Friday, April 27, 2007

A Loan By Another Name?

Putting money into things like CSBs and GICs, earning low rates of interest, is "safe"... but at what cost? When one looks at the stock market over the long term it is quite a comparison. It can make a big difference. Lately, I have been spending more time looking into mutual funds and have been surprised by the impressive returns. Its not that difficult to find 10 year average rates of 10 % per year or more.

The other day it occurred to me that when we put our money into safe GICs etc we are really "giving the bank a loan" at a guaranteed rate of interest. Then, I guess...the banks turn around and invest the money in mortgages or the stock market, depending on mortgage rates, and that is how they make their profit. It also explains why the interest rates for "safe investments" like GICs go up as the "lock in time period" increases. It has to do with market variability and probability.

I expect that a probability analysis of the return rates in the stock market or for most stock market mutual funds would show that the probability of making say more than 5 percent increases quite a bit as the time period increases. It is likely a pretty safe bet for the banks.

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