Since the dawn of time, companies have been able to borrow money in order to add value to a product or service, then charge a premium for that product or service and sell it to make a profit.
A good example of this is from the year 1602, when the Dutch East India Company became the first ever publicly listed company. At the time of their incorporation, they borrowed a sum of money, agreed on an interest rate and put money towards improving the company. Once they made the money back, they paid off their interest and then paid back the principle. They became lenders and issued shares while others became part-owners of the company. This second group of people – the owners – were able to benefit from the profits the company gained. Of course, as always, there were risks to these owners – if the company had gone under, the lenders would’ve been paid out first. Owners are always the last to be paid. Earlier, we used the phrase ‘since the dawn of time’ – because even before 1602, there would have been other examples of this – surely there was a blacksmith or farmer out there who borrowed money, added value to a product or service, and made a profit.
Here’s another example. Imagine you had $10,000 in the bank. If it’s sitting there untouched in a term deposit, whether you like it or not, you’re actually lending that money to NAB or whichever bank you’re with. And they’re lending it out to other people in the form of home loans, personal loans and other services. Sure, they will pay you some interest (which, at the time of writing, is about 0.5%), but they are using that money to their benefit. Alternatively, instead of being a lender, you could become a part owner in NAB by buying their shares. We don’t generally encourage people to buy shares in individual companies, but that’s how you’d become an owner rather than a lender.
Why is that better? You can either be a lender (keeping money in your term deposit) or an owner (by buying shares). If you buy shares, there will be more risk; more volatility. If the company goes bankrupt, depositors will get paid out first. But as an owner, you will be more profitable over time. That’s why it’s better to be an owner – you get to be part of the growth of that company. Term deposits, on the other hand, have set rates of return that won’t change. Generally speaking, companies’ profits grow at a faster rate than what they are having to pay back to shareholders. And if you want to make money in the long-term, owning part of a company is the way to go.
For more information on lending, check out our podcast on The Shocking Risk of Term Deposits.
Dallas Davison, Michael Hogue and Ali Hogue.