So on different occasions we play the role of either as a borrower or a lender and thus it is important for each of us to learn a mantra which can maximize our benefits irrespective of the role played.
Remember, lending and borrowing are two opposite activities. That being the case, can we try hard to develop a punch line, which suits both occasions? I don’t think we have to invent the wheel altogether, if we read out the following line loudly - “Borrow Short while Lend Long”.
With this, haven’t we got the right punch line addressing both situations i.e. borrowing as well as lending. In simple terms we know that a borrowing transaction normally invites the payment of interest by the borrower and conversely a lending activity involves the accrual of interest to the lender. In other words, borrowing increases one’s liability while lending enhances one’s assets. Now the mute question remains, as to how one can use both these monetary transactions such that it can lead to an overall enhancement of one’s assets and not the liabilities per se.
Let us assume Mr John has Tzs. 1 Million, which is deposited with a bank as fixed deposit for 2 years term, earning interest @ 10% p.a. After the lapse of 6 months, John is in need of Tzs. 500,000/- to fulfil some of his urgent requirement.
At this juncture, Mr John has no surplus money and he would require a lead-time of about 5 months to accumulate the needed amount i.e. by saving @ Tzs. 100,000/- per month. In above kind of situation, what possible options are available to John? Somebody may suggest the simplest appearing option that John should pre-maturely break his fixed deposit (FD).
But here we are missing one important point -premature encasing of FD may invite some monetary penalty imposed by the bank, while on other side; interest will stop accruing on the full amount i.e. Tzs. 1 Million, while John’s immediate requirement is for Tzs. 500,000/- only.
Appears to be a difficult decision on the part of John – isn’t it? No! It is quite a simple if one diligently follow today’s mantra i.e. ‘borrow short while lend long’. Ideally John should try hard to keep his borrowing period as short as possible and ensure his lending timelines to be the longest possible. How can this be achieved?
One of the options is to pre-maturely break the fixed deposit, take out Tzs. 500,000/- and place the balance amount again under fixed term deposit. Consequently, efforts should be made to re-invest the withdrawal amount by making regular investments @ Tzs. 100,000/- for 5 months, as he is likely to create a surplus equal to this amount every month.
The other option for John is to keep the FD intact and take a short term loan of 5 months duration from the same bank. This can easily be arranged on the strength of his fixed deposit by using it as a collateral security. Later on, concerted efforts should be made to pay back the loan in easy instalments - say @ Tzs. 100,000/- per month and this is how the full loan amount (including interest) will get retired within a period of just above 5 months.
By doing so, what John will ensure that his lending is larger as well as longer (in terms of quantum as well as in period i.e. Tzs. 1 million fixed deposit for 2 years) than his borrowings (which is Tzs. 500,000/- for about 5 months). In simple terms the net result of this exercise would lead to an overall enhancement of John’s assets, while containing his liabilities.
But one important point which one should always keep in mind while executing the 2nd option (i.e. Keep the FD for Tzs. 1 Million intact and borrow Tzs. 500,000/- for five months), is the role played by the prevailing interest rates as applicable for lending, and borrowing. As per market practice, bank’s lending rate is usually higher than what they pay on their deposits. The spread between these two rates is the net income of a bank. Notwithstanding the above, the substance of our today’s mantra stands.
Additionally, it also teaches us a new lesson implying – ‘borrow at low while lend at high’. This means that one must try hard to keep the spread between the lending, and borrowing rates in one’s favour. This can be achieved by finding investment opportunities which can offer a reasonably high rate of return, while in case of need look for options wherein one can borrow at a comparatively lower rate of interest.
Going forward, we can safely modify the dictum so as it reads – ‘borrow short at a lower rate, while lend long at a higher rate’. A judicious application of the modified ‘mantra’ will ensure an overall enhancement of one’s assets, while containing the impending liabilities to its minimum level.