Compound Interest: The Miracle-Gro of Financial Securityby Bernard Katz How would you like to invest only $8,000 and have it grow to over half-a-million dollars with a yearly return of over $46,000? Or invest $2,000 and end up with the same tremendous sum and yearly income? It can be done through the power of compound interest. Ask any capitalist — even one who helped found our country. Ben Franklin used the power of compound interest. Back in 1783, when Ben was 77, he added a new section to his will. He set up a codicil that was to last for 200 years after his death. Ben allotted $5,000 each to his favorite cities of Boston and Philadelphia. The money was to provide loans to needy young people. The borrowers were to pay back the loans at 5% interest over 10-year periods. Each city's fund, according to Ben's will, operated for 200 years. After 100 years, each city could withdraw $500,000 from their funds and use the money for public works. The rest of the money would still be working for another hundred years. Five thousand dollars isn't a lot of money today, but stop and think: How much was each fund worth at the end of the 200 years (1991)? Need an aspirin? How about more than $20 million! And that was after each city took out half-a-million for public works. That's right: In 200 years Ben's investment of $5,000 for each city grew to more than $20 million apiece because Ben used the Miracle-Gro of compound interest. Why not you? The idea of compound interest is simplicity itself. You invest a certain amount of money. At the end of each year you not only reinvest the original sum but the interest it earns as well — so that the interest (as well as the original principal) keeps on earning additional interest. And you do this year after 1 year. The results are so phenomenal that it's as though you put Miracle-Gro on your money. Try this example. A child is born. At the age of 1, say, a doting grandparent invests $2,000 in some vehicle returning 9%. How much will the child end up with by the time he's 65 — the current retirement age under Social Security? Here's how you figure it out. Dividing the number "72" by the rate of return (the interest) you get the number of years it'll take to double your money through the power of compound interest. If you get 9% on your money, dividing 9 into 72 means that every 8 years your money will double. Now subtract the baby's age of 1 from his retirement age of 65 and you get 64 years. Divide 8 into 64 and you get 8 doubling periods. Now do a little finger arithmetic with me. At the end of the first doubling period of 8 years you end up with $4,000 (2 times $2,000). The child in now 9 years old (1 year old plus 8 more years). At the end of second doubling period (16 years) you finish with $8,000 and the child is 17. By the end of the third doubling period, you have $16,000. The person is now 25. The fourth doubling period gives you $32,000 — and the person is 33. The fifth, $64,000 — and person is 41 years old. At the end of the eighth period, the beneficiary retires at age 65 with a whopping half-a-million dollars and a yearly income of over $46,000. At this point reinvesting at 9% stops and the beneficiary takes out the interest to do what he wants with. That amounts to $46,080 a year, year after year! You can eat pretty high on the hog with that kind of income, can't you? Let's go to our first challenge. How do you invest $8,000 and end up with over half-a-million and a yearly income of over $46,000? This time the person is 17 years old. An investment of $2,000 at 9% is made for six doubling periods, ending at the age of 65. Two years later, at 20 another $2,000 is invested, stopping at the age of 66. One year later, at the age of 30, another $2,000 is invested, ending at the age of 67. And one year after that, at the age of 21, another $2,000 is invested at 9%, stopping at the age of 68. I'll let you do the finger arithmetic. You'll see that the person ends up with over half-a-million dollars and a lifetime yearly income of over $46,000 — not to mention an inheritance that'll make any heir remember him! To do this we must ask some important questions. Where does the $2,000 in one case or the $8,000 in the other case come from? Today it's not unusual for grandparents — or some other relative or even the parents themselves — to part with $2,000. Or it can be broken up into smaller amounts — like $500 a year for four years. The results will be less, but still sizable. In the case of investing $2,000 a year for each of four years, why, the person himself can raise the money. There are plenty of part-time jobs. Some sacrifice is, of course, in order. Postponement of immediate satisfactions will more than pay off down the line. How about a mutual fund that deals in bonds? Here you have professional managers doing the selection. At the time of this writing Vanguard TT Corp. — which invests in investment-grade corporate bonds — has had an average yield of 9.3% over the past five years. And if you want higher grade bonds like general U.S. bonds, you can get into another of Vanguard's mutual funds, Vanguard Group: LTTsry. For the past five years it's averaged 9.8% a year. Incidentally, both funds are "no loads" — meaning that since you don't have to pay any commission to buy them, you have that much more money to work with. If you're convinced that stocks over the long haul give a better return than bonds — and they do — you can buy a mutual fund that invests in stocks only. Since the Standard and Poor's Average has produced a 9% return over the years, you can buy a mutual fund that's indexed to that average. They're called an "indexed fund." Again, the Vanguard family of funds has Vanguard Index 500 available, and with no sales charge. Another such fund is 20th Century Growth — and it's a "no load" fund to boot. A brokerage house may help you with the selection. I say may because they don't make any money when they buy a "no load" fund. So you can do your research by going to a decent library that has the Value Line Mutual Fund Service or Morningstar Mutual Fund Service. The books are self explanatory. The power of compound interest gives you a tried-and-true technique for applying Miracle-Gro to your money. Like Ben Franklin's legacy, it'll grow as our country has. Bernard Katz is a World War II Navy veteran. He has a master's degree in secondary education from Temple University, Philadelphia, Pennsylvania. For half of his working life he was a teacher in the Philadelphia secondary schools; for the other half he was a stock and commodities broker. Since 1982 he's been a contributing editor of the American Rationalist Over the years he's given many lectures and is the author of two books, one on the stock market, the other on debunking the Bible. Table of Contents | 1995 Issues | Subscribe Credit card Orders call: 800-321-9054 or fax: (619)676-0433 Truth Seeker is published by Truth Seeker Co., Inc. (ISSN 0041-3712) © 1996 |