Author: animeshjmathur

You cannot have financial freedom without financial discipline- Part 2

Financial Independence, Human Brain

I had written on this topic in May also. Financial discipline is absolutely critical if you have to be able to come even close to getting financial freedom.

Our biggest problem with the education that is imparted to kids in India is that they are not given any training on financial matters. I know because I am part of the same problem.

I think its a similar problem in North America as you will notice from the amount of student debt and the lack of savings that exist for retirement for the baby boomers.

Sine we did not learn it in our 16 years of education we tend to have inertia to try and learn it. Anything where there’s inertia, the brain tends to put it back in the line, because it has to do more work to get into action.

The more urgent and easier things take precedence like a phone call from a customer or an email or one more meeting and the day gets over. And I am not preaching this. It happens to me all the time and it happened to me today again.

I was supposed to deposit money into my account for buying a stock whose deadline was today. But being the quarter end , there were supplier pressures, there were our own pressures for closing order bookings and this just slipped out of my mind.

Which brings me back to the basic problem for humans. If you leave it to your mind, chances are that it won’t happen. And for us middle class folks , this costs us dearly in the long run. Therefore I keep writing about ensuring money goes out of your bank automatically into whatever investment you target on a regular basis like a SIP (Systematic Investment Plan).

That’s the only way I have been able to bring in some kind of discipline into my financial life.

Till next time then.

Carpe Diem!!!

Fractional Reserve System

Banks, cash flow, Debt, Leverage, Liabilities

When I was a kid, I always wondered how banks operate. Yes I did know they take money from us and lend it to someone on a higher interest, compared to what they give us. The difference in the two helps them make money. Because they allow you to keep the money on “tap” they give almost negligible interest rates. On longer duration deposits they give a slightly higher rate of interest because the chance of the money being asked earlier is reduced.

While this is simple I still could not understand how banks could lend so much money and how defaulters could have so much money with them.

A few years back I was sharing a ride from Indore to Bhopal – two cities in the state of Madhya Pradesh in India – with a banker. During this 4 hour journey, I happened to get talking with him on the same query. His logic partially answered my question.

The logic was that at any point in time the banks don’t allow you to withdraw All the money from a savings bank account. So they will put clauses – that in case you need an ATM facility then you need to maintain a certain amount, if you need a cheque book then you have to maintain a certain minimum amount in the bank, otherwise they penalise you. Due to this there is always money available to the bank even in savings bank deposits which will not go out of the bank in most situations. This becomes one source of low value funds. In addition there are the long duration deposits etc.

This had partially answered my questions but I was still not able to get my mind to understand how these deposits can create such high value lending capabilities for banks.

I don’t know if you have heard this term Fractional Reserve System before. If you have, then the remaining part of the post will be uninteresting to you. I first read about this in the book Second Chance by Robert Kiyosaki. Then I did some research on Google, Wikipedia etc. This got me most of the answers.

So now over and above what the banker above told me, the banks are allowed to lend a “multiple” of their deposits of various kinds. The key word is multiple. To ensure that the banks don’t go “bust” in most countries they have to hold a certain amount of their deposits with a central bank so that there is always a safety net for the depositors in case the debtors default and a bank has a run on their money.

Due to the ability to lend multiples of the deposit rate , say just for argument sake 10 times the deposit rate – if a bank has 1 million retail customers who have to maintain a minimum deposit of $100 then they have $100 million (1m*100) as the amount which would generally always be available to the bank. Now because they are allowed to lend 10 times the deposit rate, they can therefore lend $100m *10 = $1000m.

Since they always get a much higher rate on lending, and they only pay out a much lower level of interest to the depositors, the difference is huge amount of money for the bank. So on the 100m they are paying 2% per annum – which will mean giving out 2m as cumulative interest to the depositors. On the other hand they may lend at 10%. So 10% of $1000m is $100m. So at a gross level the bank has just made $98m using your $100m. I am sure there are other expenses involved, I have used 10 times just for demonstration purposes.

The challenge for the bank is when people default on paying their loans and the amount is much higher than the deposits. Therefore banks ask for collateral to protect their downside.

This was such a huge revelation for me because this is such a huge cash generator. They have so much leverage on the money which you have lent to them with very little liabilities. The key in this is the ability of the bank to have a good process to understand risk on a loan. This is why I now remember in one his interviews Raamdeo Aggarwal of Motilal Oswal, mentioned that if you want to buy the shares of a bank look at their loan underwriting process. The stronger the process the better the bank in getting its money back and the higher the profits.

I get elated when I am able to solve a query which has been at the back of my head for such a long time.

Let me know if you have had Aha moments when a query which has been long standing gets solved.

Till next time then.

Carpe Diem!!!

Using debt to grow rich

cash flow, Debt, Liabilities, possibility thinking

I had written two posts a few days back on the difference between debt and liability.

As a middle class person, the word debt has a lot of negative ideas. I have had so much credit card debt , housing loans etc. that the very idea of taking a loan or using a credit card is an absolute no-no.

Garrett Gunderson gave a very good explanation of debt versus liability which I explained in the posts earlier. I also wrote in those posts how I am trying to get my head around the ideas of utilising loans – loosely called debt to grow. I did understand the concept that if you are buying a productive asset, to buy that asset you will incur a liability. As long as your assets are more than your liabilities, its not debt. If you invest in productive assets and those assets generate cash to take care of the liability then there’s absolutely no problem.

I came across one video of Robert Kiyosaki – of Rich Dad Poor Dad fame – where he talks about how the rich actually love debt. But he makes a very clear distinction. They have teams who understand and manage the debt such that they are consistently extracting the maximum out of the asset to produce cash and pay off the debt.

This way they are able to grow their assets much faster. They then use the assets to generate more cash, pay of the liabilities / debt and start the cycle all over again. Since they now also have the asset, they are also able to use that asset as collateral to get more loans to expand further. If the assets are non-depreciating like real estate or intellectual property then its even better. What this gives the rich people is leverage to grow faster. it allows possibility thinking. Therefore the rich are growing richer.

This is something which I need to think of, because my middle class mindset is still a little sceptical. Robert also has a caveat to this theory. He is clear that its not ok for everyone to use debt because its a double edged sword. If you don’t have the guts to handle this kind of a double edged sword, then you should avoid debt at all costs.

Tell me your views on the topic in the comments section below. I will look forward to hearing from you.

Till next time then.

Carpe Diem!!!

Importance of the ecosystem in marketing

Marketing, Marketing Ecosystem, Product Management, Technology

I have been harping for a long time, in case you are coming out with a new product/service in the market, you need to check for the availability of the ecosystem in the technology market space. So if you are Google or Facebook, you cannot expect to enter or dominate the market if there is no internet connectivity.

I have also written earlier about how Thomas Edison was among the few people who had systematised the concept of testing in his New Jersey Labs . There were hundreds of people testing various aspects of his inventions in parallel. He was not testing things serially which is more time consuming.

Incidentally while the light bulb is attributed to Edison, there were at least another 20 odd people who were building the light bulb at the same time.

What is important to remember is that Edison understood the concept of the ecosystem for the success of the light bulb. If there was no electricity, the adoption of the light bulb would not happen. I guess his experience of working with the telegraph company, had given him this background.

For those of you who don’t know Edison was also among the original promoters of what we know today, as the General Electric company and it was called the Edison General Electric. So while the light bulb was being designed, they were also designing the electric network that would get the electricity to the homes of the people so that there would be an immediate market for his invention.

Edison was the perfect marketing / business person who understood that the ecosystem is most critical when getting a new concept into the market.

Even today, there’s so much noise about different technologies that are hitting the market. What is important for the technologies to succeed is the infrastructure or ecosystem to be present in a very stable condition. If the ecosystem itself is shaky then you won’t be able to get the new technology launched successfully. This is one of the most critical lessons in product management which people miss.

Till next time then.

Carpe Diem!!!