Why lenders will give you money to invest through Basic Capital
When people first learn about Basic Capital, their skepticism tends to orient around a single question: why would anybody want to lend regular people money to invest in the stock market? Why wouldn’t those lenders invest their capital themselves?When people first learn about Basic Capital, their skepticism tends to orient around a single question: why would anybody want to lend regular people money to invest in the stock market? Why wouldn’t those lenders invest their capital themselves?
These are fantastic questions.
First, let’s address the last question: if you (Basic Capital) believe so strongly in what it's building, why not just invest the money yourself?
Why lenders don’t invest money directly in the stock market
The primary reason is that lenders (be it Basic Capital or a bank who provides capital to Basic Capital to onlend to Basic Capital members) are typically looking for a very different investment return profile, time horizon, and type of risk than individuals are.
Take housing for example: if housing is such a good investment, why wouldn’t banks use their own capital to just buy housing, as opposed to extending loans to individuals to buy housing? It’s largely because banks are not designed to buy and hold real estate. They are designed to “buy” depositors (i.e. find and acquire banking customers) and “sell” depositors money (i.e. find and lend to mortgage borrowers) and make money based on the difference between the cost of “buying” depositors and “selling” depositors money to borrowers.
When it comes to other types of lenders – those who lend through Basic Capital in particular – the situation is similar. There are organizations who have tremendous capital who have a responsibility to allocate that capital to different investments based on their risk and return profiles and based on their time horizons. One type of organization might be an insurance company who collects premiums and makes money by investing those premiums across various assets to generate return. Insurance companies typically invest heavily in income-generating securities like United States Treasury Bills (UST) or even the debt issued by large corporations.
What Basic Capital does is give these lenders – insurance companies with large amounts of capital to deploy – a new place to allocate capital to. Instead of buying UST or lending to large corporations, Basic Capital allows these lenders to lend to someone who is using Basic Capital.
The importance of high quality collateral
This only works if the lenders believe Basic Capital members have great collateral to lend against.
What Basic Capital does is structure each member's fund to consist of index-linked securities (this allows members to get broad exposure, learning from the critical invention of the all-powerful index fund, as we discussed last post) and United States Treasury Bills. The underlying collateral of each Basic Capital Fund is the highest quality collateral available on planet earth: the full faith and credit of the United States, an entity that has never defaulted on its debts.
This enables Basic Capital members to borrow using term loans rather than margin loans…
Term loans, not margin loans
It is incredibly important to stress to everyone reading this that Basic Capital does not involve margin lending. Margin lending is a tool employed widely in finance that carries risks that might not be appropriate for the average investor. Margin loans give leverage to investors based on the collateral they own, but involve giving lenders the right to ask lenders to increase collateral if the value of their investment decreases, or risk losing their investment at an inopportune time. Instead, Basic Capital offers term loans.
Term loans have a set time horizon and are not influenced by the value of the underlying asset. Term loans require reliable repayments but are generally easier to understand and pose less of a risk to borrowers. Mortgages for homes are term loans, for example.
Basic Capital includes term loans that are paid off over time using gains from the Basic Capital fund investments. The work we are doing at Basic Capital – arguably what makes Basic Capital so unique – involves structuring the term loans in a way that minimizes loan repayments earlier in the lifecycle of a member’s Basic Capital Fund so that they can get the highest rate of return net of loan costs. That involves leveraging our experience in structuring a financial product, and building the technology to constantly monitor and manage the behavior of the loan in a way that gives transparency to Basic Capital members and peace of mind to lenders.
This work – the combination of innovative financial engineering and complex technology development – is ultimately how Basic Capital makes money. For many people, especially in the world of finance and technology, it's important to understand how a company makes money.