I wrote recently about compound interest. Everyone thinks they understand compound interest. They remember some quote from Einstein about it.
My point is that we don’t understand it. Our linear brains register exponential realities as impossibilities. But the math is the math. Fold a piece of paper 42 times and it will reach to the moon. Incomprehensible, but true. The Rule of 72 is a helpful guide – divide 72 by a rate of return to discover how long it takes money to double. An account that earns 8% each year will double approximately every nine years. That’s compound interest. I hoped to communicate in the last piece the importance of time – when money doubles every x number of years, the latter doublings are far more impactful than the earlier ones.
We found out recently that we’re having a baby girl in October. Our first child. Becoming a father changes my thinking. I’ve begun thinking about investing money for her and for her children – our grandchildren. Our grandchildren will be four generations removed from my grandparents. My grandparents are a useful benchmark from me because I knew them before they passed. I never met nor know much about my great grandparents. I also admire my grandpa. His name was Dallas, but everyone called him Cy. He grew up poor. Didn’t have a shower at home, so he stopped by his high school to take showers on Friday evenings before taking a girl named Madeline on a date. Cy fudged his age so he could go to war. He was a paratrooper, and he helped the Allies kick Nazi tail up and down Europe before being taken prisoner at the Battle of Bastogne. Endured some pretty awful things on the battlefield and even worse as a POW. He wasn’t a religious man, but something about war turns everyone to God. He promised God if He delivered him, he would marry that sweet girl Madeline back in Illinois and raise a big family.
His prayer was answered. He made it home. Cy held up his end of the bargain. My father is the 8th of Cy and Madeline’s nine children.
Cy never knew financial prosperity, but he instilled his work ethic in his children. Many of them went on to be successful in business. My dad had a better life growing up than Cy did. Then my dad gave me a better life growing up than he ever knew (shoutout to mom who was a big part of this too of course). I feel obligated to do the same for my kids and grandkids. I have a lot to live up to.
Thinking exponentially helps.
My baby girl arrived recently. Here’s an interesting experiment - what if my wife (Laura) and I invest $1,000/month into an account for her? Let’s assume an 8% annual compound rate of return. Here’s what that looks like over time:
10 years: $187,746
20 years: $593,075
30 years: $1,468,150
40 years: $3,357,372
I’m 30 years old, so if I work to 70 (I almost certainly will), that will get her to $3,357,372 by her 40th birthday from Laura and I investing $1,000/month. That’s $480,000 total contributions and $2,877,372 investment earnings.
That’s remarkable. But I’m not done. Not close. You’ve heard the saying. Give a man a fish, he eats for a day. Teach a man to fish, he eats for a lifetime.
Far more important than giving our daughter money will be teaching her how to earn her own. If we accomplish this, then perhaps when I’m 70 we can hand off that $3,357,372 account to her. She’ll be 40. And instead of spending the money she can pick up where we left off and continue adding $1,000/month to it. Then it starts to get interesting.
50 years: $7,436,061
60 years: $16,241,644
70 years: $35,252,237
She adds $1,000/month for 30 more years. She will have contributed $360,000. The investment earnings have grown an additional
$31,534,865. Recap: Laura and I contributed $480K and the account earned about $2.9M. She contributes $360K and the account earns about $31.5M. Those latter doublings are awfully powerful… Exponential growth.
At this point, I’ll be 100. Dead or close to it. She’ll be 70 and can pass it on to her child/our grandchild Our grandchild will have inherited over $35 million dollars around his or her 40th birthday. More importantly, I hope our grandchild will inherit the traits and habits that lead to success. The magic happens if he or she continues the tradition:
80 years: $76,294,682
90 years: $164,902,241
100 years: $356,199,316
Another $360K of contributions over 30 years. Another $320,587,079 investment earnings… At age 70, our grandchild will be worth over $350,000,000.
To recap…
Laura and I contributed $480K over 40 years and earned $2,877,372.
Our daughter contributed $360K over 30 years and earned $31,534,865
Our grandchild contributed $360K over 30 years and earned $320,587,079
Boring old eight percent annual return. Amazing what 100 years will do…
Our grandchild’s doublings are rather exciting… But only if Laura and I get the first few boring doublings out of the way. The first few folds of that piece of paper aren’t very impressive – 0.1mm thick becomes 0.2. We get the first few boring doublings done, and our children and grandchildren will reap the rewards.
Three generations will have contributed $1,000/month for 100 years for a total of $1,200,000 in contributions over a century. 100 years of compounding at 8% yields an account balance in excess of $350 million.
Most people think they need start a massive company or win the lottery to generate wealth. They’re focused on rate of return. They need to reorient their focus.
All you need is time and discipline.
It’s simple.
But it isn’t easy.
Sean Cawley, CFP®
*This is an illustration of the power of time in the compounding equation. I am far more concerned with my grandchildren being men and women of strong character than being worth nine figures. I do, however, want to bless them financially provided they have the character to handle it.
**This analysis does not account for death taxes.
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