Article in NY Times on Compound Interest

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Article in NY Times on Compound Interest

Postby lloydbraun » Tue Jan 08, 2013 1:48 am

This is a good one for young investors looking for an intro article.

http://bucks.blogs.nytimes.com/2013/01/ ... f=business
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Re: Article in NY Times on Compound Interest

Postby DaleMaley » Tue Jan 08, 2013 6:16 am

Nice article.

Thanks for posting :D
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Re: Article in NY Times on Compound Interest

Postby nisiprius » Tue Jan 08, 2013 8:04 am

I'm sorry. I find this sort of thing annoying... and overstated. No, you can't make your descendants rich by depositing a dollar in a bank account and leaving it there for a few centuries. Money compounds, yes. But so does inflation, and so does risk.

Yes, you should start saving early, but the comparison between Sarah and Roger is misleading, because due to inflation it was almost certainly a heavier burden on Sarah to save $1000 a month for those first ten years than later. In my personal case, I earned between $2,500 and $4,000 a year from in my twenties (I was a grad student), and my first real-life job came with a salary of $14,000. Even if I'd had that real job all those years instead of a grad student stipend, it would not have been so easy to save $1,000 a month.

There's a great old science fiction story by Mack Reynolds, entitled "Compounded Interest," that's worth digging up. But it's silly. The concept is that a time traveler shows up in middle-ages Venice with a proposal to a banker. The concept, which is telegraphed clearly enough that I don't think this is much of a spoiler, is that he wants to invest the money really early so that it will compound enough to make him wealthy enough to build and power the time machine.

Anyway, he shows the banker ten gold coins and says he wants to invest them. In the story, the banker scoffs, and says it would hardly be worth his while, until the time traveler says "Wait... you don't understand. I would not ask for an accounting for a hundred years." The banker pauses for a moment, presumably working the Rule of 72 in his head, and his eyes light up as he realizes what a big account this will be.

That's in the story. (The compounding of risk is dealt with, by the way. The time traveler shows up every century to renew the contract, and each time he comes equipped with a few investment tips for the bankers).

In real life, try walking into a private bank today. When they tell you the minimum to open an account is $250,000, show them ten gold one-ounce coins. When they explain that that's not enough, say, "Wait... you don't understand. I would not ask for an accounting for a hundred years." Do you think they will say, "Ah. Let's see. $20,000 at 3% interest, oh, OK, you'll meet our minimum in just 85 years. Welcome! Just fill out these forms?"
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Re: Article in NY Times on Compound Interest

Postby The Wizard » Tue Jan 08, 2013 8:08 am

It's a great article for grade-schoolers.
But it's a silly article for grown-ups since it ignores INFLATION.

We need a companion article showing how a sum of $$ compounded at 1% APR in a present day savings account results in a much reduced amount to spend after 20 or 30 years of 3% inflation compounded...
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Re: Article in NY Times on Compound Interest

Postby scrabbler1 » Tue Jan 08, 2013 9:29 am

On a lighter note, my favorite bit about compound interest came from an old Seinfeld episode, the one where George is notified by the state comptroller's office he has a dormant account from his youth which has grown over the years.

George: "Yeah, interest. It's an amazing thing. You make money without doing anything..."

Jerry: "Y'know, I have friends who try to base their whole life on that principle."

George: "Really? Who?"

Jerry: "Nobody you know..."

:D
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Re: Article in NY Times on Compound Interest

Postby Frugal Al » Tue Jan 08, 2013 9:49 am

scrabbler1 wrote:On a lighter note, my favorite bit about compound interest came from an old Seinfeld episode

Nice to see we could keep Lloydbraun's Seinfeld theme going. :D Parasitic inflation does indeed nip at the beauty that is compound interest.
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Re: Article in NY Times on Compound Interest

Postby tfb » Tue Jan 08, 2013 11:10 am

I caught this story in Richest Man In Babylon:

Gold increaseth rapidly when making reasonable earnings as thou wilt see from the following: A farmer, when his first son was born, took ten pieces of silver to a money lender and asked him to keep it on rental for his son until he became twenty years of age. This the money lender did, and agreed the rental should be one-fourth of its value each four years. The farmer asked, because this sum he had set aside as belonging to his son, that the rental be added to the principal.


The said farmer does the same today in a four-year CD that loses 1% to inflation every year … Never mind. The farmer keeps the silver in his bag.
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Re: Article in NY Times on Compound Interest

Postby ladders11 » Tue Jan 08, 2013 4:03 pm

It is certainly important to earn more than inflation, but it is also important to earn a consistent return in order to benefit from compounding. This means minimizing drawdowns, and it means being fortunate enough to have positive return years when you have the most at risk. In order to beat inflation, we need to invest in inconsistent vehicles like stock funds.*

Essentially this is why we're not all rich: nothing consistently offers returns above inflation.


*P.S. By "invest in inconsistent vehicles" I'm not recommending purchasing Dodge Darts.
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Re: Article in NY Times on Compound Interest

Postby AndroAsc » Tue Jan 08, 2013 9:01 pm

You guys are really missing the point of the article, which is save early, i.e. starting from the first day of your job. Sacrificing your "wants" in your early years, makes one's financial health much better due to compounding interest.
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Re: Article in NY Times on Compound Interest

Postby AndroAsc » Tue Jan 08, 2013 9:04 pm

ladders11 wrote:Essentially this is why we're not all rich: nothing consistently offers returns above inflation.


That's because you're looking in terms of absolutes, which is wrong way to analyze investments. It should be about probabilities. The probability of stocks outperforming other asset class (i.e. bonds) is very high to almost a certainty over the lifespan of a normal worker (i.e. 40 years). And so is its ability to outpace inflation. It's the inability to follow the plan which explains why not everyone is rich.
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Re: Article in NY Times on Compound Interest

Postby mephistophles » Tue Jan 08, 2013 9:13 pm

lloydbraun wrote:This is a good one for young investors looking for an intro article.

http://bucks.blogs.nytimes.com/2013/01/ ... f=business


Great article and thanks for sharing.
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Re: Article in NY Times on Compound Interest

Postby magician » Tue Jan 08, 2013 9:18 pm

AndroAsc wrote:It's the inability to follow the plan which explains why not everyone is rich.

That may explain why some people are not rich, but probably doesn't come close to explaining why most people who aren't rich aren't.

I suspect that poverty explains a greater percentage.
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Re: Article in NY Times on Compound Interest

Postby celia » Tue Jan 08, 2013 9:31 pm

My kids saw this type of example in school and were so struck by it that they shared it with me as unbelievable (even though they could verify the math). But when they brought up the excuse that inflation would eat up some of the growth or a million won't buy much in 30 years, I reminded them that they would have a lot more than someone who didn't put the money away.

They starting saving when they got their first real-time jobs and this example, I'm sure, had an influence on them.

Thanks for sharing this for the benefit of some of the younger members on this forum who have never seen it.
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Re: Article in NY Times on Compound Interest

Postby 325e » Wed Jan 09, 2013 10:07 am

Inflation will eat away, but we have some control over our personal inflation. Assuming housing, transportation, and healthcare are your major expenses -

Start investing early, then -
buy a house and then don't move. Mortgage stays the same and then gets cheaper (goes away).
buy a practical used car, take public transportation, bike or walk. A mustang in 1965 was $2368. You can get a more reliable used toyota with 75K that will last longer than the mustang for $5000 today (even though inflation is x7). Biking and walking cost about the same as 1965.
eat well and exercise

Not to say it won't be a factor, but you don't have to suffer the same inflation as the average. So I think this simplistic graph is still very powerful.

The point about being harder to save money earlier because you are making less is valid. But this is still motivational.
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Re: Article in NY Times on Compound Interest

Postby nisiprius » Wed Jan 09, 2013 1:05 pm

AndroAsc wrote:It's the inability to follow the plan which explains why not everyone is rich.
Which triggers a synapse... "Everybody ought to be rich" was the title of a 1929 Ladies' Home Journal interview with John Jakob Raskob (later to build the Empire State Building). In his words:
Suppose a man marries at the age of twenty-three and begins a regular saving of fifteen dollars a month--and almost anyone who is employed can do that if he tries. If he invests in good common stocks and allows the dividends and rights to accumulate, he will at the end of twenty years have at least eighty thousand dollars and an income from investments of around four hundred dollars a month. He will be rich.
(Average white-collar wage was $34/week in 1929, so fifteen dollars a month represented a savings rate of 10% of salary).

There are a few problems with this, however. It becomes clear on examination that the return he assumes from "good common stocks" did not mean the S&P average, it meant the returns he (claimed to be) getting, over the previous ten years, including the maniacal rises of the late twenties, from the stocks that he picked for a sort of young executives' investment plan at General Motors. The other problem was that it is not so easy to maintain a $15/month investment plan when one is out of work.

In reality, in the words of Frederick Lewis Allen in 1931, "a group of powerful speculators with fortunes made in the automobile business and in the grain markets and in the earlier days of the bull market in stocks--men like W. C. Durant and Arthur Cutten and the Fisher Brothers and John J. Raskob--were buying in unparalleled volume," and counting on the purchases of an enthusiastic lay public to loft their investments; in short, he had his own reason for promoting stock investments.
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Re: Article in NY Times on Compound Interest

Postby Fallible » Wed Jan 09, 2013 1:49 pm

The Wizard wrote:It's a great article for grade-schoolers.
...


I do think that even grade-schoolers (some of them sharper about finance than many adults, especially if their parents have schooled them on the subject) need the inflation angle. And they'd be better off not having read the Einstein comments in the third and fourth graphs, which still leave the impression that Einstein could have made that comment when it probably is one of the most UNlikely things he ever said, not to mention that there are plenty of great people highly quotable on compounding - such as John Bogle.
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Re: Article in NY Times on Compound Interest

Postby NYBoglehead » Wed Jan 09, 2013 1:51 pm

I'm glad that the paper that claims the title "the paper of record" publishes articles that anyone who passed 6th grade should already known. Outstanding journalism, where would be without their brilliant reporting?
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