Financial Genome Project – Chapter 5

Chapter 5 – The Payment System

“When the scheme faltered [John] Law resorted to a number of rescue packages, many of which have their echoes 300 years later. One was for the bank to guarantee to buy shares in the Mississippi company at a set price (think of the various government asset-purchase schemes today). Then the company took over the bank (a rescue along the lines of Fannie Mae and Freddie Mac). Finally there were restrictions on the amount of gold and silver that could be owned (something America tried in the 1930s).” ~The Economist, 2009[1][i]

The quote in the beginning of this chapter is about John Law, a banker and gambler, which fundamentally changed France’s financial system. His bank controlled many parts of France’s payment system, and it collapsed in four years. Understanding all the parts of the financial genome can help expose and proactively avoid financial failures. This chapter will help you with your personal finances.

In Chapter 4, we discussed the “involuntary” healthcare deduction from your salary before you receive your salary (current sequence pictured below). Before we discuss what we spend our money on, we’ll spend time looking out how the payment system works. We’ll look at it broadly at first and then dig down deeper when we go through individual expenses. The main reason we should look at it broadly first, is to understand that while spending money, you’re either losing money while spending money or you’re earning money to spend money. How we spend our own money is a choice we can control. You can work against you by costing yourself money, typically through hidden costs that we’ve accepted as a society. We can avoid these costs. Conversely, the genome can also reward you as you spend money. I’ll show you how to be rewarded and avoid some costs in this chapter. I’ll put potential costs in red font and potential rewards in green font.

CURRENT GENOME SEQUENCING

                In most countries with a modern banking system, employers directly deposit salaries into employees’ bank accounts; although, some may still give physical checks directly to employees. Checks require the employee to go to a check-cashing facility. Most people go to their own bank and deposit their check directly into their own bank account or get the money in cash; however, some people go to check-cashing facilities and get the money in cash. These type of non-bank facilities charge a fee to cash the check based on the value of the check. This is one way people can avoid costs, by cashing checks at their own bank versus using a check-cashing facility. Technology has helped us avoid costs by allowing us to cash checks using our smartphones directly to your bank.

According to a 2015 Federal Deposit Insurance Company (FDIC) report, only 7% of households were “unbanked” meaning they didn’t have a checking or savings account (.7% lower than 2013). Additionally, a total of nearly 20% of U.S. households obtained financial services outside of the banking system (like check-cashing services).[2] This means that people are being charged to gain access to their own money. Having a bank account doesn’t necessarily mean you avoid fees though.

Like we discussed in Chapter 1, banks can charge a variety of fees that you need to avoid. The most basic fees involve just having a bank account and those need to be avoided. Banks shouldn’t make a profit based off fees, they should reward people for trusting them to use their bank so they can loan that money out. This is called fractional reserve banking and we’ll discuss it in more detail in future chapters. If you use a bank account properly, you can earn rewards. Interest is the most common reward for keeping money in a bank. The interest you earn depends on interest rates, which are incredibly low right, but it’s better than paying fees.

So to recap the flow of income, your employer paid you by direct deposit or a check. You can cash the check by directly depositing it to a bank account or exchanging it for cash. You have two methods of accessing your money: 1) by using the money that was directly deposited into your bank or 2) by using cash. When money is directly deposited, you can use it by transferring it from your bank to the vendor’s bank with an automated payment, utilizing debit and credit cards, writing checks, or withdrawing the money from an Automated Teller Machine (ATM). This is quick chart of what the payment system looks like.

PAYMENT SYSTEM

Automated payments are becoming increasingly popular as technology increases. Consumers often automate their bill payments which sends the money directly from a consumer’s bank to a vendor’s bank. Large companies offer this service for free. The company has to pay for this service but it’s such a negligible cost to attract the hundreds of thousands or even millions of customers. Small companies or services may charge for automated payments, and people should avoid those payment methods if they can.

I’ll dedicate an entire chapter to using debit and credit cards, but the costs have become transparent. Companies like Visa (V) and MasterCard (MA) charge vendors a percentage of every sale. Most companies simply add this cost to every commodity and it becomes transparent (actually, just hidden in plain sight). To avoid this hidden cost, I recommend you use a rewards debit and credit card that offers rewards on every purchase—only if you can pay your balance in full every month. By not doing so, you’ll be charged the finance charge, at double-digit interest rates, and negate any savings.

Switching to check usage, some banks charge to provide checks, so there may be costs in using checks. Over time, writing checks will become obsolete. If 90 checks cost $15, each check actually costs 16 cents. If you’re writing a $10 check, then 16 cents represents a 1.6% fee. Lastly, and most unsettling to me, is the cost of withdrawing cash from your bank. Finding a bank that doesn’t charge you for checks or avoiding using checks is a great way to avoid those fees.

According to data pulled from the National ATM Council, the average ATM withdrawal is $60.[3] ATM owners often charge $2 or more for cash withdrawals. Bank-owned ATMs don’t charge their own customers to withdrawal cash. A $2 withdrawal fee on $60 is a 3.3% fee. A $2 withdrawal fee on $20 is a 10% fee. For some reason, avoiding ATM fees is not a priority for consumers and it should be. Cash provides anonymity of purchases—an ideological side benefit. Interestingly enough, businesses that have an inherent requirement for cash such as gentlemen clubs [so I’ve heard] or casinos charge the highest fees for ATM withdrawals. Some ATM fees at these clubs are as high as $8. An $8 ATM fee for the average $60 ATM withdrawal is a 13% fee. To avoid ATM fees, try using your own bank’s ATMs or find a bank that reimburses ATM fees. Planning ahead and budgeting also helps prevent unnecessary or impulse needs for cash.

So whether you pay a vendor using automated payments, debt or credit cards, a check, or with cash, the money will eventually make it to the vendor’s bank. This is important to note. Almost every step in the payment system requires a bank. Banks issue debit and credit cards managed by Visa, MasterCard and other card companies. Banks wield an extraordinary amount of power in the financial genome, and we should be very mindful of that at all times. As I’ve mentioned it before in previous chapters, transparency and access are nice, but can also lead to nefarious dealings within the genome. Here’s what our current financial genome sequencing looks like now. The payment system is not outside the genome, and we’ll start making connections in the next couple of chapters.

CURRENT GENOME SEQUENCING

 

[1] http://www.economist.com/node/14215012

[2] https://www.fdic.gov/householdsurvey/2015/2015execsumm.pdf

[3] http://www.statisticbrain.com/atm-machine-statistics/

Financial Genome Project – Chapter 4

Chapter 4 – Health Insurance—A Privilege or a Right Still Comes From Your Paycheck

“For a long time, America was the only advanced economy in the world where health care was not a right, but a privilege.  We spent more, we got less.  We left tens of millions of Americans without the security of health insurance.  By the time the financial crisis hit, most folks’ premiums had more than doubled in about a decade.  About one in ten Americans who got their health care through their employer lost that coverage.  So the health care system was not working.  And the rising costs of health care burdened businesses and became the biggest driver of our long-term deficits.” ~Former President Barack Obama[1]

In Chapter 3, our sequence (pictured below) revealed that, before we receive our salary, our employer has to pay Social Security and Medicare taxes to the federal government and we must pay Federal income taxes, Social Security and Medicare taxes, and, if applicable, State income taxes and/or bank fees. All these taxes (yours and your employer’s) totaled 31-38% of your salary. But before we finally get to the point where you have your salary in your bank, ready to be spent or saved, we must look at another “involuntary” withholding–healthcare insurance.

CURRENT GENOME SEQUENCING

                Healthcare insurance evolved from nothing in the early 1900s to nearly 70% of the population being covered by employer-provided healthcare insurance in the 1960s.[2] Health insurance used to be considered a “benefit” offered by employers and treated as tax free for employers. In January of 2014, after a US Supreme Court ruling (National Federation of Independent Business v. Sebelius)[3], the individual mandate was passed requiring all applicable US citizens to maintain health insurance. While health insurance is mandatory, you get to choose how much you’d like to pay.

Modern insurance salary-withholding types involve 2 factors—a deductible and a premium. A deductible is the minimum amount you’re required to pay before the insurance picks up the costs. With the Affordable Care Act (ACA, a.k.a. Obamacare), one can also choose to pay $0, go without coverage and pay a penalty to the IRS (equivalent to the basic bronze plan). The premium is the monthly cost you and your employer pay to maintain the insurance. The size of the deductible and premium is typically inversely proportional. The higher deductible you have, the lower your premium should be. This is because you pay more initially for medical expenses.

Insurance is one of the most complicated parts of the genome. Navigating the entirety requires advanced mathematics and economics degrees, and there are several industries supporting it (i.e., insurance agents). Insurance companies use advanced mathematical algorithms to calculate the probability of someone needing to utilize the money and how much deductible/premium each person pays. This is done by actuaries, using complex actuarial tables. Since the start of for-profit insurance companies, they’ve managed to collect more than they need to pay out—creating what’s called a “float.” Insurance companies are then allowed to invest the “float,” for their own profit.

During the Affordable Care Act (ACA, a.k.a. Obamacare) planning phase, the White House webpage once said, “…the only changes you will see under the law are new benefits, better protections from insurance company abuses, and more value for every dollar you spend on health care.”[4] President Obama promised competition from the government to private health insurers. Unfortunately, as the ACA grew in complexity, politicians from both sides took opportunities to profit from it. Private insurers made money hand-over-fist. In 2016, UnitedHealth’s, one of the largest private health insurers in America, revenues rose nearly 24% to $83.6 BILLION.[5] Meanwhile, government-provided premiums continued to rise; despite President Obama’s promise to cut a typical family’s premium by up to $2,500 a year.[6] From 2014 to estimated 2017, premiums for the basic bronze plan rose 32%; 12% just from 2016 to 2017. Bronze plans started at $359 in 2014 and rose to $475 in 2017 ($408 in 2016).[7]

One of the goals of mapping out the Financial Genome is to create a forecasting model that takes in input and provides a forecast of the potential outcomes. For example, I heavily researched the Affordable Healthcare Act and knew that private insurers would make a lot of money off of taxpayers. But without a solid model, I was too scared to invest in private insurers. As mentioned above, UnitedHealth (stock symbol UNH) is one of the world’s largest private insurers and was rewarded nearly twice as much as the general stock market (see below). This is why I’m spending the time to map out the genome.

UNITEDHEALTH (UNH) STOCK SINCE ACA PASSED

All that being said, we’ll just focus on the genome connection between your employer and you. The last step before finally receiving your paycheck. You have some control over how much is taken out of your salary by deciding how much deductible and premium you’d like to pay. It’s truly a personal finance and lifestyle choice. Generally speaking, the healthier you are, the higher your deductible should be and the lower your monthly premiums should be. This is because you’ll be taking the financial risk if you need medical care. If you have pre-existing health problems or are unhealthy, then you’ll want to pay a lower deductible and pay higher premiums. If you require frequent health care, then your insurance company may pay more than you do in premiums. With ACA granting more access for those with previously uninsurable reasons and pre-existing conditions, insurers have to cover a large pool of people requiring medical care. The government and employers tend to incentivize higher-deductible health care plans since it minimizes their portion of the premiums as well as yours. Take a look at the chart below to show the different types of typical healthcare insurance plans that are available.

TYPICAL HEALTHCARE OPTIONS

We’ll discuss in further chapters, but the world has to decide whether healthcare insurance is a right of every citizen or if it’s a privilege of a civilized society. Like the title says, whether it’s a right or a privilege, it will still come from your paycheck. The choice will be philosophical, ideological, and political. Whatever path we choose, will determine what kind of connections that are built in the genome. As for now, and with the limited amount of public information, we can say that health insurance for a typical American job can be anywhere from 0.1 – 6% of your base salary. So after adding healthcare insurance, this is what our current genome sequencing looks like.

CURRENT GENOME SEQUENCING

We are finally at the point in the genome where you receive your salary and can start to save. We’re covering the very basics at this early point in our travels through the genome. It’s important to note that your employer giving you a salary isn’t the linear “starting point.” It’s a giant, interconnected circle, which we’ll continue to drill down as we touch each part of the genome.

 [1] https://obamawhitehouse.archives.gov/the-press-office/2013/09/26/remarks-president-affordable-care-act

[2] http://www.npr.org/templates/story/story.php?storyId=114045132

[3] http://www.supremecourt.gov/opinions/11pdf/11-393c3a2.pdf

[4] http://www.politifact.com/obama-like-health-care-keep/

[5] https://www.forbes.com/sites/brucejapsen/2017/01/17/unitedhealth-and-optum-profits-soar-despite-acas-political-uncertainties/#7e96ef535769

[6] https://barackobama.com/2007/06/23/a_politics_of_conscience_1.php  (Archive page: found in this article: http://www.politifact.com/truth-o-meter/promises/obameter/promise/521/cut-cost-typical-familys-health-insurance-premium-/

[7] http://go.avalere.com/acton/attachment/12909/f-0419/1/-/-/-/-/Deck.pdf

Financial Genome Project – Chapter 2

Chapter 2 – Newton’s Third Law

For every action, there is an equal and opposite reaction.[1]

Before we begin our adventure through the genome, we should take a look at the most important piece to the entire complex system—you. You are a laborer and you are fueled by your income. Governments siphon part of your income in taxes for their engines. Then you consume by spending money, fueling businesses’ engines. You can also save part of your income which fuels other businesses through investment. The entire complex system that we’ve built as humans relies on laborers earning an income, getting taxed, and then spending or saving the rest. We keep this entire complex system running.

The engine of the genome starts with you receiving an income from a company or a government (local, state, or federal). The taxes go to a government and a part of that goes to salaries to generate government worker incomes. When you spend your money, it represents sales for a company, part of which goes to employees’ incomes. And something different happens in the genome when you choose to save money. We’ll discuss in a later chapter. Governments can only operate with taxes, and companies can only operate with sales. By working and generating an income, you’re keeping our current genome alive.

After reading that, does it seem so farfetched that in the movie, The Matrix, we are being used as batteries to keep the “machines” alive? We think we have control. We can simply stop working right?  Without government assistance, most couldn’t survive very long without relying on primitive skills. Additionally, once too many people stop working, then government assistance wouldn’t be available either. So without you working, the government, companies, and people surviving on government assistance would be unable to operate. By working and earning an income, you create a feedback loop that enables you to generate an income, while simultaneously supporting the governments and companies within the loop.

Income Feedback Loop

In the Income Feedback Loop above, check out that little blue arrow between Salary and You. Have you ever thought about all the connections that happen before receiving your paycheck? Let’s look at just that arrow in this chapter, before we address all the components of the feedback loop. Gone are the days when you worked and your employer gave you your earnings in cash at the end of the day. Now you must wait for two weeks, to a month, before you receive a paycheck. Also, you no longer receive your paycheck directly from your employer. Your employer probably uses a contracted service for distributing payrolls. Finally, your paycheck no longer comes directly to you—now it goes to your bank.

Your paycheck is purely electronic, and we continually drift away from paper money—known as fiat money, or paper money which has no intrinsic value, but is made legal tender through government decree. [2] Nearly every working person in a developed country receives an electronic paycheck directly deposited into a bank account. Only in undeveloped countries do people typically receive daily earnings or receive income in cash or goods. The whole electronic transfer process is nearly transparent to most of us. We check our bank accounts on “pay day” and if all went well, we have money in our bank accounts. Isn’t that convenient?

But this transparency and convenience comes at a cost and it is hidden in dark places of the genome. In these dark places, people are building businesses designed to make the genome appear transparent. By making it transparent, they have the ability to make microscopic changes that may negatively impact you—without you knowing it. In our busy world, where people typically check their online statements only to find out the balance after pay day, we often miss these miniscule disruptions to our paychecks. Our first dark spot in the genome is the “bank fee”—like small, hidden sand bars in a muddy river slowing speed boats down.

Until about 2008, before financial operations were in the negative spotlight, it cost you money to keep money in a bank account even though it was, and still is, mandated by employers in developed countries for payroll processing. Unfortunately, some banks still have a lot of fees just for having a bank account: checking account fees, minimum balance fees, and no direct deposit fee. Then banks charge when you spend your own money with ATM withdrawal fees and annual credit card fees. The banks are even gracious enough to let you spend more money than you have with overdraft and insufficient funds fees. In 2015, the nation’s 628 biggest banks made $11.16 billion from just overdraft and insufficient funds fees alone, according to the Consumer Financial Protection Bureau.[3] Since banks are “environmentally friendly”, they’ll also charge you a hard copy statement fee forcing you to go online to check your statements. If you want to travel outside of the country to spend your own money, you can expect to see foreign transaction fees. Even if it’s something that you can’t control like someone writing you a bad check, you may receive a returned deposit fee.

Genome – Fee Connection

Some fees have gone away as hard-pressed banks had to reassure people that keeping your money in banks was safe after the 2008 financial “collapse”. If you’re reading this, go through your last three statements and check to see if you are being charged any fees. If you are being charged multiple fees, you need to change your bank. I’ve shined the light on this genome dark spot specifically to help you receive 100% of the paycheck that you’re supposed to be earning. As you can see from the image above, these fees prevent you from earning 100% of your salary. Eliminating fees improves your “fuel efficiency” in your financial engine as we travel through the genome.

Do you ever find it unsettling that your paycheck doesn’t actually come directly to you, but goes to your bank and then you are charged fees for accessing it? Keeping your money is how banks make money. Banks with more than $115.1M in liabilities (i.e., loans to other banks, companies, and individuals) only have to keep 10% of it on hand.[4] Have you ever heard of a “bank run”? This is where many people want to take out their money from their accounts and the bank doesn’t have enough in reserve. Banks saw this happen in 2008 and, more recently, in 2016 when the “Brexit” (Britain’s departure from the European Union) happened. There’s been multiple times where people have tried to get their own money and were denied. Not having access to your own money is part of the modern genome that we must live with, but by eliminating fees, we improve our position in the genome.

My intent is not to demonize banks, but I do want to introduce to you that almost everywhere in the genome, there’s an equal, yet opposing force to everything you do. Sir Isaac Newton’s third law states, “For every action, there is an equal and opposite reaction.” We find this is true in the financial genome. For every dollar you make, there is a part of the genome trying to pull that money away from you. Some of it is voluntary, like with our spending habits; some of it is involuntary, like taxes, and some of it is voluntary only if you know about it—like fees.

This is only the top surface of the connection of your income between your employer and you. The Income Feedback Loop shows the aerial view of what the genome connections look like, but as you’ve just read, there are many connections in between only one aspect of that loop. The Genome Fee Connection exposes one dark connection that you need to be aware of and change if it applies to you. There are more connections between your employer and you, regarding your salary. In the next chapter, we’ll discuss payroll taxes.

[1] http://www.physicsclassroom.com/class/newtlaws/Lesson-4/Newtons-Third-Law

[2] http://www.investorwords.com/1928/fiat_money.html

[3] http://files.consumerfinance.gov/f/201602_cfpb_variation-in-bank-overdraft-revenues-and-contribution.pdf

[4] https://www.federalreserve.gov/monetarypolicy/reservereq.htm