Spreads — Not the kind on your toast

Working in a bank, one of the greatest insights I gained was to look at things in life as a spread.

By spread I don’t mean what you do to your Nutella each morning. No no no. I’m talking about the relative difference between two factors or numbers.

Why are spreads important? The physicist inside of me would say it’s because it’s all relative.

For example:

Borrowing money over the last decade has been “cheap”. Please note the inverted commas…

Paying 2.5%* a year in interest to a bank seems great when 10 years ago it would have been closer to 8%, but if you were the one lending money you’d only get paid a tenth of that!

RELATIVE to depositing cash at a bank, borrowing at 2.5% is expensive. You’re losing [0.25%] — [2.5%] = -2.25% a year or £22.50 for every £1000 you have. That’s the spread, and it’s negative!

So why do spreads even exist, surely there’s only one price for everything?Tesco don’t give me two prices for butter or jam?

The bid (buy) and offer (sell) price of any financial instrument (equity, debt, deposit at a bank etc.) differ to cover the middle mans costs and to reward him for the risk of showing a price that can change at any moment. This is how markets work and how “market makers” like banks get paid.

So how do we generalise this? Two words:

Assets: Your bank deposit paying 0.25%* a year is an asset. Taking your hard earned cash and lending it out (deposit) or investing it (shares) gives you a claim to something and so you get paid.

Liability: Your mortgage is a liability. You’ve borrowed money with a commitment to pay it back (loan). For this privilege you will have to pay 2.5%* a year.

You can (and should) see almost all investments like this. For the same amount of risk and all else held equal you can expect to pay more to borrow money than you’d get if you lent it because banks have revenue targets…

So what’s the moral of the story? What do spreads teach us?

Finance is relative. It’s generally good practice to pay off old debts before making new investments. So pay off your liabilities and THEN build your assets…

As I build this blog I’d love to know your feedback and any questions you may have. We’re going to explore many bite sized concept but I really want to tailor this to you guys. Answering the below typeform (30 seconds I swear!) will help me shift my focus and hopefully demystify finance and investing for you.

https://philipfortio93.typeform.com/to/j1RqqO

*General levels at time of writing