In economics parlance they say money is fungible, meaning no dollar is unique or special and they are all fully interchangeable. A dollar is a dollar.
I learned this concept early in life when I successfully paid for a GI Joe action figure entirely with pennies. Go Joe!
But this is a little more complex in the modern world, so here are some money fungibility related questions/comments I’ve received over the years.
Money is Fungible
Here are some fun examples of monetary fungibility:
“I hate coins! I’ll do anything to avoid carrying change!”
Do you know how much a GI Joe action figure worth of pennies weighs? Or how loud a cashier will sigh when they see you pull out the coin jar? Or how long the checkout line will grow whilst said annoyed cashier counts those pennies, twice? A dollar is a dollar if you ignore the social ramifications.
Perhaps the experience explains why I use a credit card for everything, where possible. I do my best to eliminate coin accumulation. It also gives me up to 30 days of float.
Otherwise…
We toss all coins into a small jar we keep near the door. When it fills up, I bring it to the nearby 7-11 and use the funds to increase the balance on my prepaid card. In the US, I used to bring the coin jar into my credit union near work to use their free counting machine. My parents would empty the coin jar once each year to help pay for the family summer vacation. (Optional: stuffing coin roll wrappers together is a rewarding and fun family bonding experience.)
I live in a non-tipping culture, but I will sometimes leave coins as a tip for small cash purchases, e.g. Taiwan has a $50 coin and maybe a coffee costs $45, so I will toss the $5 change into the tip jar. (Although my favorite nearby coffee shop now accepts Apple Pay.) In the US, paying tips in cash/coins is almost always better because it ensures that the server will benefit from it immediately.
“I have an emergency fund with $1,000 and credit card debt of $1,000. I want to get out of debt but then I won’t have any money. What should I do?”
I’d pay off the credit card debt with the emergency fund. Should an emergency arise before replenishing the savings, the zero balance credit card IS the emergency fund. (For reference, our emergency fund is about $0.)
Using just these 2 accounts, net worth is $0 either way (“I have no money”) but paying 18% interest on a credit card to keep some cash earning 0.1% “just-in-case” is a net loss every month. Which is technically an emergency.
“We want to retire early and have saved 25x++ our annual expenses. The problem is most of those funds are in retirement accounts, and our taxable accounts aren’t big enough to last until age 59.5 when we can make 401k/IRA withdrawals without penalty. What can we do?”
Pre-tax/post-tax/taxable accounts do complicate dollar fungibility a bit, as withdrawals may have different after-tax values.
However, there is a false assumption buried in this question – we can withdraw funds from retirement accounts before Age 59.5 without penalty, via Roth IRA conversions and/or SEPPs. These withdrawals are taxable, of course, but the tax burden may be zero. You can also withdraw Roth IRA contributions at any time without taxes or penalty.
What I would do: double/triple-check that you have saved 25x++ expenses with taxes included, then proceed without worrying too much about the split between pre-tax and taxable accounts. Make annual Roth IRA conversions if you can do so at a zero/low/reasonable tax rate. (Try kickstarting your retirement, even.) If the taxable account runs low as you approach age 59.5, set up a SEPP to bridge the gap between then and the big Six-Zero.
“I want to live solely from dividend income, but like the question above a lot of our funds are in retirement accounts. With only a 2% yield on the S&P500, or whatever, dividend income alone isn’t enough to cover our cost of living. Ideas?”
One idea is to not limit yourself to living solely from dividend income. It isn’t necessary. But I digress…
Another idea is to sort of make your own dividend. If you receive $10k in dividends in your retirement account, access it by selling $10k worth of stock in your taxable account. Use the retirement account dividend to purchase $10k of whatever you just sold.
You now have the same net worth, the same stock holdings, and the same amount of cash in the portfolio. After all, a dollar is a dollar.
The difference: your taxable income is lower than if you received an extra $10k in dividends in the taxable account. Only the gain portion of the stock sale is taxable, whereas 100% of the dividend would be. This is most significant in a state with an income tax and for those enrolled in Obamacare. (An example.)
“We are buying a new-to-us vehicle – what is the lesser of 2 evils, a used car loan at 5% interest or a 401k loan at 7.5%.”
Making virtual car payments to a savings account until there was enough to pay cash for the vehicle would be the ideal option, but when that isn’t possible… we can think about this in accounting terms.
Purchasing a used vehicle with a loan adds both debt and an asset to the household balance sheet.
Because money is fungible, it doesn’t matter if the loan is from a 401k or not. I’d go with the lowest interest rate option.
(I suppose with a 401k loan you might get some accidental market timing. That could be good or bad.)
Summary
The numerous account types we used in the modern world can complicate how we think about money, but whenever I get confused I just remind myself that a dollar is a dollar and it helps steer me in the right direction.
The examples using coins, credit cards, pre-tax accounts, and debt hopefully help cut through the confusion.
A dollar is a dollar. Money is fungible.
Also – if you see a kid paying for a toy with coins, please don’t be a jerk about it ;)
What are your examples of money fungibility?
Like you, I generate income by selling shares in my taxable income and immediately buying it back in my IRA where I have set aside 170K in cash exactly for events like these. I keep my expenses very low and can do quite well with just 36K a year. As a single person with only a small mortgage as my only debt, it’s very doable. One thing I haven’t figured out is how much cash can I generate via capital gains and or dividends before incurring tax? My tax rate at the moment is zero because I have zero earned income, and I want to keep it that way.
You noted: “However, there is a false assumption buried in this question – we can withdraw funds from retirement accounts before Age 59.5 without penalty, via Roth IRA conversions and/or SEPPs. These withdrawals are taxable, of course, but the tax burden may be zero. You can also withdraw Roth IRA contributions at any time without taxes or penalty.”
How much can one withdraw from an IRA with a ROTH conversion to keep one’s tax rate at zero?
Hey andrew.
The standard deduction for 2019 is $12,200 for single tax filers. That’s the amount you can convert at zero with no other income.
You can have dividends and capital gains for an additional $39,375 tax free on top of that.
One important factor if you’re retired is aca subsidies and cost sharing. If you want to stay within the $36,420 magi for subsidies, you would need to reduce the amount of you conversions or capital gains.
So,
$12,200 in roth conversions and $24,220 for dividends/capital gains to stay at true zero for a single
Hope this helps!
“dividends”:
. USA – company profit taxed (21%), dividends taxable (some 0%) = double taxation; minimum 21% tax.
. Aus – company profit taxed (27.5%) creating franking (tax) credits, dividends + franking credits taxed = single taxation (some 0%); minimum 0% tax.
. USA – no tax free income (other than capital gains).
. Aus – single non-senior: <= $A21,594.72 tax free (<=$37,000 tax 19%; capital gains 50% discount).
Once income exceeds 0% tax, $#1 is not the same as $#2 – not strictly fungible.
“no tax free income”: err, not quite.
re: tax free income – there is also the standard deduction ($12k/year/person) and 0% tax Roth conversions (tax free IRA contributions / tax free conversion / tax free withdrawals)
“there is also the standard deduction ($12k/year/person) “:
Which results in 0% tax on income other than dividends which are from company profits taxed a minimum of 21%.
HI Nate,
Thanks for the info. I also did some further research myself.
According to one of the websites I have been reading, current tax laws state those in the 10% and 15% tax brackets pay 0% in long-term capital gains tax. It states that I can have up to $51K in capital gains and up to 39K in qualified dividends without paying a single cent in taxes as a single filer as long as I have no earned income.
I am retired. This puts me squarely in the 10 percent tax bracket. But zero earned income X 10 is still zero. However, I am not sure if one type of income negates the other, i.e. capital gains negates qualified dividends and vice-versa. If not, does it mean I can have up to a total of 90K a year to spend tax free or am I forced to pick one or the other?
However, as you have noted, in order to qualify for ACA subsidies I have to stay within the $36,420 MAGI. So in effect, does it mean that I can’t collect more than 36K in total to stay tax free and also qualify for the ACA subsidies?
Thanks again!
“to 39K in qualified dividends without paying a single cent in taxes as a single filer”:
Actually ‘not a single cent extra’ – as a shareholder you would have paid a minimum of 21% tax on your company profits.
For that reason, USA companies pay scant dividends and buybacks and capital gains are preferred means of passing returns to shareholders.
yeah I get that, but I’m only concerned about what I as an individual will have to pay out of pocket.
“have to pay out of pocket”:
. USA – worth considering what type of income will be paid into pocket – dividends least preferable as is taxed an unavoidable minimum of 21% before being distributed as dividends.
. Aus – after applying 50% capital gains discount, all income, including dividends grossed up with franking (company tax) credits, is subject to the same tax rate, the minimum being 0%. All income is fungible – until progressive tax rates are applied.
This is covered pretty extensively on this site. The basic principles are here. Also look at one of the tax returns linked from that post to see it in action – I’ve done this every year.
Capital gains and qualified dividends are one income type with special treatment. If the sum exceeds the 0% tax bracket, the overage will be taxed at 15%.
The ACA is a separate/parallel system that treats all income types equally.
To qualify for ACA subsidies total income needs to be below 400% FPL. For a single person in 2019 that is $49,960.
More here.
For optimum tax minimization, a single filer would do a Roth conversion of up to $12.2k (std deduction.) This would be taxed at 0%. Other ordinary income reduces this amount (rental profit, non-qualified dividends, short-term capital gains, etc…)
Then you would harvest capital gains up to the top of the 0% special tax bracket ($39,375 for 2019 for single filer.) Reduce by amount of qualified dividends.
The sum of the standard deduction and 0% capital gain bracket is slightly greater than 400% FPL for single filer ($12.2k + 39.375k = $51,375 > $49,960) so reduce size of Roth conversion or capital gain harvest to keep under this threshold. This post discusses how to prioritize.
Not sure about the US, but in Canada at least, you have to be about the exercise of selling in taxable accounts and rebuying in non-taxable accounts. If you sell the taxable equities at a loss and re-buy them in a non-taxable account within 30 days, you can’t use the capital loss to offset taxes.
Same in the US where it can be avoided by purchasing a similar but different ETF, i.e. one that tracks a different index. For example, sell a SP500 index fund for a total market ETF. Or use this event to rebalance the portfolio.
I’ve recently setup margin on my brokerage account to invest my emergency fund.
The way I see it, there’s such a small likelihood that I’d need that emergency fund given significant positive cash flow from my job that the opportunity cost isn’t worth it.
I could throw the purchase on a credit card and have an extra month to pay it off. I don’t own a house so nothing big could happen there. I have good insurance. Having that extra money gives me an illusion of safety but with no debts and brokerage account of over a year of expenses invested in the market, I don’t think there’s a reason to keep the extra two months living expenses in cash.
This is how we do it as well. During a cash flow pinch a couple of years ago I had an “overdraft fee” of $0.13.
I also often tip in cash when eating out. I pay the bill via credit card and mark the tip line as “cash”. Sometimes I even slip a Sacagawea golden dollar in with their tip just because it seems to make people’s day. The Sacagawea might not be very fungible for the wait staff though since it likely ends saved in a desk drawer for a few years or given to a kid by the tooth ferry.
Maybe not fungible, but it is still fun, though. ; )
Max
Marking the tip line as Cash is smart. I once just put a zero there and the server changed it to an 8… calling the credit card company fixed it, but damn that is brazen.
Here is an example that made my life easier.
Budgeting. Our monthly budget is $4,000. If we spend more, we’ll pay more attention next month. Otherwise, carry on. Why worry about each little category? This works for us because we’re pretty careful already.
This is why I never budgeted. It’s all one big pot
I agree the money is money — interest, dividends, capital gains, a quarter in your couch cushions, it’s all the same. Two further thoughts:
• If one is truly retired, one may evoke the 72(t) rule to start withdrawing money from retirement savings.
• I don’t have a separate bank account for an Emergency Fund. Horrors, right? But, I find may expenses people consider “emergencies” are completely predictable. If you drive a car, it needs maintenance and will need to be replaced periodically. If you own a home, you’ll get an insurance bill every year, and you’ll need to make home repairs from time to time. Medical needs arise. But if something catastrophic were to happen, I’d either dip into other savings or put it on a credit card. Then I’d initiate a transaction to liquidate investments from a brokerage account. By the time a credit card payment is due, I’d have the funds in hand to pay it off
We don’t have a separate emergency fund either for the same reasons you mentioned.
The SEPP is the 72(t) withdrawal option – substantially equal periodic payments
GCC, I appreciate the perspective on fungibility of money. Something I would like to clarify-
“Because money is fungible, it doesn’t matter if the loan is from a 401k or not. I’d go with the lowest interest rate option.”
When you make payments to your 401k loan, you are paying the money back to yourself. Every 7.5% interest payment is being added to your net worth by being deposited into your 401k. Whereas paying a 5% loan to the bank, that money is truly an expense.
So while paying a 7.5% interest loan on your 401k will require a larger monthly cash payment, all that is doing is putting more money into your 401k. You’re simply moving money from one account to another, so there is no actual cost to you.
Obviously you are missing out on the potential growth of your capital that you have withdrawn to buy the car, but depending on the payback period that might not end up being a huge deal.
401k loans are not something I see discussed in the broader FI literature. Would the 401k loan not be the optimal choice most of the time?
I didn’t do a good job of writing about this one, sorry. I threw this in at the last minute since someone I know just asked this question yesterday. I knocked out a quick spreadsheet and it came out a wash.
You are paying yourself with the 401k loan, but the value at loan payoff is the same if the 401k total return is the same as the interest rate. At 7.5% this isn’t unlikely. (Market timing might change this, as would lower/different interest rates.) You are moving money from one count to another, but the downside is we are changing some of our post-tax dollars into pre-tax dollars without a tax deduction.
The interest paid on a car loan from a bank is gone forever, but with the lower interest rate we could increase our 401k contributions (or TIRA) to get the same cash flow. (If already contributing the max then add to taxable brokerage account. Or pay down note faster.)
In the real world example I was looking at, the person is at a 28% marginal rate with Fed/State, just contributing enough to 401k to get full match, and the numbers came out roughly even.
A different set of numbers could tilt it either way, but if in the same ballpark I would go for the bank loan as it is more flexible. (If lose job have to immediately pay back full 401k loan value or pay penalty, etc…)
The most common form of this that I see is friends paying off mortgages because it feels good to be debt free. However money is fungible so if you sold your index fund averaging 7% return to pay off your 4.x% mortgage that for example could look more like 2.x% after the mortgage interest tax deduction is that the right move? Often it may not be but all personal money and investments should be looked at together. How does a dollar here relate to a dollar over there.
Also fungible, its just fun to say haha
Say monetary fungibility 3x real fast for great fun for the whole family :)
After the TCJA few people will see any tax benefit from holding a mortgage and will just use the standard deduction. Paying down the mortgage will save you only 4% but paying off the mortgage could result in lower taxes and higher ACA subsidies for an early retiree. It depends.
Considering the 401k vs car loan scenario, I was under the impression that the interest rate on loans from your 401k are actually paid to the 401k fund, aka to yourself. That could make the 7.5% interest rate close to zero effectively (you might pay some percentage tax on the 7.5%, still a very small number).
You are paying yourself, yes. If you contribute the difference in cash flow between the 2 scenarios as an additional deductible 401k contribution, my math came out about a wash with FV of incremental 401k payments roughly equal to total bank loan interest.
My best hack for fungible money is using an HSA to pay for college. Basically we cash flow medical expenses today, save the receipts, and reimburse ourselves later when we need the money for our kid’s college. The money grows tax-free and it’s FAFSA-blind (not counted as an asset since it’s technically retirement savings, not counted as income since it’s reimbursing yourself for an expense).
Very smart. Stock piling the receipts for 10+ years down the road is a good move – I keep digital receipts of everything to avoid accidental loss.
Most of our college expenses will probably come from the taxable account after years of raising basis / capital gain harvesting. Ideally by the time Jr is 18 we have full college expenses worth of equities at basis.
The combination of these 2 things is part of why Jr doesn’t have a 529.
I spend my undesired coins at the self-service registers at various stores. You can put your change and cash in first, and then complete the purchase using a credit/debit card.
Money is FUNgible whether it’s metal, paper, or plastic.
This is great, I never thought of this. Fun and smart.
Don’t forget the rule of 55, you don’t have to wait until age 59.5 to make 401k withdrawals without penalty.
I love these ideas I agree though. I love where you point out that minus the social ramifications, money is money. A buck is a buck. This reminds me a Mr. Money Mustache article where he reminds us to reconsider the value of $10.
I agree with some of the other comments about people selling investments to pay down debt. That’s physiological and not really financial savvy.
Good stuff.