Tag Archives: risk

The Credit Card Arbitrage Talk

Posted on by
Reply

In my previous article I discussed the merits of credit card arbitrage, the potential risks and rewards, as well as my plans for what I would do with the transfer. I was convinced the math worked. There was inherent risk but I was willing to accept it. The only question was would HoneyShrugged agree?

Prior to a full fledged discussion I wanted to prepare her. I let her know that I wanted to share something with her and that I wanted her opinion. This let her know that I was planning for the future and I fully expected to share that future with her and that I valued her feelings on it. It wasn’t all roses and puppy dogs though; I warned her that I was going to bust out a spreadsheet. Surprisingly, not everyone shares my passion for neatly organizing numbers in an appealing chessboard of rows and columns.

During the actual discussion I started with a brief outline of what my plan was. This took us in all sorts of discussions about interest rates and investment options but we didn’t get too derailed (one of the many reasons she is HoneyShrugged is because of our fun and lively discussions). I opened up a fresh spreadsheet and we talked through the timing and potential complications. It was helpful since we both had input in creating it instead of me presenting some monolithic wall of numbers. This is what we came up with

This isn’t the cleanest or prettiest job but it’s functional. Afterwards we agreed that the rewards outweighed the potential risks and that there was a lot of potential upside. I made sure I stressed the worst case scenarios such as losing my job or the stock market crashing. She pointed out that if any of these events happened I’d have worse things to worry about and would still have the means to pay off this loan.

I asked her what she thought I should do and gave several alternatives. I could ignore this completely and wait for a better offer. I could use a percentage of the money instead of the entire amount (the effects of which were easy to see since we had made a nice functional spreadsheet). She pointed out a couple of items I had just abstracted away originally like what if FAX goes up substantially before I was able to buy it.

In the end we agreed that the model was solid and that it would be smart to maximize this opportunity by removing the full amount possible. This was a lot of money but it wasn’t life threatening – the worst case scenario would harm me more than the fallout from this transaction would. Finally it was time to put our words into action. I carefully reviewed my past couple months of transactions to make sure I had changed any reoccurring charges to a different account and triple-checked that I didn’t have any balance remaining that would rack up interest while my balance transfer sat at 0%. Now that it’s initialized I’ll update this article once I have it invested so you can track my progress.

Pondering Credit Card Arbitrage

Posted on by
1

I received a semi-reasonable offer from one of my credit cards offering a balance transfer offer. For those unfamiliar, a balance transfer is nearly identical to any other sort of loan such as a car loan or mortgage. Just like these loans, I need to be careful of three things:

  1. Term (the loan duration)
  2. Interest rate
  3. Fees

In this case I’m offered 0% until November 2012 with fees of $5 or 3% (whichever is higher). My Money Blog even details how to separate how easy the process is. Back in the heyday of fantastic credit card offers, I could easily get 0% and no fee cards for 18 months (and often did). I’d take this money and stick it into a splendid ING savings account spitting out 5% or more. I called this credit card arbitrage since it sounds sort of hi-tech and stealthy. In the current environment my ING account is sputtering along at a much less awesome 0.9%.

If I followed my old method, I would take out $10,000 from the card, rack up $300 in fees, and deposit it. Each month I’d make $7.50 ($10,000 x 0.9% / 12). After my one year I’d have made $90 while paying $300, not something I should just shrug off! To break even, I need to see my good old friends risk and return.

Investopedia's Badass Explanation of Risk vs. Return

Since I want a higher return, I’m going to need to accept higher risk. The most obvious place would be the stock market – so how about one of my old reliables: FAX. This is an interesting choice since I’d get $0.035 centers per share per month. Currently this works out to about 6% per year – double the return I’d need to break even. However, with this higher return I’d be accepting much more risk than a nice safe FDIC insured bank account. Just look at what happened on Oct 4th; FAX dived down to $6.28 per share! That’s down over 10% from its current price ($7)!

On the other hand, I want to own a lot of FAX. I love this equity and seeing those monthly dividends roll in makes me a little misty eyed. If I assume that within the next year I would have invested $10,000 into FAX anyway, I can look at this as a not-quite-free-lunch. I get to invest my cashola before I even get it by giving up the first 6 months worth of interest, not a bad deal as long as I’m confident that I would actually do this in the next year.

The time frame is important because of the terms of the loan. Paying 0% interest for a year is awesome, but what happens after that? It skyrockets up to a nasty 13.9%! Being a good-looking and of above-average intelligence Adam Shrugged reader, you know to pay off your credit cards when they aren’t offering you 0%. If I do not pay it off in time, even one month could easily erase any of my gains since I might need to sell it at lower price AND pay the super high interest!

So the question is: just how confident am I that I would want to invest $10,000 in FAX over the next year? Should I go full force, victory or death style and withdraw a full $10k? Maybe I should temper my enthusiasm a bit and do half of that amount. Being able to swing $5,000 over the next year sounds a little more realistic. Of course then I’d be limiting my potential gains both from dividends and if FAX increases in value over that time. If it jumps up to $8 per share I’d make a bonus of over 14% (assuming I sell in time).

One final and very important point to consider is that this shouldn’t just be my decision. I need to discuss this with the real boss – Honey Shrugged (the girlfriend). Moving a five figure sum of money around is a potential game changer – what if FAX goes kaput and I lose it all? Very Bad Things (VBT) – I’d probably be sent to my room without any desert or something even worse. So while ponder this move, I’m awaiting an opportune time to discuss the matter with her. In the meantime, feel free to share your advice or bitter sweet reality checks.