Compounding Interest Rates

[Ripley]

Sidney Homer, author of "A History of Interest Rates" wrote:

"$1,000 invested at a mere 8 percent for 400 years would grow to $23 quadrillion- $ 5 million for every human on earth. But the first 100 years are the hardest."

Just curious, why is the first 100 years the hardest? Is it because the return in the initial stages is low when compared to the latter stages?

 

[mschey]

Take excel, and run the numbers, then create a graph of the function and you will see what happens in the first 100 years and what happens after that.

The question remains, where are you going to get 8% on an that much money?

 

[Ripley]

I know.. the numbers would be significantly less for the first 100 years. But why would that be "hard" to do?

From a cost-benefit analysis for the first 100 years, you can derive more "utility" from using up your $1000 dollars rather than investing it for 8%. Guess thats why it is hard to do.

Compounding returns take on that exponential factor, and you can only get to that point with some initial pain.

Good to know!!!

 

[spreadem]

Run the numbers for 30 years ... that info would be more beneficial.

 

[cakulev]

Quote from Ripley:

Sidney Homer, author of "A History of Interest Rates" wrote:

"$1,000 invested at a mere 8 percent for 400 years would grow to $23 quadrillion- $ 5 million for every human on earth. But the first 100 years are the hardest."

Just curious, why is the first 100 years the hardest? Is it because the return in the initial stages is low when compared to the latter stages?

The first 100 years are the hardest because within that period you die.
On a more serious note, getting 8% real return is admirable. The GDP of US has been growing 3-4% at the last 100 years, and I suspect the rate was similar in the past. Note that investing in an index is trading since the index by definition is getting rid of the dogs –survival bias.
Most of the time humanity is doing fine, but from time to time, nasty things happen – wars, revolution, defaults, currency debasements etc.. Just ask someone that invested in the Russian stock market before 1917…

 

[mschey]

Quote from Ripley:

I know.. the numbers would be significantly less for the first 100 years. But why would that be "hard" to do?

Taxes are going to take a chunk of your returns, it is very difficult for someone to stick with something for a few months, let alone 100 years, IMO!

Ask yourself, could you stay the course, earning a measly $80 a year, and keep up with it year after year?

 

[Ripley]

Lets change the numbers and find out.

If you are between 30 and 40, would you invest 1,000,000 for 30 years at 10% (historical stock market returns) and have 17.5 million when you are between 60 and 70 years old.

I would contend that you can get better "returns" without investing your million.


It is assumed that the investor in question is an astute investor, 10% returns are after tax, and 1 million is all the savings.

Would you do it? Would you give up your 1 million and all the joys it could bring today, for 17 million in 30 years?

 

[Ripley]

Compound Interest looks all well and good on paper, where the numbers go from 10,000 to 20 billion in 100 years etc.

But if you can realistically look at Compound Interest within the time frame of a lifetime, also factoring in income factors etc, I don't think compound interest is worth it.

 

[cakulev]

Quote from Ripley:

Lets change the numbers and find out.

If you are between 30 and 40, would you invest 1,000,000 for 30 years at 10% (historical stock market returns) and have 17.5 million when you are between 60 and 70 years old.

I would contend that you can get better "returns" without investing your million.


It is assumed that the investor in question is an astute investor, 10% returns are after tax, and 1 million is all the savings.

Would you do it? Would you give up your 1 million and all the joys it could bring today, for 17 million in 30 years?

10% historical return of the stock market is not tax/inflation adjusted. Assuming you are taxed 15-20% and transaction costs are ~.5% and the inflation is 3-4% you get real return of 5% at best. In about 28 years you’ll manage to have 4 times in real terms. Not too sexy for a life time.
Let’s say you don’t pay taxes and the inflation + transaction cost is 3% (very optimistic!) –real return of 7%. In about 29 years you’ll have 7 times in real return.
Of course if we have large inflation like in the seventies you’ll get zilch or negative real return. This is because in such environment p/e ratios tend to shrink, even though there may be growth. But I digress..

 

[PitchBlack]

Quote from Ripley:

Compound Interest looks all well and good on paper, where the numbers go from 10,000 to 20 billion in 100 years etc.

But if you can realistically look at Compound Interest within the time frame of a lifetime, also factoring in income factors etc, I don't think compound interest is worth it.

Compound interest is worth it. But before investing you must study the way compounded interest works. There are 2 elements in it:
return per period
number of periods

So if you can make 1% net per week, you will have approximate 1,766,503 $ after 10 years.
So if you daytrade stocks and try to make 1% per week, compounded intrest works very well.