Welcome back to another week of Financial learning. Last week, we started by looking at what savings meant and the distinction between savings and investment.
We learnt that Savings was addition of one’s income whiles investment multiplies our income.
We further went on to discuss some of the reasons for savings and ended at the pointers to look out for when we decide to invest our hard-earned monies.
The first pointer we learnt last week was the yield on the investment. In explaining this point, I said that there were three major components that determined the yield on our investment.
The first component was the Treasury bill rate as determined by the Central Bank. I would not want to go into details as that was exhaustively explained last week.
The second component which I would like to explain today is the Central Bank’s Policy rate.
Policy rate simply as explained by Focus Economics is the “ interest rate that the monetary authority (i.e. the central bank) sets in order to influence the evolution of the main monetary variables in the economy (e.g. consumer prices, exchange rate or credit expansion, among others). The policy interest rate determines the levels of the rest of the interest rates in the economy, since it is the price at which private agents-mostly private banks-obtain money from the central bank. These banks will then offer financial products to their clients at an interest rate that is normally based on the policy rate”.
Just as explained last week, the Policy rate is also determined by the Central Bank. The policy rate is the rate at which the central bank lends money to commercial banks. So let’s make it practical now.
A Policy rate of 20% means that any Universal bank that goes for lending support from the Central bank will be charged this rate. Now the question is, what is the impact of this rate on my yield?
In simple mathematics, the higher the Policy rate, the higher the yield on your investment. This principle works just like the treasury bills. The Policy rates impacts on the asset (loan) base of the financial institutions. The Policy rate offers a hard stick against which financial institutions can charge rates on their loans. The swing in the rate will offer corresponding swings in commercial banking rates.
A higher policy rate will lead to most banks giving out loans at corresponding higher rates. This will also translate into investors calling for a higher yield on their investments. It works in a simple logical sequence. Once again, when the Central Bank wants to control the rates of loans in the economy, one of the components they easily target is the use of Policy rate due to its ripple effect on money supply.
I hope I have not confused you with this second component.
The third component is Inflation. At the Senior Secondary level, we were taught that Inflation was the sustained increase in the price level of goods and services in an economy over a period of time. Simply put, the rate at which prices of goods and services rise over a period of time.
Assuming I went to the market in January to buy a carton of milk at the cost of GHS 80. I may return again six months’ time, ordinarily I would be expecting the price to be at GHS 80.
But that is not the case in reality. The price may either be the same, gone up or reduced. Most often than not, we will find the price going up. So that carton may cost about GHS 85 now. The consistent upwards changes in the prices of commodities will start to impact on our pockets.
So what your income of GHS 2,000 could do in January will be falling short in June. This feeds into the yield on investments too. You would now want to invest your monies to get returns which will be higher than the impact of losses if you kept the money with you.
No wonder investment interest rates rockets high whenever inflation is very high in the country.
In conclusion, therefore, a high Treasury bill rate, policy rate and inflation will eventually lead to high returns (yield) on your investment.
Declining Treasury bill rates, policy rate and inflation will also lead to declining yield on your investment. Any investment with a yield increasing at the time when all these components mentioned are declining is bound to fail!
To refresh our minds, the current average Treasury bill rates in Ghana are 13%. The average policy rates in Ghana this year is 16.5%. Inflation as at my last count was averaging 9.5%. The average rate of these three components in Ghana now is 13%. To be on a moderate side, most financial institution wanting to attract more clients because they can also give out your investment as loans to other client can give you a top up average rate between 5-7%. Effectively, based on the current happenings in Ghana, your investment rate earned annually should be between 13% – 19%.
When you push the financial institutions to go beyond this threshold, you are just preparing yourself for future calamity. They will be forced to give your monies out to people who will agree to give them margins on your rate even when they are not sure about their ability to repay.
I keep telling my clients who always crave for higher yields in the face of these falling components that, they want to force me into giving bad loans. The good clients who will come for loans know the Policy rate and Inflation has dropped and as such would not accept my bank lending rate. At the same time, we are also pushing the banks to give us higher unrealistic returns on our investments.
The financial institution is therefore at a crossroad! Take normal or high risk?
Your guess is as good as mine!!
I will return next week God willing to start the second factor to look at when investing our hard-earned money i.e Safety of Investment.
A Related Article: SAVINGS 101: Your Weekly Investment Tips
Author: Patrick Baah
Patrick Baah is a chartered banker with over 5 years experience in main stream banking having worked in various capacities. He is currently at the Branch Manager Position of his institution. He has been a qualified member of the Chartered Institute of Bankers, Ghana with a good membership standing since the year 2013. He also holds EMBA and BA from Kwame Nkrumah University of Science, Technology, and the University of Ghana respectively. Patrick is the originator of the daily epistle dubbed “Savings Tip of the Day” which has been running for over a year on WhatsApp and Facebook.Patrick has also been teaching on the Topics Savings, Investment and Financial Independence for over 2 years and a research fellow for ILAPI Ghana. Patrick is into youth facilitation and counselling.