The Compound Interest Effect
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” Albert Einstein
Renowned physicist Albert Einstein when asked what he considered to be the most powerful force in the universe answered: Compound interest!
Benjamin Franklin provides us with an actual rather than a hypothetical case. When Franklin died in 1790, he left a gift of about $2,000 to each of his two favorite cities, Boston and Philadelphia. He stipulated that the money was to be invested and could be paid out at two specific dates, the first 100 years and then 200 years after the date of the gift. In 1894, at the end of the first 100 years, the Boston fund had been used as instructed and had grown to $391,000. In the following century the bulk of the proceeds were used to fund public works in Boston. In 1905, $322,490 was used to establish the Franklin Union, a technical school. The remainder of the funds continued to be loaned out for apprentice programs and scholarships. In 1990, the end of the second century, Franklin’s Boston endowment was worth more than $5,000,000 and the Philadelphia fund about half that. In both cities Franklin’s endowment has been used to help thousands of young people and has served as an enduring testament to philanthropy and community service.1 Franklin’s example teaches all of us, in a dramatic way, the power of compounding. As Franklin himself liked to describe the benefits of compounding,
“Money makes money. And the money that money makes, makes money” Benjamin Franklin
Making Snowballs in August
Oftentimes a company’s board of directors shares the profits of the company with the share owners and declares a dividend. This is expressed as a dollar amount per share, not a percentage of the stock price. An investor can choose to simply pocket the dividend, or take another option: understanding Mr. Franklin they could reinvest any dividends.
A compounding effect occurs when an investor reinvests the dividend by buying more of the company shares. Those shares pay their own dividends which can be used to buy more shares, and so forth. An owner of a dividend paying stock or mutual fund shares the profits of the company, not to be confused with interest. Dividends are never guaranteed and the compounding effect created by reinvesting them carries more risk and is different than compound interest.
Around the time Einstein was born in 1897, before he declared compound interest to be the most powerful force in the universe, the ten year US treasury rates were 4.22%2,3 Today they are 2.34%. Today Albert might have also mentioned the possible compounding effect of reinvesting dividends, as described above paid by some of the best companies on the planet!
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E=MC2 or A = P(1+r/n) ^nt?
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Content provided for information only. It is not meant to be a recommendation to buy or to sell securities nor an offer to buy or sell securities. Past performance is no guarantee of future results. Any rates of return shown are for illustrative purposes only and are neither guaranteed nor implied. Actual rates of return will be based upon the actual performance of selected investments. Taxes and fees are not a consideration in the illustrated returns.
Securities and advisory services offered through Independent Financial Group, LLC (IFG). Member FINRA/SIPC. Symphony Financial and IFG are not affiliated
1. Your results will vary https://eddiethompson.org/2012/09/30/franklin_endowment/
2. brainyquote.com/quotes/quotes/m/mignonmcla158995.html
3. http://www.multpl.com/10-year-treasury-rate/table/by-year
To learn more about Rick Willoughby, view his Paladin Registry research report.
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