- May 7, 2024
- Posted by: legaleseblogger
- Category: Related News
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### Understanding Different Answers to Financial Questions
When faced with questions regarding financial investments and borrowing, individuals may provide varying responses due to differing perspectives and levels of understanding. Factors such as financial literacy, risk tolerance, and personal financial goals can greatly influence the way individuals interpret and respond to financial inquiries.
#### Investment Scenario: Term Deposit with 5% Interest and 4% Inflation
For instance, consider the scenario where an individual invests in a term deposit with a 5% interest rate while inflation stands at 4%. At first glance, one might think the investor is making a 1% profit. However, a deeper analysis reveals that the real return on investment is influenced by inflation. Here, the AI Legalese Decoder can assist by accurately interpreting and analyzing the financial terms and implications, providing a clearer understanding of the actual profit made after factoring in inflation.
#### Borrowing Scenario: Loan with 5% Interest and 4% Inflation
On the other hand, when borrowing money at a 5% interest rate and facing 4% inflation, individuals may assume they are paying 5% in total interest. However, similar to the investment scenario, inflation impacts the real cost of borrowing. Utilizing the AI Legalese Decoder can help individuals decipher the legal and financial jargon involved in loan agreements, enabling them to comprehend the true cost of borrowing in relation to inflation.
By leveraging the AI Legalese Decoder’s capabilities in demystifying complex legal and financial terminology, individuals can make more informed financial decisions and better grasp the implications of their monetary actions.
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****** just grabbed a
That’s why inflation is called The Silent Tax.
That’s why borrowing is never 5% when inflation is 4%.
One thing that jumps out at me is your use of the word “investment” coupled with interest. You typically don’t invest for interest. You invest for returns, those returns are risky and aren’t guaranteed.
To make this a fairer comparison (either cash savings vs. cash savings or investment vs. investment), your second sentence should be:
Say you borrow some money, pay 5% interest, put it in the bank for 5% interest and inflation is 4%, how much are you paying?
Now it’s quite clear that you are really comparing whether you borrow or not. The second case is obviously inferior as after tax you can’t win.
Similarly, frame them as investment comparisons:
1. Say you invest some money in X, with an expected return of 5% and inflation is 4%, how much are you really making?
* 1% real return before tax
2. Say you borrow some money, pay 5% interest, invest it with an expected return of %5 and inflation is 4%, how much are you paying?
* Too hard to answer, you’re probably negatively geared, hoping for capital gains, maybe it will work, maybe it won’t
You’re not comparing apples for apples here…
The answers would be different. In the first scenario you’d be gaining by 1% (0.96% to be mathematically precise) whereas the second scenario you’d be losing by 1% (0.96% to be mathematically precise). In the first case, inflation is reducing your effective returns, meanwhile in the second case, inflation is reducing the effective impact of the interest. The absolute values are the same but relative values are different as one is gaining while the other is losing money.
The only way where scenario 1 would be the same as scenario 2 would be if in scenario 2, inflation was 5%, while the interest rate is 4%. But this would never happen because why would banks want to loan out money at a lower rate than inflation.
Answer to the first. You make 1% after adjusting for inflation and retain the capital
Answer to the second. You are losing 5% and have no capital as you borrowed it from the bank. The cost of inflation does not affect you as the borrower until the bank adjusts the rate of interest you are paying.