Mailbag: incl. The pros and cons of 'debt recycling'. December 17, 2023

25:14By the way, both directions. My views, i.e., I don't think it's worth doing. The other is I'm probably not going to give you a completely unbiased view because I'm not doing it. So I've decided for my own purposes it's not right. I might be entirely wrong in that view. Complex-ish kind of question, Ram, any thoughts? Let's pretend as a hypothetical that I don't know what debt recycling means. Okay. You know, hypothetically, how would you explain that to me? My best guess is that money's... Because I'll admit I've got no clue what that means. My best guess is rather than paying off the mortgage, you draw down the mortgage and you put that money into shares instead.

25:48I think it's straight out. I think it's just buying against the house to buy shares is my best guess. Oh, yeah, yeah, yeah. I don't know whether the strategy entails using the dividend income to pay off the mortgage or buy more shares. I just don't know what Peter's... And again, I'm sure Luke's absolutely right. Once you've mentioned someone's name, I'm not sure whether we're representing that person's particular strategy accurately. So I'm always mindful of just being a little bit careful of someone's debt recycling strategy could be different than someone else's. Is it doable? Sure. Is it smart?

26:17Probably. I don't do it as I said. Maybe it's costing me money. I kind of like having mortgage lower rather than higher and I kind of like the idea of not being on the hook for larger amounts of debt for a couple of percentage points of gain, particularly with rates at this level. I've said before, if I could borrow a million dollars at a super low interest rate with no margin call to buy shares for the rest of my life, I'd do it now. Oh, heartbeat, yeah. But I wouldn't, I don't, if I had a no margin call promise and I could borrow at 5.74 % to buy shares, I don't think I'd do it.

26:55Particularly borrowing against the house because after tax, I'd have to earn meaningfully more than that? Was it 8.5 % something? Am I hoping to get that? Yeah. Am I sure I'm going to get that? No. Do I want to take that risk and risk my principal place of residence with higher amounts of debt for the off chance I might earn an extra percentage point of gains? No. Does that make me, you know, lazy and stupid and not harnessing the full value of tax planning strategies? Probably. Yeah, I mean, I think it's always good to sort of do, you know, do a multi-scenario analysis. In other words, just sort of like test a bunch of assumptions.

27:33If it comes down to, if it's a line call, I'm definitely going to go with you, mate, and just sort of say, what's the point? Yeah, it could be better. Is it going to be like three times as good? Well, hell yeah. I mean, you know, I love that. Yeah, exactly. That's right. If you give me a 20 % return, I'm happy to mortgage the house to the hilt and then, you know, sell my kid, you know. Done, done. But if it's marginal, it's, you know, and I don't know the specifics of the strategy. And Peter Thorne is a good guy. I've got his book. I remember seeing him live speak probably 20 years ago or something and he just really sort of opened my eyes.

28:10And it's actually my go-to book for when people say, why shares? I was like, well, here's why. Even though it's not the strategy I employ, I think he makes a very good sort of case for it. So I'm going to assume that he, and he seems like a pretty conservative, prudent guy. So I don't want to say anything negative about the strategy, given I don't clearly understand, you know, what it is involved. So I'll say all of that. I do think that there is something to be said for paying the house down. What it does provide is a massive buffer and margin of safety, right? So that's always nice. But it also gives you optionality, you know?

28:52So if you turn out that your user goes, you know what, I'm just going to focus everything on reducing the loan here. And as you rightly said, it's not an easy thought, but you're a guaranteed return in interest saved. And it's close enough to 6%. Exactly. Guaranteed. Now, look around the world for guaranteed returns, 6%. But actual guaranteed returns, not promised guaranteed returns. Not promised. Yes, not promised. I mean, it's a pretty good deal. But let's say that you pursue that for 10 or 15 years and you wake up one day and there's just a ton of equity in your house. Like, well, you can draw down on it then, right?

29:27I've said to you many times, it's like my real goal in life is just to get a house and not have a debt against it. Because when that's true, I don't need to earn much money. If I was on 50 grand a year, you know, I'm just not into sports cars and yachts and expensive things. It's sort of like, so I've got a bit of rates, a bit of maintenance, It's a bit of upkeep, some groceries, some bills. You know, it's like 50 grand a year is a very modest salary in the year 2023. Once you take out the need to pay regularly for a home, whether it's rent or mortgage, when you consider the fact that the tax rates on that sort of income is very, very low.

30:08Oh, my God. It's huge. There'll be people listening who are like, 50 grand, I can't survive on that. It's like, okay, take out your car repayment, take out your mortgage, take out your rent, take out the private school fees, take out, you know, and you don't want to and that's fine. But what Ram's saying is this is the opportunity, right? So should you want to? I mean, the financial freedom that comes with that is extraordinary. Oh, mate, so that's why our parents are living the life of Riley, right? Every other boomer in the world out there. It's not because their incomes are that special necessarily.

30:33It's that none of them have any housing debt, right? Like that is the goal. That is the goal here. And I think that it is underrated. As I've said to you before, like the number of people that are rent vesting and doing all this stuff, it just seems it is – you know, historians will look back on this period and go, wow, like what? Just as we look at the Easter Islanders and going, what? You destroyed everything for these giant heads? Like, well, we're destroying everything for these piles of bricks and mortar and fibro and weatherboard in many cases as well. It's an insanity, my personal way of thinking.

31:13And there is nothing like, I know that this is a finance investing podcast, right? I know that we're here for the money. Obviously we are. Actually, I'm not. I'm not. I'm here for the freedom. And I think other than that, maybe you're particularly greedy and you just like big numbers and you do like expensive things and that's cool. There's no judgment on that. But what I value more, this is me personally, and again, no judgment, but what I value more than anything in the world is control over my time. if I can wake up on any given day and just decide what I want to do, that is the height of wealth and freedom to me.

31:46Yeah, 100%. You know, and if that means that I've got a house in regional New South Wales and I've got a couple of side hustles that sort of bring in something, I'm happy as Larry. Am I living on the harbour? Have I got like three sports cars in the go? No. But also I know people like that and they work like dogs, you know, and they are miserable. and they look 20 years older than I do. And it's just sort of like, really? You'd be dead tomorrow. That's just me. And I'm not making any, I'm not saying Luke for a second is like that. Someone who's a paramedic is obviously a very socially minded person.

32:26And I think these people are just like the absolute heroes of our society. In fact, if you're ever asking who's a hero in society, it's like anyone that was labeled an essential worker during COVID. That's right. You know, the world went on when the marketing execs couldn't get to work, right? But when these people didn't show up, oh my gosh, things got real. So I don't know. What am I saying here? It's like we said last week, right? There's no right answer here, but there's a right answer for you. So if in doing this analysis you feel that the upside is significant relative to what you could otherwise do and you feel you're not sailing too close to the edge in what might go wrong, And it's not about saying, oh, this will definitely blow up, but it might, right?

33:10And if you're comfortable with all of that and it puts you in a really good position, then by all means do it. I don't want to rain on the parade at all here. But there is something to be said. It won't fit in the spreadsheet, but a life of far less stress and anxiety is probably not a bad thing either. I mean, you're right. This is a podcast about money. And I've had on the good oil a couple of financial independent retiree earlier, the fire people. And I think there's just a lot of value in that way of thinking. And I think it's going to be right for some people and not right for other people.

33:48And if you want different things out of life, if you like your fast cars, knock yourselves out. I think there's so much to be said for a bit of – I'll say therapy. I don't necessarily mean therapy therapy. I just mean a bit of that kind of introspection, a bit of that idea of like actually what am I doing and why am I doing it? and how much of what I'm doing is just because that's what I think I'm supposed to do. Living on the harbour is lovely and driving a Tesla, I'm sure, is fantastic and whatever. Oh, if I won the Powerball, don't get me wrong. Right. We bought a second-hand Hilux for cash.

34:19It wasn't 2 years old. It wasn't 15 years old. And when I say for cash, I don't mean a big note myself. We just chose to save for it and not take out more debt. We could have bought a new one for 30 grand more. I was like, no, we'll save for the car and we'll buy the car and that's what we wanted to do. and for me it was like I own the car. I don't pay anyone every month to drive the car. Is it the flashiest car in the world? No, I actually really quite like it. It does exactly what I want it to do. I'm a pretty utilitarian kind of guy. It does exactly what I want it to do. It takes us out back and we do our holidays.

34:48That's what we chose to do. And I think to your point, mate, when you stop and this is hard for couples too, right, because different personalities and different approaches to money but you ask yourself what are we doing and why are we doing it? To your exact point, it's a bit of a throwaway line but the old thing about if you win the rat race, you're still a rat. Yes. And not a rat in a bad way, just you've had to play the game. So you're in that space. Now, if you want the house and the waterfront, you want to work 60 hours a week and have stress and worry about losing your job and whatever, knock yourself out.

35:18Go for it. To your point, I choose not to do that. I'm a pretty low-key guy, generally speaking, as are you. And I think that introspection is super useful because when you really ask yourself, there's a great Toyota management way of thinking called the five wires. the only reason you ask yourself why does something happen they answer but why is that but why is that but why is that you've you've kind of talked about the same kind of idea before and think about investing if you think about lifestyle right i need a house by the water why is that because i like it why is that because i want to be better than everyone else okay so that's something about yourself and do you want to do is that really what you want or do you think you should you know when you really really genuinely interrogate your motivations you find yourself in a very different place and as you said mate no judgment anyone who wants to do it differently but i would really encourage our listeners to have that conversation with themselves and with their partners because life's too short you know it's it's just not worth well maybe just for some people for me it's not worth the effort i happen to love what i do i'm very very very fortunate um you've said before you know would you would you if someone gave you 200 grand more to go work for macquarie would i do it i would not do it no no um and plenty of people would in that you know and i'm i'm fortunate that i don't need to take that money to live my life but there's plenty of people doing it tough right now I was saying she said I'd kill for an extra 10 grand so I could pay the bills and I get that right I know I'm very privileged and and very fortunate but just kind of keeping your expectations in check I hope I'm doing this job in 20 years time but I hope the last 15 years of it because I love it not because I have to yeah you know we do this podcast I mean I do it in work time but you know we don't get paid extra to do it it's it's it's fun we do it because it's interesting we hope we help people and we enjoy it and you know I'd like to keep doing that because it's just fun interesting um but I'd like to do it because I like it not because I feel like I to get a paycheck to keep up with the Joneses.

37:01Yeah, I'll just reference one more thing. I know I've mentioned this several times and I will again in the future. I mean, science has got a lot to say on this front and surprise, surprise, evidence-based kind of approaches are usually the way to go. Who'd have thought it? But when they ask people towards the end of their life, their regrets, it is no one, like a rounding error of people will say, geez, I wish I spent another 10 hours a week in the office. I wish I had that fifth investment. I wish I finished that report. Zero people say that. Everyone says family, friends. We are a social monkey.

37:42That is really important. It doesn't mean like we often joke, you and me, we don't have a large circle of friends, but we've got a tight circle of friends. And that tends to be what matters. And so could I potentially earn more money? yeah what does that mean i never get to see my kids grow up no hard pass hard pass for me because i'm i know what i'm going to regret and is it you you've mentioned before i think is it bezos who uses the regret minimization framework yes which is another way is that when are you making a decision particularly big life decisions is ask base it on which one will cause me the least regret in the future and i can almost guarantee you that whether you got the higher model car or the extra Christmas.

38:25I mean, they're lovely things. I don't want to sort of, I mean, I'm going to pretend that I'm a monk that has no desire for earthly pleasures. Of course I do. Right. But, but there's also, I'm very cognizant of those other things. And I, we've hemmed the point ridiculously at this stage, but there it is. I would think about that. It's important. I hope that helps Luke. Yeah. I'm not going to, I'll go over the old ground other than to say that money's a means to me, not the end in itself. That's a tool. That's what you're right. And that's what we're want it for. So, you know, this podcast to help people, you know, have more tools to use.

38:57And if you want to go and maximize them and knock yourself out, Buffett famously was going to give his money away at the end of his life because he wanted to have the biggest pile possible to give away. And then he was convinced by Bill Gates, geez, must be 15, 20 years ago now, that actually you could do more good by giving small amounts of it away regularly. Still compounding, by the way, still very, very rich, but just choosing to do things differently. I think there's something in that as well. 100%. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener.

39:28Hey, mate, this one comes from Anonymous, which is interesting, who says, he or she says, hello to, quote, Scott, the optimistic fool employee, end quote, and Ram, quote, the pessimistic billionaire employer of straw people. If that's not on your business card at the end of this week, Ram, you're doing something wrong. If I had a business card, maybe. Pessimistic billionaire employer of straw people. It's got a ring to it. Long-time listener, first-time questioner, says our anonymous correspondent, who starts with first question, what is straw man? Online private investment club. There you go.

40:00I should have thought to ask that. You did. I'm disappointed. Second question. In the past, I considered myself an individual of fair intelligence. In recent times, my inability to understand franking credits has left me with one conclusion. I am just as dumb as any other hairless ape on the planet. could you please explain frankincredits to me like I'm a six-year-old? There is a last question too, which I will hold for now, Ram. Do you want to have a go at frankincredits? Yeah, I'll give it a go. Go for it. I mean, I'm not going to do maths here, but all it does is prevent double taxation. So a company has earned money, it's paid corporate tax, and then it may choose to distribute some of that after-tax or after-corporate tax profit to the owners of the business, i.e.

40:45the shareholders. and the taxman says, well, we've already had our bite of the cherry. So the only tax you have to pay is if your personal rate of tax is above the company rate of tax. If it's at the rate of tax, same rate of tax, then you pay nothing. And if it's less, you actually get a refund. That's it. Pretty straightforward. Yeah. I have written an article called, I can't remember now, Why Bill Shorten is Wrong and Right on Franking Credits. Oh, yeah. Long title. very old it was back to the frank and credit election um if you want to there's a bit of a work example in there if that's useful for you so have a look at that if it makes sense i'm going to use numbers very quickly ram for anonymous correspondent just because i think hopefully i'll try and keep them simple and i will actually absolutely make up some numbers um but i just want to and it makes it sound a little bit worse but i need the rounding to make it easier to understand let's say a company earns 100 bucks in profit before tax they're obliged to pay 30 percent corporate tax right so they make the hundred bucks they pay their 30 bucks left with 70.

41:48I'm going to keep it really round here mate. They take that 70 bucks and say to the shareholders here you go you guys we don't need the money it's all yours. Andrew was the shareholder of that company he happens to be on a 50 percent tax rate again there is no 50 tax rate it's made my life easier. Sure. He gets his 70 bucks and says okay I've got to pay 50 tax on that so I'm going to send 35 bucks to the government I keep the other 35. So the company's paid made 100 bucks in profit and effectively the government's collected 65 of that in tax and that's the double taxation bit the company pays tax then ram has to pay tax at his marginal tax rate on top of that being left with 35 out of 100 bucks that was originally earned now i there is arguments about frank credit refunds that's a whole different thing i'm not going to go into that now because it is already going to be complex enough but the government took the view under paul keating originally and the subsequent governments have supported it, that taxing that profit once in the cans of the company and a second time when it gets paid out as dividends is double taxation to Ram's point.

42:52If I earned$100, let's go back to Ram. If Ram earned$100 from working, he pays 50 % tax rate and he'd have$50 left over. So effectively dividend income gets taxed more significantly, much more significantly than does earned income from working. Now, what franking credits do, I'll just stick with my example here, is the company earns$100. And the government says, okay, well, let's assume Andrew earned that whole$100 himself. The government, start again, the company's already paid$30 with the tax. So Andrew gets$70 in his hand, but the government says, well, okay, but let's assume you got the whole$100.

43:29And let's assume that$30, that's already been paid in tax. So the government says, well, Rami, you're on a 50 % tax rate. $100 the company earned in profit. but you should pay$50 worth of tax for that because that's your tax rate. But here's the thing. You've already got$30 worth of credits, i.e. franking credits, tax credits effectively, that have been paid by the company on your behalf for that profit. So you're going to pay the extra$20 to bring us up to the 50 % tax rate. And that's how franking credits work. They basically say, we will credit you for the tax paid by the company. Now, there's no free lunch.

44:03We're going to tax the whole$100 in your hand rather than just the$70. but we're going to give you the credit for the tax that's already been paid on that profit. Yep. So Ram's example was much more – Ram's expression was much more prosaic than mine but if you wanted some numbers just to understand why that's doubled up, that's where the value is. One thing I'd add too is if you happen to be in a situation where you have no taxable income, tax has been paid – you've essentially paid extra tax. Yes, correct. And now you can claim a refund on tax, not that you paid because you didn't pay any, but it was paid on your behalf.

44:40That's why certain segments of the community got quite upset when Bill Shorten threatened to sort of take it away. And, you know, let's not get into that debate, but that's important to mention as well. Yeah, yeah. So the idea is basically that the company, for this purpose, the company is treated as a pass-through mechanism. You are the ultimate beneficiary of the profit and the government chooses to say, you know what, the company's just passing both the profit and the tax through to you, you are the one who has to make good on the difference, which is why if you're on a zero tax rate, the company says, well, sorry, the government says, well, the company shouldn't have had to pay tax on your income, you're on a zero tax bracket.

45:17Therefore, you get a refund because your tax rate should have been zero, you've actually been taxed at 30%. That's not okay. And again, the rights and wrongs are different. If you're taxed at 30%, you should pay 50%, you've got to pay the extra rather than having to pay it on the whole amount altogether. And I hope that makes sense. The last question from Anonymous says, is there any chance Ram could share his story of why he went into entrepreneurship and any mistakes that others could learn from when building an online business? Which now makes me think that maybe Andrew was the one who sent this question, hence the anonymous nature of the question.

45:51We talked about this a little bit, mate, in the past. I don't know that we've done the why specifically and I wonder whether, in fact, actually, no, I will. I'll take this back. You and I had a conversation on the good oil. I'm going to give a plug to the other podcast, partly because I do it, partly because you did it with me that time. Go back to the good oil's archive, the good oil with Scott Phillips, it's called, I've said before, it's called that because I had to put my name on it because there's other good oil podcasts, not because I'm a megalomaniac narcissist. So the good oil with Scott Phillips.

46:16Go back to the Rams episode. We actually talked about all of this stuff, and I really would commend it to you because it was, you and I have known each other for years, but it was fascinating to kind of be able to sit down with you and ask you those questions almost across the virtual table. but I won't leave it unanswered. So maybe there's a, it doesn't need to be super short, but a shorter version than the one-hour podcast we did on why. Why you went into entrepreneurship? Why give up a flourishing career at The Motley Fool? Why throw all that away recklessly? No, I'm kidding. But why entrepreneurship, mate?

46:49And what lessons did you learn from mistakes you may or may not have made? Do you know that God's honest truth is, in a word, naivete. That's why you didn't not do it, but why did you do it? Yeah, I mean, people talk about all of the characteristics that, you know, people who start their own business or go into business for themselves, you know, they need to have this attribute. And it's all very flattering for that person, of course. But I would very straight-faced, very seriously say naivety is the biggest because hope springs atonal. So, you know, back when I was thinking, I mean, I had an itch and all of that stuff and I thought, oh, this could be cool, but I thought it'd be really easy and I thought it wouldn't cost that much.

47:36That's why I did it. I mean, if I - So your mistake's made. Yeah, I mean, if I travelled back and said, just so you know, be aware, this is going to be a journey, right? And it's not unusual because I think the stats are that most people who are successful in business fail many times before, but they are successful. And even those who get early success tend to, it's not immediate, you know. And there is, the grass is always greener. I mean, I do, what's the word for it? I do, I'm very aware of now, especially what I gave up, which was the fact that I didn't have to think about work when I clocked off at the end of the day.

48:25Yes. You know, that's, that's a big tick. I got a, I really liked it that, um, and not that I ever wished ill on any of my employers, whatever, but it was just like, whatever was happening at the business level, as long as you had enough to cover the employee salary, you know, that was kind of like, I'm okay. Right. Um, yeah. So I, I feel, I feel it was, it was definitely, I just thought, oh, here's an idea. Why isn't anyone doing it? Well, maybe I'll give it a go. But it was only because I thought it would be easy. Like how dumb is that? Like you just so, if anyone's thinking of doing it, all I would sort of say is do it, right?

49:00Because you only live once, right? You don't know. You try it. Just never try in a way that if you do fail, it wipes you out. You never want to go all that. So I would, gosh, would I do things differently again if I could. But it is a very satisfying experience at the same time. So, you know, and yeah, I don't know. I think that's the short answer. I want to ask you again actually because you kind of said noivity was the reason you didn't not do it but didn't really explain why you did it. In other words, had you known, you may not have done it. But you didn't know and you did it anyway. So there was a why there somewhere.

49:47What's the Andrew Page why? Why not just stick at your job, get paid reasonably well, have a nice career, doing a really good job at the Motley Fool as you were at the time? What is the – you kind of went, thanks, but I need to do this. Yeah. What was the why? Not so much – like I said, the naivety was the reason you didn't realise you shouldn't have, but why did you? What was the driver? What was the urge? What was the itch? I just thought it was – how arrogant this sounds. I thought it was a good idea, right? And the early inception of the idea is very different to how it ended up. There was a gazillion pivots along the way.

50:19But you had an idea, you thought something would work, you had to go and do it because you just knew it worked. Why isn't anyone doing this? You're telling me that Hot Copper is the only online forum that Australian investors can get. Are you serious? No one else has done this? Like why not? It just had to be done, right? And you want to also a truth telling? I thought I was going to make a squillion dollars out of it. That's also what I thought, right? and that - Big market opportunity. Yeah. Online businesses scale beautifully. Oh, yeah. I'll do, you know, get an exit for$20 million and sail off into the sunset.

50:53Oh, no. As I say, naive, right? Like it's super naive and it's nothing like we joke about, but it's, you know, it's a lifestyle business at best. I mean, yeah, I think that's right. But I think you have to be. I think entrepreneurship doesn't work without people who have that sense of, I just need to do this thing. I think, you know, no, I guess I know in their right minds which sounds very, very rude. That's true. Giving up. Well, I mean, for most people, most people aren't entrepreneurs. That's the thing, right? I ask this question of my good oil guests almost every time, which is I'm a wage slave, right?

51:25I mean, I like my job. I could, you know, do other things, whatever. But I don't feel as many need to go and throw it all in and do something else because I'm cautious by nature and I kind of like my job and I'm getting paid pretty well and I don't need to walk away and do something new or different. I don't need to. I don't have an itch to scratch. If I do, the itch can be treated with calamine lotion. It doesn't need to be kind of scratched and scratched and scratched. But the entrepreneur, there is just something super innate and I actually envy it in a lot of ways because kind of having the idea, I think we've all had ideas, right?

51:54I don't know that entrepreneurs have more ideas. Probably they do actually. I think it's probably something genetic or experiential or something or just whatever about them. They do have more ideas. But I reckon everyone listening has said, I reckon our company should do this or why does no one do that? and to your point you were like why is no one doing this thing well i better do it then you know and it wasn't it wasn't a case of you weren't the first person to think of it and you know it wasn't it wasn't through lack of ability of other people to do you was like i need to i just need to do this thing this i you know there's money there there's an idea there i think it'll work i need to go and see if this works and i think that's that always fascinates me mate because that's i've got an idea and i think it'll work and i really wish someone do it i really should go and do it but i I won't.

52:36And that last bit where it's like you and I have the same journey, not the same idea, but, you know, the same journey broadly, and I get to the gate and go, yeah, nah, and you're like, hell yeah. I think that's the fascinating bit to me. Yeah. There's no right way, you know. The grass is always great. I caught up on the weekend with some mates and there's another friend there who owns a business up in Brisbane and he's done all right out of it. But, gosh, what a stressful journey. it's been, you know, and we're both sort of saying, oh, had we known, you know, there's, there is a lot, the, as I said, when you're, when you're an employee, you always look at, oh, I would love to be my own boss, et cetera, et cetera, et cetera.

53:18That's why the franchise industry is so strong, you know, because it is in a business in a box kind of thing. Open the box up and away you go. And it's incredibly appealing. I'm my own boss. And often you get the wrong motivations because my, my boss is an idiot and I just want to escape that. And I think I could do better. and there's all these kinds of things. And the freedom and I love the creative control. And that's all true, right? Like you get all of that, but you don't get weekends. You don't get holidays. The buck stops with you. Cash flows are very, you know, significant all of a sudden.

53:50And if they're not made enough through the business, it comes out of your pocket. And there's a huge amount of stress that goes with all of that. So, you know, I just think as long as you go into it eyes wide open, as long as you go into it in baby steps. I think when I've looked at others who have had some success in that space, what I find interesting is that they all almost without exception have made all kinds of dumb mistakes and ideas that never went anywhere. But there's two things that separates them. The first is that they fail early. In other words, I think this is a good idea. I'm going to give it a go.

54:29Okay. It's not working. I'm out. whereas ego and hubris would for a lot of us go, no, I'm not, no, it's going to make it work. If I pull out now, I admit failure and how embarrassing will that be? And all my friends and family will laugh at me and it's like, nah, who cares? I tried, it seemed good. I tried. It's not working. I'm out, you know, and they take a loss on that. Loss of all the time invested, loss of all the money invested. So I think that's true. And again, it is many rolls of the dice before it hits. So I think you, yeah, I would go into it with that attitude. Nothing is guaranteed.

55:09Even the ideas that sound really, really, really great. Maybe it is a great idea. Not even just sound great. It is great. Then you've got execution. Then you've got just you're a victim of circumstance and timing. And it's like, hey, this is a brilliant idea. Yes, I'm going to do it. And then we have Great Depression 2.0. You know, it's like, oof. Now, any other point in history, it might have worked brilliantly, it just happened that you just got unlucky, right? So, but if the listener is thinking about it, hell yeah. And just the other thing to do is because hope does spring eternal, when you're sort of crunching your numbers and how many people do I need to, customers do I need to have and what, you know, ask the big basic questions, what do I need to get to?

55:51You will err on the side of optimism subconsciously because you like the idea. I want this thing to be real. Yes, correct. Yes. What would I pay? Oh, I would pay heaps for this kind of thing, you know. Which is both necessary, right? The market fit, you need to have some sense of it, but also it can blind you to the average person. Unless you're the average person, be careful what you assume the average person will do. And just think of it like with investing, you know, in shares. Like think of the downside. What is it that I might get wrong? What does it look like if my assumptions are way off base?

56:20Let's halve some numbers here. And just think it all the way through and then put some milestones in that sort of like, what do I need to see to continue? What do I need to see if I'm going to stop? And pre-committing to those things can be very powerful as well. But it's a journey. Mate, you mentioned, oh, go. No, I just, I wouldn't ever try and talk anyone out of it. I'd just say, again, eyes wide open as you go into it. Makes sense. You mentioned a couple of phrases. You mentioned the grass is greener. You mentioned another one, which reminded me of a joke, which I'm going to share with you.

56:54Oh, please. Which is a terrible, terrible joke. Dad joke incoming. Man goes to the doctor. He says, doc, I've got a problem. I can't stop humming the green, green grass of home. And the doctor says, I know what it is. You've got Tom Jones syndrome. The man says, I've never heard of it. Is that unusual? Oh, screw it up. Is that common? The doctor says, it's not unusual. There you go. I was so close to that one. I got it. I got it. I love it. Love it. Love it. Anyway. Should never tell jokes on the podcast. Mate, last one from Heath. It says, hi, Scott and Andrew. My name is Heath and feel free to use my name as you need to, which I appreciate it, Heath.

57:30So I'm going to take out some bank loans in your name. I'm going to book some restaurants in your name. I'm also going to pretend that I'm you when the police pull me over. So thank you for that permission to do that. You've heard it on the podcast. Oh, it must be true. I kid. Firstly, it says, Heath, I enjoy the podcast. Some of the rambling answers make it hard to keep track of what the original question was. Guilty. But you do eventually circle back and it all makes sense in the end. or I think it does. I also like Ram's quote about no dumb questions. As if I'm thinking it, then others probably are also.

58:01And he's correct because there have been questions floated through the pod machine that I have thought that is a question I've been pondering, but I wasn't sure who to ask or where to get the answer. So thank you to you both, so Steve, for being a forum which novices like me can get answers that actually make sense and aren't spun to fit a sales pitch narrative. Can I say, can you imagine being the marketing team for either of our two businesses? Nope. Oh, no, don't say that. Oh, no. Although technically I am the marketing department, so yeah. And you should be very disappointed in yourself. Yes, I really should.

58:36That's all I'm saying. Yes. Andrew, the marketer. I want to see one of those skits where you're wearing different hats, a bit Jimmy Rees kind of, you know. I want to see Andrew, the investor. I want to see Andrew, the CEO. I want to see Andrew, the marketing team. I want to see that conversation. Maybe they could do something Jimmy Rees-esque. There we go. With that. We could try. Anyway, he says, I have a question, which I think you two would be the perfect people to answer in a no BS fashion. What has always intrigued me about the interest rates is the official RBA cash rate fluctuates, which is what the banks and non-bank lenders use to secure funding, then pass on to the consumer.

59:12However, if I borrowed enough to buy my house eight years ago and the bank lent me the money eight years ago, surely they are not constantly borrowing the money every month to fund that loan, i.e. once the funds were transferred to the seller, a transaction was completed and the bank isn't constantly transferring money to the seller each month. So why am I not locked into a rate at the time of borrowing? It was a single transaction at a single point in time. I understand having a variable rate on a credit card or a line of credit as each transaction is in itself a separate loan, so to speak. Thanks again for the informative and ranty podcasts.

59:50And that's from Heath, whose name I will use as I see fit. So call me Heath, Ram. Okay, Heath. It's a good question. It's an excellent question. If I take out a 30-year mortgage, why does my mortgage rate vary with the cost of funding? If the deal's already been done, the money's already been transferred to the seller, the transaction in theory has been completed, surely. It's such an excellent question and it's not an easy one to answer, which gives you a bit of a hint at the complexity of the financial system. But it's probably - Heath, you've stumbled onto one of Ram's more recent hobby horses, so I will try and keep this answer to at least 45 or 48 minutes.

1:00:32Yeah, we'll see how we go. But there are certain things that you accept as true until you look at it and go, that's not the case. So there's a couple of things I'm going to pick you up on there, Heath. it's not, banks aren't borrowing from the RBA, right? In fact, that cash rate is really just the overnight rate that they charge any bank, that charge banks for any funds that they leave there overnight. And if there's a bit of a shortfall, it's the interest rate they charge them. It's more a reference rate, right? It's a reference rate. The vast majority of a bank's capital comes from deposits and the rest come from the private market where they issue corporate bonds.

1:01:15Very little. And it's really just sort of making sure that everything's sort of square at the end of the day. So there's a little bit of excess, a little bit of a shortfall. We have these sort of reserve amounts that are really interbanked tokens that they sort of transfer behind the scenes. So if I'm Westpac and I own Commonwealth Bank, I can settle that with some of these reserve funds. I can't spend them in the real economy. There's not notes or anything like that. but it is more of an accounting system within the financial system. And the reason why it's not matched at the time, it's because of a thing called duration matching.

1:01:51Do you remember what happened to Silicon Valley Bank at the beginning of the year? So what did they do? What went so wrong there? They were lending short and they were borrowing long, right? In other words, and that's fine. Jogging alert, jogging alert. Okay, okay, okay. So you're lending someone money for 30 years. In the US, it's very different. I mean, it kind of - Yes, yeah. It's a real eye-opener for Australians, right? Because everyone's on variable mostly. And if you are fixed, you're fixed for a few years. No, in the US, you fix it for 30 damn years. And that's the sort of standard way it goes.

1:02:23But I'm borrowing money from depositors whose money is on call. They can come in any day and grab it out. And so Silicon Valley Bank, in fact, a very significant number of regional banks, and in fact a very significant number. In fact, all banks. Let's just be real, right? So they've got all this money that in theory you could take out tomorrow and they've lent that to other people who won't pay them back in the entirety for potentially 30 years. And then they had a bit of excess so they put it into these long-dated bonds and the bonds fell down. There was a bit of a rumour that went through the market.

1:02:59Enough people took their money and was like, we don't have the cash. We don't have the cash. I mean, our balance sheet says we've got the cash, but we don't really. We've got some assets here. And these assets actually are carried at a certain value. But if I need to realize them in the market today, I can't. I caught a friend of mine the other day saying, oh, my car's worth this. It's not, dude. It's not, right? Until you sell it, it's completely made up. And what you will find is that forced sellers or distressed sellers never get the fair market price. So it's very easy to get into a bit of a rant here.

1:03:32but it is a reference rate. And the way that it works, the mechanism, I'm still trying to get my head around it, I'll be honest with you, but the way, and correct me if I'm wrong, but my understanding is the way that it works is if I'm Commonwealth Bank and the central bank has said to me, any money you park with me overnight, let's say the RBA put the reference rate up to 10%, right? Now I can lend money to punters to buy houses and I can charge them, I can get a 6 % return on that or I can just park it in the RBA and get a 10 % return. One is risk-free. I'm going to do that. As risk-free as it gets anyway, but yes.

1:04:15I'm going to do that. That's what I'm going to do, right? And so it's there to make alternate decisions more viable for the bank. So when things are really hot and you want them to pull back on things, you'll increase the interest rate. So it's sort of like it is more and more and more compelling to take money out of the real system. Speculation. Yeah. And when things are really sluggish and you want to encourage banks to lend, you'll offer it's like, oh, I'm not getting anything with the RBA, so I guess I'll lend it out to these muggins over here and let them speculate on Aussie Ponzi property, which works out pretty well too.

1:04:51Oh, my God. And so, yeah, it's – what am I trying to say here? And I'm going to try and be a little bit excessive here, but really just to ram home the point is that it's all a confidence trick in the sense that it's all made up, right? And it is okay as long as we all collectively believe in it and we all collectively believe that forever I want my little amount, it's going to be there. It's a system of trust. I think confidence game is a little bit too cynical. Yeah, confidence trick especially, yeah, you're right. Right, but it's the other side of that same coin. I mean, confidence tricks rely on dishonestly earning the confidence of a party.

1:05:39I don't think there's probably a lack of awareness or a full understanding of the system, but generally speaking, as long as I believe that my bank is lending out my deposits fairly and as long as you believe that it's worth borrowing that money and as long as the boss believes I'm doing work that is worth paying for, as long as I believe the boss will accept that and pay me the money. I mean, these things are all, trust is what makes the whole economy work. It's what makes credit work. It's what makes transfers, it's what makes currencies work. And otherwise you'd say, well, actually, hang on, no, you're going to have to give me the three pumpkins for my sheep because that metal token or that piece of stick or whatever it is, I don't believe I'm going to be able to exchange that later for those pumpkins.

1:06:18So I want the pumpkins now. Yeah, that's exactly what it is. Yeah, it is exactly what it is. And it's, you know, I would actually push, one thing I will push back on a little bit because I agree with everything you said, but I reckon if we went down to the main, into the CBD and we stopped 100 people in the street and said, how does a bank work? Yeah. You know, on the weekend I had this conversation. And I just offhand made the remark that your money's not at the bank. It's like, oh, yeah, well, where is it then? It's not there, dude. Correct. I think we have this antiquated notion that there's a big vault at the bottom with money and they go in, they put it there, they'll lend some of it out, sure.

1:07:01But what we don't understand, they're lending out far more than they've actually got there. And I'm not trying to sound like a – this is just facts, right? And I'm not necessarily saying it's even a bad thing when done judiciously. It is actually a really great thing because it frees up a lot of capital, it helps fund businesses, it helps create jobs. Fractional reserve banking within reason is a very good thing. It's a very good thing. So I'm not a hardcore, you know, crazy person. But just remember that that money isn't there. What is there is a bunch of promises. And that's cool. That's cool.

1:07:37But and even between the RBA and the banks, that's just a series of promises. Remember when they dug up a buried city in Mesopotamia a while ago, and they found all these clay tablets. And I was like, wow, stories from the ancient world. I think 98 % of them were financial records, something like that. And it was the same 10 ,000 years ago as it is today. We use clay tablets and Ahab owes this much grains to whatever. It is fine. You need a system of accounting like that for it all to work. But don't ever feel dumb that you don't understand the modern financial system because I would say straight and sternly as I possibly can, I don't think 98 % of people do and I think I'm only on the fringe of understanding because it's hyper, hyper, hyper complex.

1:08:37Is that too unfair a statement? Again, not that there is a conspiracy of lizard people here. I just don't think that we, most of us, really grasp the mechanism that's in play here. And so Heath's running and going, I don't really kind of get that. And it's like you're not alone, Heath. You are not alone. The fact that you've even questioned it, I would say, kicks you off on a very interesting journey down a very deep rabbit hole of how the hell does this all work? And it's complex. It is. And I think there's an element of – you're right, mate. It depends on where you are on the spectrum of Pollyanna through to believe the world's against you.

1:09:22And it's a long continuum. It's not that. No, no, but I guess I'm making the point that everything you've just said can be described at any point of that continuum. It's all about the risk you put on it and the expectations or whatever that the microtismans believe. You know, the same system can be used and rorted as can be, you know, frankly, the last 300 years works because we all believe this thing works. Yeah. And there's something weird about the – and this is going to sound a little bit weird as we finish the podcast, but, you know, it's a bit Peter Pan or something. It's only true if you believe it and it stops being true if you don't believe it.

1:10:03but it's a bit like Schrodinger's cat that the idea of the system itself the exact same system to your point about Silicon Valley Bank the exact same system stops working the second we stop believing but if you believe it works perfectly now which is true well both and neither that's what screws you with your mind right because it's no different system if you stop believing in it if you stop trusting it the system is still exactly the same as it was when you trusted it and if you stop trusting it it stops working a bank run and Commonwealth Bank is no more or less solvent the day before or the day after a bank run.

1:10:38Yeah. But as soon as we lose confidence in it, it breaks the whole thing. And that's not... Some people listen to this and say, oh, my God, this is horribly scary. Kind of, but that's the same thing. Is it scary or is it wonderful? Yes, both. And again, I don't want to be too weirdly philosophical kind of, you know, but that's absolutely true. Trust and the stories we tell each other, we've said this before on the podcast, are what makes society, civilisation work. Otherwise, we are just apes. Yeah. who are throwing feces and bananas at each other because we don't like each other, we don't trust each other, we don't think this is going to work.

1:11:07That's kind of how it works. And I think that's kind of worth pointing out. I want to go back to the question just really quickly from Heath before we wrap up. Sorry, I took this in a very different direction. No, it's perfect, mate, because it explains it perfectly. I just want to use a different example. Aussie Home Loans and Wizard Home Loans. Aussie Home Loans was John Simon's thing, Wizard from Mark Burris. They were non-bank lenders that flourished in the lead-up to the GFC. And your point about borrowing long and selling short, I can't which way around it, you said it. Help me out here.

1:11:36The banks are borrowing, they're lending money from people who was at a call and they were giving it to other people who were contractually obliged to give it to them over 30 years. They're lending long and borrowing short. I think I got that. And the thing is when you have deposits, deposits are pretty sticky. Yeah, we spend some but we save some. We don't tend to move banks very often. And so banks can kind of believe that money is there. When the GFC hit, Aussie and Wizard were sent straight to the wall. They both got acquired but would have gone broke without it. Rams Home Loans ended up having to sell off the loan book and it was just a weird time.

1:12:10Rams was the other one. For those who remember that one, RHG was the code way back in the day. I totally remember it. Yeah. So what they'd done, so this was that exact version on steroids. They had said, what we'll do, we'll do 30-year, probably 25-year mortgages back then. We'll do 25-year mortgages. Andrew can borrow money for us, 25 years. and we're going to lend him a million bucks. But what happens, just back to Heath's question, sorry. The key thing was the bank said, we'll give Andrew the million dollars to buy the house. Andrew's got to pay us back over 30 years. But he's not going to pay us back straight away.

1:12:46So to keep that alive, I've got to recycle that debt. I've got to keep that debt on my books and Andrew pays it all off. So I've got to borrow that money from someone else so I can lend it to Andrew. Now in deposits, a vanilla bank, This doesn't work, but let's assume it did. The most-view-dollar option would be Scott deposits a million dollars in the bank. The bank lends it to Andrew to buy his house. Andrew pays Scott back over the next 30 years, and Scott eventually gets his million dollars back. And I pay Scott 3 % for his deposit, and I charge Andrew 6%. It's called the 363 rule. Borrow at 3%, lend at 6%, on the golf course at 3%.

1:13:19Buy 3. So that's how the system would work. What Aussie and Wizard decided to do, and Rams, was actually I'm going to borrow on the wholesale money market and I'm going to borrow 30-day bonds and then give a 30-year loan. Now, that sounds stupid except they went, well, actually, it is, but I can just recycle. All I'm going to do is every 30 days I'm going to give back the person I'm borrowing the money from. They get their money back plus a tiny portion of interest. It's 3 % per annum, but let's call it, what's that work out to, mate, doing the last for me, 0.25 % a month. Maybe, yep. So they're going to get their million dollars back plus the 0.25.

1:13:54Andrew's giving me that money. I'm passing it to them the 363 rule as you just said Andrew pays me a bit of interest I pay the rest of the bank sorry the lender every 30 days and around and around we go what happened was those 30 day lenders at the end of 30 days one time went I need the whole lot back now please and Aussie went but Andrew's going to pay back over 30 years how about we just roll this debt over and I'll just give you the interest like we used to do it because that worked for years and years and years and it was a great model because it was really cheap lending you could borrow really cheaply that's why Aussie and Wizard existed because they went, well, stuff the depositors.

1:14:27I'm going to get this from the wholesale money market. It's going to be really easy, really simple. That's what I'm going to do. Yeah. And so they did until the lenders went, no, I want all the money back now. Yeah. And Ozzy went, but Andrew can't pay me the mini dollars back now because he's got a house. Dude, not my problem. Give me my money back. Yeah. Right. And that's exactly what happened. And so the result was they went to the wall because all the lenders went, I want it all back right now. Ozzy and Wizard and Rams went, I don't have it. and they said, well, you're now insolvent. It's worse than that.

1:14:57It's a background. Because it's not like you put a million dollars in the bank and then they gave me a million dollars. You put$100 ,000 in the bank. They created$900 ,000 by pressing a few. No, this is just fractional. I'm not. I know, I know. That's the thing. It sounds crazy, right? Go wrong. It's a whole different rabbit hole that takes 15 minutes to explain. Yeah, but just that is why I just want to really hammer this point because we have a 30-year-plus stretch in Australia where banks are the most safest blue-chip thing. They are by design a very leveraged business model. Yep. That works.

1:15:33And, you know, you are leveraged something like eight or ten to one on the actual deposits that you have. So that's why it doesn't take much for things to really get out of kilter. And we've seen that in the US. We've seen it here in Australia recently. Westpac nearly went under in the 90s. It just happens. And so I make the point because I think we now have a situation where people in their 50s, in their entire working career, have never seen this happen. And it's just unimaginable that it could. And I'm not saying it will happen, but just I think we have lost sight of the risks. And I, for one, feel that history repeats because we always – a new generation comes in, they forget the lessons of the last generation and we repeat the same mistakes again and again and again and again.

1:16:27Other than that though. Other than that, you know. And so, look, so much to say on this. All I'll say, Heath, is keep reading, right? Go to the RBA's website. It's fascinating. They publish their financial statements. Have a look at that. It is wild reading. And all I'll say is it would be really nice if someone invented some kind of trustless instant settlement system that we didn't have to rely on the good faith of other institutions. But that's a whole other rabbit hole. I will say only that our anonymous questioner, second to last, did say, P.S., please give the people what they want. No more conversations about Bitcoin off air.

1:17:03Sorry, just a bit of a callback to that one. Mate, we've probably tortured this one. Hopefully it's been useful. Hopefully it's instructive and great questions. No dumb questions. All excellent questions with complicated but worthwhile answers. So thank you for spending a bit of time with us on your Sunday morning. Andrew's off to get back into the ice bath. So, mate, enjoy that. Good luck with that. And if you're not frozen solid, I will see you next Friday. Thanks, mate. Until then, full on. Appreciate it. Cheers. The Motley Fool and people appearing in this program may have positions in the companies mentioned.

1:17:35General advice only. Please speak to your financial professional to understand how it may pertain to your situation. Subscribe to the free newsletter at fool.com.au forward slash listener. The Motley Fool operates under Financial Services Licence 400691.