How the banks robs us of our own money
Before you in the banking industry react to the title of this post and before I get tons of negative comments from those who are involved in banking let me first tell you to read the entire post first before making any reaction of any kind.I’ve chosen this title just to attract attention. Banking is of course an honorable business and oh what we do without banks!
However, just to get the point across, let’s take a close and serious look at the illustration I am about to give. I’ve been ranting about the Rule of 72, how it is the foundation of all investing and what are the lessons that we can learn on the Rule of 72. To further emphasize the importance of the Rule of 72, let us study this illustration. I always give this illustration in my business law class.
A 29 year old Overseas Filipino Worker (OFW) decided to put aside P 100,000.00 (Philippine peso) for investment. Unfortunately, the only thing he has learned or has been taught about investing is to put his money in a bank.
So he went his way to see the bank and explained the situation to the bank manager. The bank manager, wanting to help him, suggested that he put his money in a time deposit account which earns interest at 4 % per annum. He decides to follow the bank manager’s advice considering that he is planning to lock away his money for a long period of time.
He went back to his job abroad and worked hard until the good old age of 65. Contemplating retirement, he went back to the bank and asked about the status of his P 100,000.00 placed in a time deposit. He was quite happy that his P100,000.00 has grown to P 400,000.00 because of compounding interest interest. He was overjoyed! His money really worked hard for him. The bank manager with a big smile on his face approved the withdrawal. He withdrew his money and retired happily.
Do you consider this a successful investing story? Did his money really work hard for him? What made the bank give him an extra P 300,000.00 after 36 years? Look closely at the following table:
In order to understand this table more precisely, you need to understand how the rule of 72 works. As I said in previous post, The Rule of 72 simply gives you the number of years it takes for your money to double. To solve this divide 72 by the interest rate given.
In our OFW story, we can compute that every 18 years his money will double. (72 divided 4 % per annum = 18 years.) Since he deposited his P 100,000.00 at age 29, at age 47 his will double to P 200,000.00. Finally at the age of 65 his money will double to P 400,000.00.
While he works his ass off in some foreign land, the bank, sits around and works smarter not harder. They take that P 100,000.00 and invest that money by loaning it to other people at a higher interest rate. They also invest the money in various other investment vehicles such as the stock market, the money market, government bonds, corporate bonds etc. Of all the investing activity that the bank does, it averages a 12 % return on the same P 100,000.00 that is placed in time deposit by the OFW. Using the Rule of 72, the bank doubles the P 100,000.00 every 6 years. (72 divided by 12 % interest = 6 years)
No wonder that after 36 years when the OFW went back to the bank to claim his P 100,000.00 the bank manager had a big smile one his face when he gave him back his P 100,000.00 plus the interest of P 300,000 totaling to P 400,000.00. The bank already made P 6 million pesos out of his P 100,000.00 ! What the bank gave back to him are just bread crumbs compared to what they made out of his money! Now that’s hi-way robbery! (That’s according to one of my former professors in corporation law)
Well I really don’t personally think that the bank committed hi-way robbery or something akin to that nor am I implying that bank managers are evil greedy agents of bank owners who are looking for gullible persons to victimize. As I said, I just used this controversial title to shake you up a little bit and to illustrate an important point. Elements of the story might be fictional and blown out of proportions but it has tremendous real life application.
What the bank did was just to apply the Rule of 72 to invest their money wisely. They know the tremendous power of compounding interest and they used the Rule of 72 to their benefit. With access to stock piles of cash, more profits could be made by banks. Truly there is no other business like the banking business!
Don’t let the banks rob you of the profit that should be yours! Learn to invest wisely. Use the Rule of 72 to your advantage!
Hi ! my name is Zigfred Diaz, Thanks for visiting my blog where you can learn stock market investing the Warren Buffett way and using other value investing methods ! Never miss a post from this blog. Subscribe to my full feeds for free. Click here to subscribe to D’Intelligent Investor by Email
I’ve been aware of how banks profits. Currently, I have money sitting in my bank account. The bank is happily using it to invest and make great returns while I only receive less than 1%. I’m currently learning all that I can about investment. I don’t want to hastily make decisions and end up losing considerably so for now, my money is sitting in a bank until I’m able to come up with a plan on investments. I do, however, already have several retirement investments, but I was hoping on going beyond the 401K and mutual funds.
Iris: Yep I agree. But you can invest in companies with durable competitive advantage bought at a fair price with a huge margin of safety. It is almost always guaranteed that you will grow your investments !