two years in a Bank of Amer­ica sav­ings ac­count your $10,000 will ac­crue six whole dol­lars! If you reach the Plat­inum Honors Tier, which re­quires an end­less amount of bu­reau­cratic hoops to jump through and also sac­ri­fic­ing your first­born to Mam­mon the prince of Hell, they will toss in an ex­tra $6 and a lol­lipop.

And then, they’ll charge you $192 in monthly ser­vice fees.

Ac­tual rate of re­turn: nega­tive 2%.

Scam me­ter: to­tally a scam.

Cer­tifi­cates of De­posit at Big Banks

0.03% in­ter­est will dou­ble your money in a mere 2,310 years, not count­ing taxes. If that’s a bit too slow, banks will offer you a cer­tifi­cate of de­posit, or CD. CDs offer a higher rate of re­turn in ex­change for plac­ing more limits on your money. CDs have a set ma­tu­rity date and with­draw­ing money prior to that date in­curs a penalty. In the few places I’ve checked, the penalty is about a quar­ter of the to­tal in­ter­est that would be earned for the full term.

CD rates at the big banks vary from 0.1% at Bank of Amer­ica to 2% at Wells Fargo if you lock the money down for two years. So $10k in a Wells Fargo CD will turn into $10,201 af­ter two years, or $10,050 if the money is with­drawn af­ter one year: $100 of in­ter­est minus $50 in early with­drawal penalty.

There may also be fees as­so­ci­ated, and in­ter­est on CDs is taxed as in­come. Marginal in­come tax rates are be­tween 22%-37% for Amer­i­cans earn­ing $38,000 or more, so even in the best case sce­nario a two year CD will only net $201 * (1-.22) = $157.

**Ac­tual rate of re­turn: **0-1.5%.

Scam me­ter: only a bit of a scam.

Sav­ings Ac­counts and CDs at New Banks

Nerd­wallet has a list of rates offered on CDs and sav­ings ac­counts at var­i­ous in­sti­tu­tions. The big­ger es­tab­lished banks are clus­tered to­wards the end of the list, while the top of it is pop­u­lated by smaller, newer, and on­line-only banks look­ing to ag­gres­sively grow their cus­tomer base. Some of these banks offer 2% on sav­ings ac­counts and 2.6-2.7% on CDs. If you think there’s a chance you may need the money be­fore the CD ma­tures, the two op­tions are prob­a­bly equiv­a­lent in terms of ex­pec­tancy.

In any case, if you want a high-yield ac­count with a bank it makes sense to shop around for a young bank des­per­ate for love, not one of the old fat cats.

Ac­tual rate of re­turn: 1.5-2% af­ter tax.

Scam me­ter: barely a scam at all.

CD Se­cured Loans

If you do open a CD, and es­pe­cially if you ask about with­draw­ing the money early, the bank will start mar­ket­ing to you a mirac­u­lous fi­nan­cial product called a CD se­cured loan. Are you cyn­i­cal enough to guess what that is?

The bank, via a well-dressed “re­la­tion­ship tech­ni­cian” or a brochure with glossy print, will in­form you that while nor­mal bank loans have an in­ter­est rate of 10-12%, you can get a loan at in­ter­est rates of just 4-8% as long as it’s fully se­cured by your CD. In case it’s not clear: the bank will give your own money back to you, with zero risk to the bank it­self (since the loan is fully col­lat­er­al­ized), while charg­ing you 2-6% in­ter­est for the plea­sure.

And if you ask why on Earth you would pay 6% in­ter­est on your own money when you can just with­draw it and pay 0% at worst, the bank will tell you about the won­ders it will do for your credit score [3]. At this point I recom­mend shout­ing “Be­gone, de­mon!” at the top of your lungs and run­ning out of the bank branch while your soul is still in­tact.

Ac­tual rate of re­turn: nega­tive 6%.

Scam me­ter: Shame­less and dis­gust­ing scam. I wrote 5,500 words defend­ing the fi­nance in­dus­try but then added a caveat: fi­nance turns bad when it col­lides with the as­tound­ing fi­nan­cial illiter­acy of the av­er­age Amer­i­can. CD se­cured loans are as bad an ex­am­ple of this as I know. It’s a fi­nan­cial product de­signed solely for peo­ple who are eas­ily per­suad­able, fi­nan­cially ig­no­rant, and flunked mid­dle school math.

In­dex Funds

By and large, the best tool for low-yield in­vest­ments is the same as the best tool for high-yield in­vest­ments: in­dex funds. In­stead of lend­ing money to a sin­gle bank, bond ETFs (ex­change traded funds, the eas­iest way to in­vest in in­dices) al­low you to buy pieces of loans to the US gov­ern­ment and other low-risk in­sti­tu­tions.

Be­cause of their equity-like struc­ture, the value of ETFs is a bit more volatile day-to-day but on a scale of a year or more bond ETFs ba­si­cally repli­cate the yield of the un­der­ly­ing bonds. If an ETF just keeps buy­ing trea­suries that have 2% yield, the ETF will in­evitably yield 2%. More im­por­tantly, ETF gains are taxed at the cap­i­tal gains tax rate (15% if held for more than one year) in­stead of as in­come tax (22%-37%).

Two great op­tions are Van­guard’s money mar­ket fund, VMFXX, and bond fund, VBMFX. VMFXX holds short-term US gov­ern­ment trea­suries and bank re­pos, with an ex­pected yield of around 2-2.5%. VBMFX holds two-thirds long-term US trea­suries and one-third cor­po­rate bonds. The ex­pected re­turn is around 3% to­day, but the av­er­age ma­tu­rity of the bonds is 8 years which can lead to some short-term di­ver­gence be­tween the ETF re­turn and the bond yield if in­ter­est rates change.

Ac­tual rate of re­turn: 2-2.5% af­ter taxes and Van­guard’s tiny fees (0-0.15%).

Scam me­ter: Ba­si­cally, ev­ery­thing Van­guard does is the op­po­site of a scam. RIP Jack Bogle, the trillion-dol­lar real-life Robin Hood.

Wealthfront

In­vest­ing is a story of trade-offs. High-re­turns, low volatility, low tail-risk, flex­ible ac­cess to money – you have to pick some and com­pro­mise on the oth­ers. You can’t have a re­turn higher than the fed­eral funds rate, zero volatility, FDIC in­surance, and no-limit ac­cess to your cash at any time.

Oh, wait, you to­tally can with Wealth­front.

The Wealth­front cash ac­count offers 2.51% re­turn with no fees, FDIC in­surance up to $1,000,000, and un­limited free trans­fers. I swear they’re not pay­ing me to recom­mend them (al­though I do get a small bonus if you use my refer­ral link). I just re­searched fi­nan­cial brochures for sev­eral hours, and then Wealth­front just turned out to be bet­ter than ev­ery sin­gle bank on prac­ti­cally all pa­ram­e­ters.

I’m not en­tirely sure why this is the case. It could be that Wealth­front just has much lower costs, be­ing a small startup with no phys­i­cal branches or fancy in­vest­ment man­agers with MBAs. Per­haps they’re eat­ing through some VC money in the hunt for mar­ket share growth. And per­haps, the num­ber of Amer­i­cans who can ac­tu­ally do the math and figure out the best deal is so small that ev­ery big bank would rather spend money on mar­ket­ing to idiots than on pay­ing their cus­tomers ac­tual in­ter­est on de­posits.

My goal to ex­pand the num­ber of the fi­nan­cially liter­ate, one blog post at a time.


  1. All rates in this post are in an­nu­al­ized terms, so 2.5% means 2.5%-a-year. ↩︎

  2. Other cur­ren­cies have differ­ent rates set by their re­spec­tive cen­tral banks. ↩︎

  3. The credit score sys­tem is it­self a meta-scam. It’s a way for fi­nan­cial in­sti­tu­tions to sucker you into pay­ing in­ter­est on debt, which is good for them and bad for you. You can build up an OK credit score by do­ing sen­si­ble things like open­ing a few good credit cards and pay­ing them off ev­ery month with no in­ter­est. But then, once you’re emo­tion­ally in­vested in the sys­tem, the only way to im­prove your score is to take on debt with in­ter­est.

    Spoiler alert: the way to pay less in­ter­est is to pay less in­ter­est, not to pay more in­ter­est in or­der to “build up your credit score”. ↩︎