Sunday, January 12, 2014

The Investment Analyst

There was once when my brother and his bumiputera wife (now ex-wife) contemplated taking up a loan package from a local bank to invest in the ASB. I'm afraid I'm not very well versed with the exact details of the transaction, but if I'm not mistaken it had something to do with borrowing some money from the bank which is then to be deposited into ASB. 

The returns from the investment in ASB is then utilised to pay the bank. The gains from the ASB investment is big enough to offset the interest charged by the bank so that the investor still ends up with a positive returns. However, it goes without saying that the gains would be smaller when compared to an investment where the investor uses his own money, since he will get to keep the entire gains from ASB without deductions to pay the bank.

The question that begs to be answered is whether this is a smart investment approach?

In the last couple of weeks, several people on my facebook friends' list have shared an interesting post about the above investment scheme. It is written in Malay, if you are keen to read more, check it out here. It's apparently an analysis by an investment analyst, although I have to admit that I haven't investigated the author's background. But even if he is not a qualified investment analyst—and I'm not saying that he isn't—the post does reflect someone with some knowledge in investment.

The article goes on to analyse the investment scheme as outlined above, and then finds that in the end the bank makes more profits than the individual investor. 

He then poses the question: Siapa yang untung sebenarnya? (Actually, who gains?)

And then he answers himself impressively: Bank!

A paragraph later, he poses another question: Yang rugi [?] (The loser)

And again he answers himself: Anda sebenarnya!!! (Actually, you!!!)

Therefore, he concludes, it's better to invest with your own money; don't use borrowed money to invest.

Well, I'm not an investment analyst, but I know a little bit about mathematics. In fact, a zillion years ago, when I was in school, maths was my favourite subject. But for those who really know me well, they would also know that I'm a keen observer of psychology; about people in general. 

However, before I go into psychology, let me just say that I disagree with the author of the above post. The point is that a gain is a gain, and it is as simple as that! So let me give my answers to his questions based on the investment model in his article.

Question: Actually, who gains?

Answer: Both the bank as well as the investor because the latter still ends up with more (although the bank gains more)

Question: [Who} loses?

Answer: Neither, based on the model.

Now let me share my thoughts on the article as a whole. It bears no resemblance to reality! The truth is that the majority of people just don't have it in them to save up enough capital to the extent of enabling them to invest with their own money. Otherwise, there is no need for the government to establish the Employees Provident Fund (EPF) as a means of forced saving scheme. 

I said majority, not all. Of course some people are the weird ones—I have a friend whose father came from China before the formation of Malaysia. He started working as a labourer, saved some money, then started a small business. He maintained his lifestyle and saved every single sen he earned. When he died, he had several shops and a successful wholesale business. This is one very rare example. But for each such example, there are hundreds, perhaps even thousands more of those who couldn't do it the same way.

Most people just don't have the saving habit. An office clerk can suddenly buy a cellphone worth more than a month's salary. A fresh university graduate drives his own Kancil within the first month he gets a job. I think the Investment Analyst is just too naive in his analysis and totally disregards human nature. The reality is that most people will need to borrow money—and yes, incurring interests for the loan—to start a business, or any investment as a whole, to buy a house, to buy a car. Otherwise, they will never start a business or investment, never own a house, a car.

Borrowing from the banks is not necessarily a bad thing. You get the opportunity to open doors to realise your potential. Sure, you will have to pay interests for the loan (sorry, nothing is free), but while they make money, you too can make some money. Surely that's a whole lot better than you not making money at all?


renroc said...

While reading the analyst's conclusions(before reading any of your comments and without attempting any calculations), I arrived at exactly the same conclusions as you did !

Anonymous said...

The analyst's calculation seems correct to me. For option A, investor has to pay RM731/month. So if 7.5yrs repayment (according to his example) = 90mnths, repayment for the bank loan = RM731 x 90 = RM65,790.

But he also uses up RM7,000 dividends yearly to help pay the loan. Meaning RM7,000 x 7.5yrs = RM52,500.

When both those amounts added together, the total will be RM65,790 + RM52,500 = RM118,290 over 7.5yrs. But at that point he has only RM100,000 net in his investment. He gets LESS than what he paid. So it is a loss, right?

Cornelius said...

Haha!...renroc, great minds think alike!

I'm sometimes encouraged anew when I realise that I still have some very loyal readers, even though I'm less active in updating my blog! Thanks, my friend!

Cornelius said...

Thank you, Anonymous friend, for your comment. But, no, the analyst's calculation is wrong. Back in my day in school, maths used to be a weakness of the majority of students. And I suspect that hasn't changed very much up to now. The analyst doesn't know elementary mathematics, that's why he gets all his figures wrong.

Let me try to make it simpler to understand.

According to the analyst, the investor paid about RM220,000, but only got RM100,000 after about 8yrs. If that were true, then of course it's a loss-making venture. But is it indeed true?

That RM220,000 is made up of RM731 monthly payment, plus RM5,000 of the investor's own money (capital), plus the RM7,000 yearly dividends which he earns from the investment.

The analyst says that the investor gets RM100,000 at the end of the 8yrs, but he has forgotten that apart from the RM100,000 net after 8 yrs, the investor has also been receiving RM7,000 (dividends) which he used immediately to help pay up his loan. So, actually the investor gets RM100,000 net after 8yrs PLUS RM7,000 yearly, thus resulting in a total earning of over RM150,000, and not RM100,000 as calculated by the analyst. So he pays the bank about RM120,000, but so what, he's still up by over RM30,000.

For as long as the revenue is more than expenses, your net position is a gain.

I hope the above explanation helps.

Cornelius said...

Damn!...that's the trouble with butter fingers!... I meant to say RM120,000, but typed RM220,000 instead! Sorry if that's too confusing!...hehe

Cornelius said...

Oh! I think there is another way of seeing it!

Still using the same investment model, you deposit RM5,000 of your own money, and then pay RM731 every month for say 8yrs. So your total amount that you pay out of your own pocket for the 8yrs would be about RM75,000, but by then you have RM100,000. (Forget about the bank; don't confuse yourself by grudgingly harping on the fact that you have to pay interest for the loan!)

Now you tell me if that is a gain or a loss.

Cornelius said...

I have since received a text message from a friend who's confused with all the figures given above (smile). Somehow it's all too complicated to understand!

I want to say that those are figures I merely estimated from the top of my head, not using a calculator to count. But my intention is not to arrive at the exact amount in dollars and cents anyway. I wanted to demonstrate that it's not a loss-making venture.

OK, let's be simple, never mind all those complications, and forget about the interests upon interests receivable and payable. Just bear in mind that the investor starts by depositing his own money RM5,000 for the investment. Then he pays RM731 per month for say 8 years. The earnings from the investment pay the rest of the loan. The total amount he paid from his own pocket for 8 yrs would therefore be RM5,000 + RM70,176 [RM731 x 96months] = RM75,176. But by then, he would have RM100,000.

Think about it, is that not a gain of about RM25,000 over 8 years?