INVESTMENT. A term that involves spending a certain amount of money now to earn more in the future. But who first introduced this concept of investment?
According to Warren Buffett, currently the world’s most successful stock investor, the basic mathematics of investment was first introduced by an ancient Greek storyteller named Aesop, who lived around 600 BC. Aesop conveyed moral lessons through fables (animal tales), and these fables can still be found in bookstores today. One familiar fable is the race between the “Tortoise and the Hare,” ultimately won by the Tortoise.
Another of Aesop’s fables that introduced the concept of investment is the story of “The Eagle and the Finch,” where a finch being attacked by an eagle pleads for release, arguing that there are two birds behind the bushes. This plea is firmly rejected by the eagle who states, “It is madness to release something in hand for other birds unseen.” From this point on, the investment principle “A bird in the hand is worth two in the bush” became known.
However, unfortunately, Aesop’s investment mathematics in this fable is incomplete, as it does not explain how long it takes for one bird to become two, what if there are three birds, or even if there are no birds at all behind the bushes. The missing factor in this investment mathematics is the interest rate, referred to as the return rate of an investment. The interest rate answers two fundamental questions of investment:
- How many birds can actually be obtained? (Profitability)
- Is the number of birds obtained worth the investment compared to other alternatives? (Comparability)
Before investing, we need to determine how much return can be expected and when it will be realized. In other words, we are trying to evaluate the future. All returns are expressed as percentages.
However, due to the limitations of the two most important resources in life, money and time, we also need to compare this return percentage with other available investment alternatives, to find which investment will yield more returns faster.
A common and frequently used comparative alternative is the central bank’s benchmark interest rate, such as the “BI Rate” for Indonesia or “The Fed Rate” for the United States. This article will not discuss the macroeconomic aspect of benchmark interest rates in a country’s economy, but rather focus on the meaning of these rates for businesses or investments (microeconomics).
The movement of the central bank’s benchmark interest rate is vital in shaping the price or appeal of an asset or business. For example, an investment in an asset or business that provides a 14% annual return becomes very attractive if the benchmark interest rate is 5% per year. However, the story changes if the benchmark interest rate is 20% per year, where one might prefer keeping money in the bank.
From March 2020 to March 2022, The Fed’s benchmark interest rate was 0.25% per year. During this period, compared to keeping money in the bank, it was better to invest. Therefore, during this time, startups found it easier to obtain funding from Venture Capital. Thus, any asset or business offering a low return rate, if it was above 0.25% per year, seemed appealing. Assets or businesses looked cheap. Likewise, searching for partners for mergers, acquisitions, or funding felt easier.
However, everything started to change direction when The Fed continuously increased the benchmark USD interest rate since March 2022. By December 2023, it had been raised 11 times, and the last recorded rate was 5.5%, the highest level in the last 22 years. At the time of writing this article (January 2024), if you wish to save USD deposits in banks in Singapore, you can easily find offers with interest rates of 5 – 5.25% per year, for USD, the strongest currency in the world.
This has serious implications because assets or businesses offered now must be able to demonstrate potential returns above the benchmark USD interest rate. If not, be prepared for the asset or business to be bargained at a low price, so that the investor or buyer can achieve a higher return rate than the USD interest rate. During this period, we got acquainted with the “Funding or Tech Winter,” where startups found it extremely difficult to obtain capital, culminating in the shutdown of their operations. Likewise, mergers, acquisitions, or fundraising became more challenging to realize. Asset or business prices seemed expensive, and one had to be willing to accept lower offers for deals to occur.
This is why interest rates, referred to as the “Gravitational Force” in the world of finance, regulate the price movement of assets or businesses. As an investor or businessperson in this period of high interest rates, what should we do? As an investor, ensure that the story and supporting numbers of the investment offers received are indeed valid, providing higher and safer returns compared to the benchmark interest rate. As a businessperson seeking funding or investors, strengthen your focus and operational efficiency, and prepare mentally to accept lower price offers.
