The first term of the return equation is time compensation: holding today's money until the future deserves compensation in itself. The interest rate is the price of this exchange across time, set jointly by people's patience and by investment opportunities. True compensation must be measured in purchasing power; and when the time a promise pays out differs from the time the money is needed, the compensation is discounted.
Over a lifetime, a person's income and spending do not line up in time. Income is low in youth, exceeds spending in middle age, and nearly disappears after retirement. Firms are the same: building a plant or doing research requires spending now, and the returns arrive years later.
So the market has two kinds of people: those who have spare money now and are willing to defer consumption, and those who need money now and will be able to repay later. Letting them trade makes both better off. Fisher made this clear in The Theory of Interest in 1930: the interest rate is the price of this exchange across time, determined on one side by how long people are willing to wait, and on the other by how much the money would earn if put into production. The life-cycle hypothesis proposed by Modigliani and Brumberg in 1954 added that people tend to smooth consumption over their lives, saving when income is high and borrowing or drawing on savings when it is low.
The rate written on a deposit slip is the nominal interest rate; it promises how many units of currency you will get back. But a unit of currency in the future may buy less than it does today. Fisher also pointed out that the reward for waiting should be measured by the real interest rate after inflation: roughly the nominal rate minus the inflation rate. With a nominal rate of 2% and inflation of 3%, the amount on deposit grows while its purchasing power shrinks.
The amount grows; purchasing power may not
10,000 yuan deposited for 20 years. Adjust the nominal interest rate and the inflation rate, and compare the amount in the account with what it can buy.
This means the very phrase "capital protected" needs a definition: is it the nominal amount that is protected, or the purchasing power?
Maturity is the other face of time compensation. If the money is needed before the promise pays out, the only options are early withdrawal or a sale in the market, often at a discount; if the promise pays out too early, the money sits idle somewhere with a lower return. Whether a product's maturity matches when the user needs the money is the first design question for any financial product.
The cost of a maturity mismatch
10,000 yuan in a three-year fixed deposit. Drag the time when the money is needed to see how much interest early withdrawal costs.
Time compensation looks the simplest, yet it is the easiest to gloss over in a product description.
The same rate of return means something entirely different over a one-month holding and a three-year holding; annualized returns and holding-period returns should be stated separately.
Distinguish protecting the nominal amount from protecting purchasing power; for long-term products, also show results after inflation.
Show the rules and costs of early withdrawal or selling before maturity, so the user knows them before buying.