Money's Worth!

Money has evolved so much from what it used to be hundreds of years ago. With gradual advancements from the traditional barter system to individual IOUs to gold and silver as the direct representative of money – money has always been a measure of one’s wealth. Somebody with over a hundred thousand in cash was termed ‘लखपति’ and considered very rich, when I was a small boy. Today, finding someone with over a million rupees is not a rare instance. Does this mean that the Nepalese society has gotten richer? Or we have reached a newer height of prosperity? No! One of the fundamentals you must learn about money is that it is only worth what it can buy. Everything else is irrelevant.

Here’s a historical reference you might find interesting:

The Incan civilization had a lot of silver mines beneath their hills. While the primitive Incan population simply considered them tears of the sun (gold) and light of the moon (silver), the Spanish conquerors in early fifteenth century mined the hills and shipped all the bullions back to Spain. With increasing supply of gold and silver in Spain, people’s value for it decreased, as people already had abundant of it. This made gold and silver less important and thus people had to pay more to buy the same values that they previously bought for lesser amount of gold or silver.

To summarize, this surplus of precious metals did not make Spain richer, they simply made prices higher as an increased quantity of money chased the same amount of goods. What the Spaniards didn’t get is that

1.       Money is only worth what other people will give in exchange for it!

2.       Even a lump of clay can have better value than gold or silver, if people have more confidence in them!

This is a basic fundamental we all know by the terms of “Supply of Money” and “Inflation” that results from over-supply of money. For more about money supply in Nepal, refer to quarterly bulletin issued by Nepal Rastra Bank for the general price index developed by NRB’s internal research division. For more on how the government plans to tackle it, make a read of the Monetary Policy issued by the same office. The Budget Plan by the Ministry of Finance should come in handy as well.

Now let’s make a simple illustration.

If you check for how much you needed to pay for a bottle of Coca Cola two decades ago, and use that amount to divide how much you pay for that amount of Coca Cola today, that is the amount of inflation you have endured in the last twenty years. That means, that is the percentage by which your money eroded out of your hands!

What makes money so abundant and makes it loose its value? The answer is simple. When everybody is rich, nobody is actually rich. And when everybody can afford to buy something, and actually want to buy it, the merchant will start charging higher, and money simply starts buying less than what it used to.

For an individual exercise, take a ratio between how much your salary is now with how much 10 grams of gold costs today. Again, take the ratio between how much 10 grams of gold cost when your dad was your age. Now compare the ratios. This is a real-value comparison of your dad’s salary at your age with what you earn right now. Which one is higher?

Credit Card: Management Tips

Credit card is technically a loan facility your bank provides you. Loans provide you a leverage to realize your future income in the present day itself. Unlike Home Loans, Auto Loans, etc. that lets you realize your years of income in present day itself, credit cards simply lets realize your next month’s income. Following are the basics of how credit cards function with Credit Card providers in Nepal:

·         Re-Payment Structure: There are basically three structures in which you can service your credit cards:

1.      Pay full due every month on the due date

2.      Pay a certain percentage of your due amount on the due date. Pay the rest at your convenience.

3.      Pay a certain fixed amount every month on the due date. Pay the rest at yoru convenience.

·         Interest Free Credit Period: You pay your credit card dues on monthly basis. For example, even if you purchased an item on September first, you will not be billed for it until the first of October. On top, you receive a 15 day interest free grace on it. That means, you are entitled to a maximum of 45 days (30 + 15) and a minimum of 15 (if you purchased on September 30) days interest free period on each payment made through credit card.

·         Interest Rate is very high: Credit card is the most expensive credit product in the financial system. That is why your offer letters have interest rates quoted on monthly base instead of the conventional annual. That is, if it says your interest rate is 2.25% per month, your interest rate is 2.25% X 12 = 27% per annum. Wisest of credit card users never pay interest at all, and simply enjoy the monthly benefits.

·         Limit Approval Discretion: is primarily factor of your monthly cash flows. The basic service credit cards provide is for you to realize your next month’s salary right now – so you do not have to worry about the balance in your account, every time you feel like having a shopping spree at your favorite outlet. Banks set your credit card limits based on how much you can service every month.

Detriments to using a Credit Card

Ignoring common sense is one detriment of foolishly using a credit card. Going into debt over your eyeballs is another. Credit cards were designed to pay for things with the intention of paying off the entire balance at the end of a month. If you don’t, or won’t have the funds available at the end of the month, please do not end up buying something you can’t afford, or probably wouldn’t have bought, had you not had a credit card in the first place.

Discipline becomes a major challenge when using credit cards. Human brain is not yet equipped to calculate their purchases against their monthly budget and ability to afford them, when their credit card is there to tell them how easily a swipe over the POS machine can buy them everything on the trolley! It has been proven by several researches that consumers are likely to spend more when they pay using credit card. That’s because they do not feel the abstract ‘pain’ of payment when they use credit card. And when the monthly bill comes knocking on their doors, they realize they need more than a few months to settle its dues. And the mountain high interest rates make things even more difficult for you.

High Costs is undoubtedly the biggest risks in using a credit card. You’d be surprised to realize that First Premier Bank (10^th largest issuer of credit cards in the United States) has a record of charging as high as 79.9% p.a. interest rate on its credit cards. When banks only offer 6% to 8% on your savings account, they charge as high as 27% on your credit card. It would be foolish to use up your credit card without making a proper judgment call on it.

While the interest rates are there, customers sometimes ignore the annual fees and commissions merchants pay the bank on each of their purchase. Its only obvious - it is ultimately the consumer that pays the bank fees, though banks directly charges the merchants. Merchants would have already built in this cost in their price they quote you. This way cards actually make the market more expensive, along with they themselves being the most expensive financial instrument available in the banking industry.

Fraud Risk cannot be ignored when it comes to cards. There are several kinds of fraud risks – all to be fairly taken care of, should you be more careful and smart. There are several cases where the waiters in restaurants bill you twice, but provide you a receipt for only one. And they use your other bill to compensate for some other table’s bill where the customer chose to pay using cash. ‘Tip’ or partial cash payments in the manager’s record will reconcile at the restaurant’s end and the waiter takes some extra cash to home. If you are not used to checking your monthly credit card bills and reconcile with your monthly expenses, you will simply never know if you were cheated this way.

Then there are cases where somebody has stolen your card and used it. If you have noticed, POS machine swipes do not require you to press your PIN numbers, but require you to sign the slip. To minimize the risk, the merchant usually checks if your signature on the card resembles the signature on the slip to ensure your card is not being used by the guy who stole it. However, nothing mandates this upon the merchant, nor are these security aspects any popular in our markets. Best practice here would be to keep record of the Cards department of the bank that sold you the card. These department service lines are active 24/7 and receive your panic calls anytime. So call them the moment you realize your card is missing and they will block it for you.

There are many other fraud issues and precautions on them too, but these two should basically cover up most common problems. Basic other points to note include not letting someone take the card out of your sight, not using the card in un-trusted locations/shops/restaurants, etc.

Why take a credit card then?

Of course it is expensive, risky and difficult to manage. But they are still selling like hot cakes and everybody wants them. The primary benefit they provide is the flexibility in your monthly cash flows. Your expenses are not equally distributed across the months, but your salaries usually are. Just because you need a little more money for extra supplies this month your company won’t advance out the next month’s salary to you. Even if they do, its far more complicated than using a credit card for it.

Credit card also acts as a safety cushion. You own one, keep it in your drawer, and use it only when you meet some cash flow mismatch. Slowly settle it over the next few months and then dip it back into your drawer. While this would be a more ‘conservative’ user that is very much risk-averse and scared of using credits or loans, this does highlight one of the primary benefits of owning a credit card. In a way, it also provides you financial security. Even when your bank account is low, you still have a back up.

Credit cards also add to convenience. Just like any other cards, it means you do not have to carry a lot of cash along with you when you wish to buy the month’s groceries, or that 62” plasma TV you planned up since last year. Of course, you shouldn’t over do it, manage your money well, and keep it as a last resort to your finances.

Optimum utilization of a Credit Card

I am sure the 45 day interest-free period struck hard on your mind the first time you heard/read of it. It actually is the coolest offer a credit card can make to a consumer. Consider you are to purchase a particular furniture for fifty thousand rupees. If you pay it from your bank account, you stop earning interest on your savings account for that amount from the date of payment. It’s a simple logic, bank won’t pay interest on the amount that isn’t there in your account no more. However, if you’re using a credit card, then the amount stays. So you continue to earn interest on that amount. On top, there’s no charge on your credit card either. It means, you actually get an interest free credit and yet continue to earn interest on your savings which you would otherwise use to pay for your purchases.

You should not ignore the subscription and annual fees you pay on your card either. Lets consider a card that charges you a thousand rupees a year in annual fees. If we consider a loan of five lakhs at the interest of 16% p.a., your monthly interest is still lower than one thousand rupees (your annual fee on your credit card). This means, if you plan to spend less than five lakhs a year using your credit cards, you end up paying more on your credit card, even if you always pay in time and never server any interest on the dues.

To summarize: as long as you pay your credit card dues within the 15 day grace period, you do not pay the brutal interest rates that come along with it. But if you do not plan to use your credit card wisely and regularly, you might as well never subscribe to one and waste money on subscription and annual renewal fees.