Arbitrage is the practice of taking advantage of a price difference between two or more assets or markets, and profiting until the price difference disappears. Being able to recognize and then take advantage of kinks in the system will be one of your greatest catalysts towards financial freedom.
For example, as a elementary-schooler in Taipei, Taiwan, I would buy Nerds candy at the U.S. commissary for 25 cents and sell them to my classmates for 50 cents. Only foreign service families had access to the commissary. But eventually, other candy stores opened and my profits were competed away.
Today, I’ll share with you one of the most obvious arbitrage opportunities. It is an arb that my wife and I are wholeheartedly engaging in because we love free money.
The Easiest Way To Make Free Money
The 10-year bond yield has fallen from a high of 3.21% in October 2018 to ~1.56% in September 2019. A 1.65% decline is huge because, on a percentage change basis, we’re talking about a 51% decline.
Back when the 10-year bond yield was at 3.21%, one of the best online savings rates I could find was CIT Bank at 2.45%. I track CIT Bank closely because they not only offer one of the best rates, but they are also an affiliate partner and I get all their updates via e-mail.
A 2.45% online savings rate back then was competitive because the yield curve was upward sloping. Getting a higher risk-free rate would require owning a longer-term Treasury bond until maturity. The reward for locking up your money for 10 years in a Treasury bond was therefore 3.21% – 2.45% = 0.76% a year.
Given the 10-year bond yield is down 1.65% since its 2018 peak, you would think that CIT Bank’s savings rate would be down a similar amount. In fact, that’s not the case at all.
The latest savings rate for CIT Bank is 2.3%, a decline of only 0.15% since its 2018 peak. In other words, U.S. buyers of 10-year Treasury bonds today are being NEGATIVELY rewarded by 0.76% (1.56% – 2.3% = -0.76%).
Not only is the online savings depositor now earning 0.75% more than the 10-year Treasury bondholder, but there is also no lockup period and no risk up to the FDIC-insured $250,000 per individual and $500,000 per couple.
We are now talking about one of the greatest risk-free arbitrage trades in modern financial history. As a result, everybody should be taking advantage until this arbitrage disappears by opening up a high-interest savings account.
Because eventually, after CIT Bank and other banks providing a similar online interest rate have received enough inflow of deposits, they will lower their interest rates and this opportunity will disappear.
If you want to take on risk to potentially make more money, you can open up a high-interest savings account and short long-term Treasury bonds through an ETF like IEF. There is certainly a chance that after such a huge move up in Treasury bonds, they could come off. But I’d rather keep things simple, especially if you don’t have experience shorting securities.
A History Of Money-Making Arbitrage Opportunities
Here are some other arbitrage examples that have helped me boost wealth.
1) Went to a public university for $2,800/year in tuition. I saw my older sister attend a private university for $22K/year and saw no noticeable benefit. In fact, attending a private university was probably a detriment because my parents didn’t make that much as government employees.
The max arb was going to one of the cheapest public universities and then getting a job in one of the most lucrative industries. Even back in 1995, $2,800/year sounded like a bargain because I could cover the tuition working at my $4/hour minimum wage job.
More than 20 years later, it’s funny to see that people still believe there’s a positive spread in attending a much more expensive private university than a public university. Unless you are already rich or have huge scholarships, please save your money and go to the best public school available.
2) Buying San Francisco real estate in 2003. I came to San Francisco with a raise and a promotion after two years in NYC. The finance industry was thriving in SF and I realized plenty of people were making just as much money as people in NYC. Yet, San Francisco real estate was ~30% cheaper on average than New York real estate.
The massive valuation discount was odd because I found the lifestyle in San Francisco to be better. The weather was pleasant year-round. The city was more beautiful and less stressful. After going snowboarding in two feet of powder on a Saturday in Lake Tahoe and then playing tennis in 70 degree weather on a Sunday, I was sold.
When I walked into the open house for a two-bedroom, two-bathroom, 1,000 sqft apartment with a view of a park in Pacific Heights for $580,500, I clearly remember thinking it was a steal. Before walking up, for that price, I thought there’d be no view!
This condo would have sold for at least $750,000 back in Manhattan. Although NYC real estate has also done very well since 2003, it is not uncommon to hear reports that SF real estate is now equal to or more expensive than NYC real estate.
3) Starting Financial Samurai in 2009. After finishing up business school in 2006, it became apparent that having an internet-based business with unlimited scale was the future. Our commencement speaker was Reed Hastings of Netflix who helped inspire us to think bigger. Once the financial crisis hit, I decided it was finally time to put my mind to work.
Although there were plenty of personal finance sites in 2009, I didn’t recognize any personal finance sites written by someone who actually had a finance background. As someone who had 10 years of finance industry experience at the time, starting my own site seemed like an opportunity.
10 years later, there are still very few personal finance sites that are written by people with financial backgrounds for some reason. Therefore, there are still opportunities for finance industry folks to engineer their layoffs and start a finance website.
If you have experience in a field that is dominated by people without relevant experience, it behooves you to fill that hole. If you keep at it for a long enough period of time, I’m positive you will enjoy incredible rewards.
4) Buying panoramic ocean view property in SF. Believe it or not, I did not realize there were panoramic ocean view properties in San Francisco until 13 years after arrival. Neither did most of my peers.
But after I found panoramic ocean view homes in 2014 priced at a ~30% discount to the median-priced SF home, I decided to rent out my old home that was trading at a 20% premium to median and buy a fixer in Golden Gate Heights.
In no other major city in the world do panoramic ocean view homes trade at a discount, and I’ve been everywhere. They all trade at hefty 30% – 100% premiums. The discount has since narrowed from around 30% to 15% in 2019, but I still see plenty of opportunity to buy property with views on the western side of the city.
It is my belief that by 2025, the discount will narrow to 0%. We’re talking about a $240,000 arbitrage benefit based on the median-priced home. By 2030, ocean view homes in San Francisco should start trading at a premium.
I encourage you to drive all around your city one weekend and see if you can find some neighborhood gems. I’m sure there will be places you have never seen or heard of that will blow your mind.
5) Investing in heartland real estate. Although there is a micro-arbitrage opportunity to buy homes in SF with ocean views, there is a macro-arbitrage opportunity to buy real estate in the heartland, mainly due to cost and technology.
If it really now takes at least ~$343,400 in household income to buy a median-priced $1.6 million home in San Francisco, then SF-based companies are getting squeezed.
Google announced in early 2019 it will spend $13 billion to expand in Nevada, Ohio, Texas, and Nebraska. Meanwhile, Uber in late 2019, announced it has leased an office building in Dallas for 3,000 employees.
It’s obvious that companies based in expensive coastal cities will continue to expand inward to lower-cost areas of the country. And it is logical to conclude that employees will follow suit. Technology allows us to easily connect with each other around the world.
My bet is that a portfolio of commercial and multi-family properties in the heartland through real estate crowdfunding will provide me a healthy return. After three years, the portfolio has done well overall: 14 investments have been very positive, three investments have been positive but ho-hum, and one investment has been a turd.
The key is to find the next San Francisco, Seattle, NYC, and D.C.
Keep A Look Out For Arbitrage Opportunities
There are money-making arbitrage opportunities, large and small, every single day. Take some time out of your week and dedicate at least one hour to figure one out.
At the very least, everybody should take advantage of risk-free arbitrage opportunities such an online savings account that offers a much higher rate than the 10-year bond yield.
My immediate focus now is paying attention to the San Francisco real estate market before a wave of tech IPO liquidity gets unleashed at the end of 2019 and in early 2020.
I’ve spoken to dozens of employees from Uber, Lyft, Pinterest, and so forth and the majority of them will be selling some stock at the end of 2019 and selling more stock in the beginning of 2020 to minimize their tax liability and diversify their wealth.
It is my belief there is a window of opportunity to buy property right now when rates are down, fears of a recession are high, and a flood of money will be looking for a more stable asset.
For the even more brave, there’s a rare buy signal that’s flashing for the S&P 500, which I’ll touch upon next.