When you rent a flat, you pay rent to the owner. They let you use their property for a while, and they're paid for it. Money works exactly the same way. The interest rate is the rent on money.
Why does money have a rent?
Ask a child: "Would you rather have 10 francs today or 10 francs in a year?" They'll say "today" without hesitating. And they're right.
More than a century ago, the Austrian economist Eugen von Böhm-Bawerk explained this reflex: something you have now is worth more than the same thing later. You can use it straight away, you don't have to wait, and the future is always a little uncertain. Whoever lends gives all that up for a while. Interest is the reward for their waiting.
The American Irving Fisher added a second reason: borrowed money can be used to build something that earns, a workshop, a machine, a business. The borrower is happy to pay rent because they hope to earn more with that money.
The two sides of the rent
- When you save, you're the owner: the bank pays you rent to use your money.
- When you borrow, you're the tenant: you pay.
A small example: Buddy lends his cousin CHF 20 for a year at 5%. A year later, his cousin gives him back CHF 21. The extra franc is the rent.
The side people forget
The rent on money also works like a snowball, in both directions. Compare over five years:
- CHF 1,000 saved at 2% a year becomes about CHF 1,104.
- CHF 1,000 borrowed at 10% a year, with nothing paid back, becomes a debt of about CHF 1,611.
The saver sees their money grow gently. The person who borrows to spend sees their debt grow fast. That's why small loans to "treat yourself now" cost so much.
The real rent
Fisher also showed that you have to take off rising prices to know the real rent. If your account pays 3% and prices rise by 2%, your real gain is only about 1%. And if the account pays less than rising prices, your money loses strength, interest or not.
Try this tonight with your child
Open the "Bank of Home". If your child lends you part of their pocket money for a month, you pay them a little rent (say 10 centimes for every franc). The other way round, if they want an advance on their pocket money, they pay the rent. They'll quickly work out which side of the counter is the better one.
Further reading
- Böhm-Bawerk, E. von (1889). Kapital und Kapitalzins. Zweite Abteilung: Positive Theorie des Kapitales. Innsbruck: Wagner. (English translation: The Positive Theory of Capital, 1891.)
- Fisher, I. (1930). The Theory of Interest. New York: Macmillan.
Put your child on the right side of the counter. Join the Mangosteen Buddy waitlist: Book 1 of the comic is free, and the first 500 families get their first year of Premium on us (worth CHF 150). Save my place
Educational content, not investment advice.