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195% Returns! Interested?

Give me a fixed amount every year for 20 years and in the 21st year I will return to you 195% of the total amount you deposited with me. Guaranteed and 100% Safe.

Interested? I doubt if anyone can resist such mouth-watering returns.  

Well, if you say yes, you are in for an unpleasant shock. Wondering why? Wondering what's wrong with earning 195% returns? Am I telling a lie?

No, I am not telling a lie... and yet I am not speaking the whole truth either. 

Ok. Here's the real story behind the half-truths of all such big big numbers thrown at you. 

Suppose you give me Rs.50,000 every year for 20 years i.e. a total of Rs.10 lakhs. 195% of Rs.10 lakhs works out to Rs.19.5 lakhs. So I will give you back Rs.19.5 lakhs in the 21st year. 

The half-truth is in the presentation of the numbers. 195% returns is over 20 years. Whereas our minds are tuned to think in terms of returns per annum because that's how returns are "normally" mentioned. Therefore, we unconsciously compare 195% with say 9% interest on FDs. Hence, 195% looks enormously attractive. 

Also, 195% includes both principal+interest earned over 20 years. But in normal terms, when we talk of returns we talk only of interest income.

On a simplistic basis, 195% over 20 years is equal to 9.75% per year only (Beware. As I explain next, this simple division of 195 by 20 is not correct. But for the moment let us keep the story simple and move forward.) You would agree with me that we may not give a second look to an offer of 9.75%. Yet, if the very same offer is presented as 195% returns, it will attract our attention. 

So that is the whole idea behind companies highlighting gigantic numbers such as 200%, 400%, etc. — to lure you into investing in their schemes.

Why the simple division of 195% by 20 is wrong? Because, it does not account for compounding.

The normal practice is that you get your interest at the end of every year. This gets added to your principal and the next year's interest calculation is on this higher principal amount. And this goes on year after year for 20 years. This process is called compounding. The number 195% ignores this compounding aspect.

In the above example, if we calculate the effective returns as is normally understood (i.e. the returns per annum and compounded every year), we get the answer as 6%. Yes, 195% that was promised to you, actually means only 6% p.a. returns in day-to-day terminology.

So now you see how, to fool you, a small number of 6% is inflated beyond all reasonable proportions and presented as 195%.

If you really care for your money, you would ignore such mis-leading half-truths.

An Investment In Knowledge Pays The Best Interest ~ Benjamin Franklin

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