Cryptocurrency trading

Background

There are three major types of financial exchanges

  1. Stocks and bonds
  2. Commodity exchange
  3. Foreign exchange (Forex)

Stock exchanges, where stocks and bonds are traded, are highly regulated and don’t transcend national boundaries. The listed companies have to follow disclosure protocols decided by the government and the exchange. The stocks that are traded on these exchanges are mostly unique to the exchanges. For example, Google is only listed on the American exchange of NASDAQ. So, to buy Google stock, you need to conform to American laws. Also, you can only sell these shares back on NASDAQ and that too only within certain hours of the day. Therefore, these exchanges have some monopoly power.

However, commodities can be easily resold and delivered on other domestic exchanges and with some effort across national boundaries as well. Therefore, unlike stock exchanges, commodity exchanges do not have a monopoly over what’s being traded on them. The only advantage they can offer to the traders is a marketplace where they can find counterparties to take a position against their trade. Traders don’t have to arbitrate, that is, buy from one market at a lower price and then sell to another at a higher. Just the fact they can do it ensures that prices differences are minimized. Crude oil is the most actively traded commodity in the world and unlike Google stock, a trader can trade in crude oil, practically, in any commodity exchange in the world. Some other commodities could be traded in exchanges specific to a country.

Foreign Exchange (forex) markets are different. In theory, one can be run a US Dollar – Euro foreign exchange in Nigeria. Therefore, these transcend national boundaries. Most forex markets, however, are regulated. Forex markets are practically 24-hours a day, 7-days a week. Since major currency pairs like USD-EURO can be traded in any major forex exchange on the world, these markets practically never close. This distinction is subtle but important. For example, consider Apple Inc. which is listed on NASDAQ in the USA. If some bad news related to say Apple is published in media on Friday evening after NASDAQ is closed for trading then the traders cannot trade their Apple stocks till the Monday morning. But if Britain’s exit from EU (Brexit) is canceled on a Friday evening then the forex market will react immediately to the news.

Another subtle distinction is that big stock exchanges can enforce their rules and if a trader behaves badly then they can ban him/her for life. Getting banned from a major exchange is career suicide. A trader who, say specializes in tech stocks or healthcare stocks of a country cannot simply move to another country and learn the rules there. Commodity and forex markets are different. One can simply register in a different jurisdiction and start trading. Thanks to the Internet, being registered in Malta does not require one to live in Malta.

Type Monopoly Restricted to a country 24-hours a day
Stock exchange Yes Yes No
Commodity exchange No Partially Yes
Foreign exchange No No Yes

Crypto Exchanges

What’s traded on crypto exchanges is not unique to those exchanges. Just like USD can be purchased on pretty much every exchange, one can buy Bitcoin from any exchange, 24-hours a day. But while Forex markets are trading on the optimism or pessimism around a nation’s economy, commodity markets are pure speculation around demand and supply of a commodity. Therefore, cryptocurrency exchanges are akin to commodity exchanges. And since the goods are virtual, they easily transcend national boundaries. Therefore, inter-exchange trading implies price arbitrage will be rare in the longer run. So, what decides one exchange will win over another? Given that an exchange does not have the monopoly over what’s being traded, the only major barriers I can think of are either regulatory or higher liquidity.

Finance 101: A basic plan

(Since my previous posts, quite a few people asked me a basic plan which can be followed, here it is)

The items are ordered from first thing to be done to the last thing which can be done (assuming money is still left).

  1. Emergency savings
    Put 6 months worth of expenses in a Series I-Bonds (sold by treasurydirect.gov) – they try to match inflation rates (but nothing more than that) and can be sold after holding them for at least a year. The idea behind this is to minimize downsides in case of a major market crash. Also, I-Bonds are not counted towards state taxes and a max of 10, 000$ can be purchased in a single year (per SSN).
    Another simpler approach is to put money in high yield savings account like Barclays Savings or American Express Savings, of course, there is no rate guarantee and rate do fluctuate (usually go down) over time.
  2. Max out pre-tax 401K
    Assuming there is an employer match or if the person can convert it into Roth IRA.
    Otherwise, don’t do it.
  3. Backdoor Roth IRA
    Invest 5, 500 $ in traditional IRA, hold that for a few weeks and then convert it into Roth IRA and let the money grow tax-free.
  4. REITs and Preferred’s
    Investing in dividend paying (or “fixed income” as they are called) equities is not the optimal strategy for someone who is working full time but I think its psychologically beneficial to get regular dividends especially when market tanks down.
    An approach for that is to first figure out the amount of monthly dividend one wants to receive and then invest accordingly. For example, to get 100$ pre-tax a month in dividends from saying HSBC preferred shares (HCS) which has an 8% annual yield, the total investment has to be 15, 000 $.
    A caveat here, dividends coming from preferred are qualified and taxed at a lower rate while dividends from REITs are not, they are considered a regular income. The trick is to hold REIT in Roth IRA account where the income becomes tax-free.
  5. Municipal Bonds
    (Disclaimer: I have not tried these)
    Municipal bonds are usually issued for long-term (30 years) and the dividends they pay are tax-free (no state or federal taxes) provided the person is resident of that state. Rich people love these especially because the dividends are tax-free and there is no risk (except for municipality filing bankruptcy) if they are held till maturity.
    If they are not held till maturity there is in interest rate risk where bonds can go down in value if the interest rate goes up. So, the current market value of the bond will go down and vice-versa.
    In the current scenario (2013), interest rates are low enough that they can only go up, so, investing in these does not make sense unless the person is planning to hold them till maturity.
  6. Three-fund portfolio
    Rest of the money should go into a three fund portfolio (discussed earlier).

Finance 101: Cheatsheet

(Based on what I have seen financial savvy people doing and makes sense to me. Disclaimer: These are my opinions.)

  1. Should a person contribute to pre-tax 401K?
    Only if the company has a matching policy, else wise, its money trapped till the person reaches retirement age.
  2. Should a person contribute to post-tax 401K?
    Only if the company has a matching policy, else wise, its money trapped till the person reaches retirement age.
  3. What about pre-tax 401K vs post-tax 401K?
    Post-tax  401K is better than pre-tax only if

    1. The person decides to immediately convert to Roth IRA (since in Roth earnings will be tax-free while in post-tax, they are tax-deferred, this depends on whether the employee permits it or not.
    2. If the employer does not permit Roth conversion but still the person is either on a really low tax rate for that year (eg. not working for a full year or had added dependents to the family etc.) or expects the future tax rates to be much higher.
  4. What about traditional IRA?
    Same as pre-tax 401K, contributions are tax-deductible (if the income is below certain limits which are relatively low), earnings are tax-deferred either ways.
    The only case where this makes sense is to contribute and then immediately convert to Roth IRA where earnings will grow tax-free.  This technique is popular enough to acquire a name of its own “Backdoor Roth IRA“.
  5. What about Indexed Universal Life Insurance?
    The solution of guaranteed no-money-loss in a single year sounds really promising but its stupid to be told that I have to pay interest to borrow my own money and will be charged a premium for someone else to make money off of the money, not to ignore the fact that this insurers itself can be at the brink of bankruptcy.
  6. What about tax efficiency?
    Long-term stock gains and qualified dividends receive favorable tax treatment, that is, lower tax rates.
    Bonds, interest from bonds, short-term stocks, interest from bank accounts(yeah that pesky tenth of a penny) are treated as regular income, so, these things should be better held in either tax-deferred account or tax-free (retirement) accounts.
    International stocks should be held in taxable (normal) account since they are taxed by foreign countries and one can receive a foreign tax credit by holding them in a taxable account. All other stocks should be held first in taxable and then left over in tax-free and then tax-deferred account.
    Do note that stocks held in a taxable account will be taxed at a lower rate than in tax-deferred account where they are taxed as normal income upon retirement.
    More details on Bogleheads.
  7. What about tax loss harvesting?
    Complicated topic, I will write a blog post some other day.
  8. What would be a basic allocation?
    Go for Bogleheads three fund portfolio.
    Invest in three things

    1. Total US stock market (VTI or VTSAX)
    2. Total world stock market excluding US (VEU or VXUS or VFWIX)
    3. Total bond market (BND) ~ %age allocation should be almost the person’s age (conservative rule – reduce this %age to be more aggressive)
      Split between (1) and (2) should be roughly 80:20 or 70:30.
  9. What about rebalancing?
    As the person invests more, s/he should put more money in a manner to ensure that the above allocation ratio is maintained.
  10. Should the person go all in or slowly move money into the market (Dollar cost averaging)?
    Dollar cost averaging outperformsone-timee all-in in only 33% of cases (Vanguard study) but I think it makes one feel psychologically safer, IMHO, first timers should go for DCA.
  11. What about exotic stuff like commodities, precious metals and rare earth metals?
    The only time people think about buying these is when everyone else is talking about them, these have already peaked in prices and its an even worse time to buy them – paraphrased from The only investment guide you will ever need.
  12. What about P2P lending?
    Income  from P2P lending is considered regular income and losses are not tax-deductible, therefore, from a financial perspective, it makes sense to invest only via Roth IRA. Apart from that, I believe its too much hassle in terms of time (see my previous post on Peer to Peer lending).

Finance 101: References

Books

  1. One up on Wall Street by Peter Lynch – a good book on stock picking
  2. A random walk down the wall street by Burton Malkiel – a good book on why not to pick stocks
  3. The only investment guide you will ever need by Andrew Tobias – a hilarious summary of investing/saving and many other random money related topics
  4. The retirement miracle – For people who believe in indexed universal life insurance plans (I don’t)
  5. Where are customer’s yachts – hilarious read on wall street trader who profit on the expense of customers (won’t help in investing though).

Blogs

  1. fairmark.com – There only guides are thorough and amazing but requires some effort to grasp (only recommended for advanced and the curious)
  2. bogleheads – Interesting forum of people who believes in Jack Bogle’s philosophy of index investing (Jack Bogle is founder of Vanguard), definitely read three-fund portfolio
  3.  Twenty Common Sense Investing rules
  4. 401(k) Guide

Good portfolio checker sites

  1. sigfig.com
  2. personalcapital.com
  3. futureadvisor.com
  4. feex.com

Finance 101: Table of contents

  1. Terminology – of the terms used in other sections
  2. Type of accounts – a summary of  retirement and non-retirement accounts
  3. Building towards basic plan
  4. A basic plan
  5. Credit Cards
  6. References

Disclaimer:

  1. These blog post(s) are based on my perception which might deviate from the reality. Use these as a data point, not as a sole data point.
  2. Given a choice between being comprehensive and accurate vs. being concise and inaccurate, I decided to choose the latter. Since I believe there is enough text out there for the former audience.
  3. In some cases, I have implicitly assumed a single, unmarried, under 50, Silicon Valley engineer. While most of the blog post(s) still remains valid, some things might change because of that.

Finance 101: Type of money holding accounts

Money has to be held in some form or the other. It could be cash, physical gold, land or more conveniently accounts. The blog post is only about the last one.

Normal accounts (or non-retirement accounts) – held at banks

  1. Checking account –
    1. Post-tax contributions
    2. Earnings are realized immediately and taxed as ordinary income
    3. Account will never down in value (insured by FDIC for upto first 250K $)
    4. money is highly liquid – can be deposited/withdrawn any time (and absolute limits on deposit/withdrawal are usually of order of 10, 000$ per day)
  2. Savings account
    1. Post-tax contributions
    2. Earnings are realized immediately and taxed as ordinary income
    3. Account will never down in value (insured by FDIC for upto first 250K $)
    4. Money can be deposited anytime but can only be withdrawn six times per month

Investment accounts (for lack of better term) – held at stock brokers
These can be held as retirement or non-retirement accounts. Tax treatment of contributions/earnings/withdrawals depends on the type of parent account they are part of.

  1. Money market account
    1. Post/Pre tax contributions (depending on whether its pre-tax account or post-tax contribution account)
    2. Earnings are realized and taxed as ordinary income
    3. Primarily used for holding money temporarily before it is used for stocks or bonds (or more exotic things like options)
    4. Account can go down in value, though it happens rarely
  2. Brokerage account
    1. Account which holds holdings in stocks/bonds
    2. Earnings are not realized till a sale happens and then taxed as ordinary income or capital gains/losses depending on the holding period

Retirement accounts – held at stock brokers

Retirement accounts provide certain tax advantage (like tax-free or tax-deferred growth), usually, these accounts come with a restriction like money cannot be withdrawn at all till age of 59.5 years or can be withdrawn before that by paying a penalty (account specific details are given below).

IRA = Individual retirement account, just like a bank account, anyone can open it at pretty much any broker.
401K = employer-sponsored account, can be opened only by employer and contributions can only be made directly via paycheck [and employer contributions], the choice of funds to invest is also controlled by employer, sometimes, employers provide a match to encourage employees.

  1. Traditional IRA
    1. Direct contributions have a maximum limit (5,500$ annual limit in 2013 for people below age 50).
    2. Contributions are tax-deductible if income is less than a certain limit (limits are pretty low, though).
    3. Earnings are tax-deferred but taxed as ordinary income on withdrawal.
    4. Money can be withdrawn after age of 59.5 (or before with 10% penalty unless it’s a case of financial hardship).
    5. On leaving an employer, its 401K plan can be converted to traditional IRA account.
    6. See more gory details at Wikipedia page.
  2. Roth IRA
    1. Direct contributions have maximum limit same as traditional IRA but income limit to make contributions is much lower.
    2. Indirect contributions can be done via rolling over 401K money (if employer allows) or backdoor Roth IRA (contribute to Traditional and convert to Roth).
    3. Earnings are tax-free.
    4. Contributions can be withdrawn after a seasoning period (5 years) with no penalties (provided there is a reason – like financial hardship).
    5. Earnings can be withdrawn after age of 59.5 tax-free or by paying both tax and penalty (10%) before that age.
    6. Roth IRA is the only retirement account with no RMD (required minimum distribution clause).
    7. See more gory details at Wikipedia page.
  3. Pre-tax 401K
    1. Contributions are pre-tax (max employee annual contribution limit $17.5K – must come directly from paycheck), employer contributions are not counted towards this limit (they are subject to a total retirement contribution limit which hovers around $50K).
    2. Earnings are tax-deferred.
    3. Withdrawals taxed at ordinary income tax at the time of withdrawal.
    4. Some 401K plans don’t allow any withdrawal (even for financial hardship) till age of 59.5
    5. An employer decides which funds will be available for 401K plan.
    6. See more gory details at wikipedia page.
  4. post-tax 401K
    1. Contributions are post-tax. (same limit at pre-tax 401K)
    2. Earnings are tax-deferred.
    3. Contributions are withdrawn tax-free, earnings are taxed at ordinary income tax at the time of withdrawal.
    4. Some people prefer post-tax since they can effectively contribute more money into the account.
  5. Roth 401K
    1. Similar to Roth IRA in the sense that contributions are post-tax (for most people) and earnings are tax-free.
    2. Withdrawal though, is controlled by employer and might not be possible without leaving the employer or attaining the age of 59.5.
    3. Usually, it’s a good idea to convert post-tax 401K to Roth 401K (or Roth IRA) if that choice is available in employer’s plan.
  6. Some other exotic options like SEP IRA, 403(b) plan – I don’t know these and they won’t be covered here

Retirement accounts (contributions vs earnings chart)

Retirement accounts (summary)

Which plan should a person go for?
See my next blog post for the same.

Finance 101: Terminology

  1. Contributions – Money being put into an account is called a “contribution” to that account.
  2. Earnings – Money “earned” in an account. Usually, as an interest or dividend on the money contributed but can also include things like bank bonuses.
    As a concrete example, a person opened a new bank account and “contributed” 1000$ in the account, the bank gave him a 150$ bonus and by the end of 31 Dec, the account earned and interest of 35$, the “earnings” will be 185$ (150 + 35).
  3. Withdrawal – Money “withdrawn” from an account of one type into an account of a different type. Movement of money between accounts of the same type is not withdrawal.
  4. Realized and Unrealized gains – Suppose a person buys stocks worth of 1000$ and it gains 5% in one month, the gain of 50$ in this case would be “unrealized” till the person decides to sell the stocks, at which point, the gain is “realized”.
    Why does this matter? As per the contemporary IRS rules, gains are taxed on realization based on tax laws at the time of the realization.
    Note: In the case of bank accounts, earnings are realized as soon as the bank pays interest at the end of the month.
  5. Pre-tax contribution – A contribution made from the pre-tax money, the money from which state and federal income tax have not been deducted.
  6. Post-tax contribution – A contribution made from post-tax money. Such a contribution won’t be taxed again (provided the person is careful), the earnings on it might/might not be taxed depending on the type of account earnings were generated in.
  7. Tax-deferred growth – An account where earnings are not taxed till a withdrawal is made from the account (what if 10% money is withdrawn from the account? well, that is account specific and will be covered in a different blog post)
  8. Tax-free growth – An account where earnings are not taxed ever – usually these accounts have certain constraints like age at the time of withdrawal should be more than 59.5 or money should be held in the account for a certain period of time or both. Trivia: Mitt Romney holds money in one such account.
  9. Equity – A piece of ownership of land or company
  10. Share/Stock – A piece of ownership of a company
  11. Bond – A piece of ownership of a debt given to a company. Safer than stock but yields lower return.
  12. Options/Futures/Currencies/Shorting/Margin trading – A collection of exotic complicated financial instruments which I don’t fully understand. Please refer to one of the references if you are interested.
  13. Municipal Bonds (munis) – The earnings on these bonds are not subjected to federal and state taxes as long as they are from the same state as the buyer’s state of residence. High earners love these.
  14. Ordinary income tax – A tax which applies to regular income  like salary and interest paid by the banks. This tax has both state and federal tax components.
  15. Capital gains tax – A tax which is applied to the appreciation in value of an equity (like stock or house), this tax is either short term (if holding period of equity is less than 365 days) – where it is counted as part of ordinary income or long-term – where it gets a preferred treatment and is taxed on a lower rate (more on this in another blog post).
  16. Required Minimum Distribution (RMD) – A lot of retirement accounts mandate that the owner must start withdrawing a certain amount of money from the age of 70.5, the minimum withdrawal limit is controlled by IRS [source].
  17. Expense Ratio – A percentage of money which a mutual fund eats into every year. Eg. if expense ratio is 1% than a contribution of 1000$ with 10% gain will become 1090$ at the end of the year.

Trivia: Reason being 59.5 being the retirement age is detailed here.

Relocating to California for internationals – Part 3

  1. Manage your finances
    Use Mint for getting a complete view of your finances. CreditSesameCreditCreditKarma, and Quizzle for free credit score tracking. Quizzle always try to sell something; others are better. The score they provide is not the same as the FICO score but is highly correlated. Use Splitwise or Buxfer for splitting bills with friends. Vanguard has a great selection of index funds. Matrix ITA for air fare prices. yapta for tracking air fare prices over time.
  2. Get three free credit reports every year
    Set a google calendar event to get a free report every four months rotating between Equifax, Transunion and Experian (major credit report providers) via annualcreditreport.com. Each company is bound to provide you with one free report once a year.
  3. Return policies are really lax in CA (and the US in general)
    Buy almost anything including electronic gadgets like phones and laptops to try. If you don’t like it just return it within a set time period, usually 15 days or 30 days, for free.
  4. Healthcare
    The US has one of the most expensive health cares in the world. Employers provide health insurance – medical, dental and vision. For healthy individuals, usually, the less expensive plan (HMO) is a better option. Dental insurance usually covers two teeth cleaning per year for free. Vision insurance covers one vision test, which is usually not free but with a nominal co-payment. Medical insurance usually covers a physical checkup.

To be continued to part 4 (Retirement accounts, investing, Things to do in and around California)

Relocating to California for internationals – Part 2

  1. Buying a car
    Due to the deliberate destruction of public transport, driving a car is cheaper on the west coast compared to taking public transport unless your employer subsidises commute via public transport. Decide ah car you want to buy, Honda Civic and Toyota Corolla are value for money for singles. Honda Accord and Toyota Camry are better for people with families. Specially, who have young kids which require child safety seats.  On luxury end, Toyota Lexus, BMW, Mercedes and Tesla are the popular ones. A car’s average age is considered to be 200, 000 miles. So, be wary of that while buying a second hand car. Do check car’s mileage (miles per gallon) on fueleconomy. Car model years are a bit misleading, model 2013 usually, came out in June 2012 and for some companies even earlier). If you are buying a new car, then go to multiple dealers and bid them for the best price, it is usually easy to get 10% or more off from the marked price of the vehicle. If you are buying second hand, ask for a Carfax report which gives the detailed history of any recorded accidents which car had. Check the price of second hand car at Kelly Blue Book, in my opinion, they are marked upwards by 10%. craigslist is still one of the best source for buying and selling cars. Avoid buying cars with non-Californian license plate since you have to register them next year. Specially, avoid cars coming from cold states since they might have been corroded by salt which is used to prevent ice melting on roads in these states. Go to DMV and inquire if that car has any pending fees/parking fines which are unpaid for. Buying second hand cars from individuals, as opposed to dealers, is usually cheaper. But dealers will sell second hand cars with a warranty to justify the premium, do get details of the warranty. If you are buying from an individual, do get a thorough inspection done at a car mechanic (costs  < 100$).
  2. Car insurance (Auto insurance)
    Do hunt around for multiple quotes, try insurers to match quotes from others. Good companies are AAA (recommended) and Geico (they never gave me a good rate though). Smaller companies like StateFarmFarmers, and Provident (to name a few) might give better rates as well. Usually, phone calls will return better rates than the websites. If you are driving history in the US is not long enough, be ready to buy an expensive insurance for ~6 months and then buy a new one. Have minimum liability of 100K/300K (meaning 100K per individual in an incident and 300K per incident). If your car is new, get a comprehensive insurance with high deductible like 500$ or 1000$.
  3. Maintain emergency cash
    The usual rule of thumb is to maintain 6-8 months of expenditure at a safe place. Checking and savings accounts are insured by FDIC up to $250, 000 per customer per bank. So, keep it in a high yield savings account (Barclays offers 1.0% – which is high by US standards). A more elaborate list is available at fatwallet. Another alternative is to buy Series I Bonds by US treasury. The purchase is limited to $10K per individual and they have to be held for at least 1 year after purchase. They are inflation-protected, meaning, their value will go up with inflation. They are not taxable by state and city governments.
  4. First tax filing
    California has state taxes. Both state and federal tax filings are due every year in April for the previous year. I used to use pen and paper for a couple of years. It was a great learning experience but was unsustainable in long run. So, I started using TurboTax instead. Keep an eye around for TurboTax deals.
  5. If you are paying full price for anything you are probably paying too much
    All marked prices whether it’s rental cars or food, there are deals/discounts going all the time. Whether it’s worth spending the time to look around for discounts is a personal choice. As a rule of thumb, looking around for discount coupons/deals when you are paying more than 100$ is not a bad idea. If you work for a big company, they will usually have an internal perks site. Also, you can check out perks eligibility at larky based on your employer, city and state of residence, insurance and credit cards.
  6. Eating out
    Use yelp to find good restaurants. Tipping norm is 15-20% for food served on the table, anything less than 10% looks ugly. Taking food out as “to go” has no mandatory tips. Subway is a great healthy place for “to go” sandwiches. Starbucks fulfills the national coffee addictionMogl provides 10% cash back on selected restaurants in California.

Continue to Part 3 (free credit reports, managing finances, health care …)