The Velocity of Money: Part Two

Introduction

It’s been a couple of weeks since we talked about thinking about the velocity of money as an APR. As a quick reminder, when you make a spread for moving money around, you can think of the profit in terms of simple APR as:

APR = spread * banking_days / settlement_time

In the example from last time, a spread of 0.65% gave an effective simple APR of 54.6%.

Making it More Complex and Accurate

But, when you’re earning a spread, you’ve got that spread to invest after it’s paid out too which makes simple APR tell an under-optimistic story: Basically, if you earn $650 for moving $100,000, next time you’ll have $100,650 to move, so you’ll earn a bigger payout if you reinvest your earnings. Assuming you’re paid on some frequency we’ll call payout_frequency, we’ve got effectively a compounding APR (APRc) formula that tells a more complete story (editor’s note: if the formula isn’t rendering properly, check the web site here):

{APR}_C = \left(1 + \frac{{spread} \times {banking\_days}}{payout\_frequency \times {settlement\_time}}\right)^{payout\_frequency} - 1

As my super annoying physics and math professors used to say in college, the derivation of that formula is left as an exercise to the reader. Of course it’s not super annoying when I do it, it’s cute right? Right?

Putting that all together with the numbers from last time, spread = 0.65%, banking days = 252, settlement time = 3 (avoid kiting), and payout_frequency = 12 (monthly), we get a compound APR of 70.6%. If you find a spread that pays out every time you move money, payout_frequency becomes 252 and, you’ll net even more with an effective APRc of 72.5%.

Conclusion

A small spread can look unappealing and make your brain flash a 🤏 emoji, but a small number compounded together a bunch of times can still turn into a big number. Obviously if you can do better than 0.65% on your spread of profit – fees (which you often can), then things look even better.

Happy Monday friends!

MEAB in a few decades; just like present MEAB, except older.