Benjamin Franklin provides us with an actual rather than a hypothetical case.
When Franklin died in 1790, he left a gift of $5,000 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 the second 200 years after the date of the gift. After 100 years, each city was allowed to withdraw $500,000 for public works projects. After 200 years, in 1991, they received the balance—which had compounded to approximately $20 million for each city. 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”
So how long do you let your money compound?
Is it saved one or two years and then spent?
Have you ever calculated the value of your money 10, 20, 30 years out?
So, the other day in an effort to keep my kids informed – you see – I have this fear that the shoemaker’s kids will have no shoes.
You know the money guy’s kids don’t understand money.
I wonder sometimes if with all my education, videos, podcasts out there if they listen – so every once in a while, I want to make sure they have the proverbial shoes.
Anyway, my daughter just saw a good friend of her get a brand-new car. Now we all need cars and although it’s the biggest waste of money, we like to get as new as we can afford, right?
Afford may be the wrong word – but let’s not go there today.
She found out the car cost $20,000. Not a lot of bells and whistles but it was brand new.
Our daughter on the other hand had to settle for a little older car with a few miles on it for less than half that cost.
I wanted her to see what that really meant in her lifetime. I mean, at 21, still in college most of these kids don’t understand how to balance a check book let alone the power of compounding.
What do they learn in college? Oh I guess that’s another subject
So, I asked her about her car. Do you have any idea what that car cost us? She said, like $10,000. And I said, well a little less than that, but let’s use that figure of 10k.
I said, so you think the car cost us $10,000 right.
Have you ever heard of a mathematical formula called the Time Value of Money?
She said, no – so there you go, I was worried that the shoemaker’s kids had no shoes, and I guess I was right.
Argh – I gotta make sure my kids watch my videos and listen to my podcasts!
So, my next questions, crossing my fingers, hoping she’d get this one right….
Have you ever heard of compounding interest?
She said, yeah, sure Dad I’ve heard of that.
I thought, YES, I did something right!
Then she quickly busted my bubble. I’ve heard of it, but I don’t really know what it means –
POP – well there goes financial advisor of the year….
Okay my dear, let’s just see what happens to money if we can leave it along.
I went to a TVM calculator on the internet. These are all over the place and if you haven’t played around with one, you really should. Compounding is amazing!
What we first did is plugged into the calculator the PV or Present Value of the money.
In this case we were using 10,000 dollars.
I then had to coach her on the next question because I was certain she had no idea what the answer would be.
I asked, what rate of return do you think we could get on this money year after year. As suspected she had no idea.
So, I said, let’s be really conservative and assume we don’t want to lose this money and so let’s use 5%.
Then I said, you are 21. Let’s suppose we could let this money grow until you are 65 and ready to retire with your husband, okay?
That means we can let the money grow and compound for 44 years.
So, we inputted 44 years in the periods box.
Then I said, before the drum roll, give me a guess as to what you think $10,000 could grow to at 5% over 44 years.
She didn’t have even an educated guess, but took a stab at it and shyly said $20,000 as if that was going to be an extraordinarily high number.
I said, okay, good guess, well, let’s see….drum roll please….
Then I hit the FV – future value button and out came the answer – $85,571 bucks!
Her eyes got wide, and I said, you see, that car didn’t just cost $10,000 it really cost us $85,000 I future real money, had we been able to leave the money alone and compounding.
Now, I said, what if during your let’s suppose interest rates went up and down but overall, they averaged 7%. What would that look like?
Turns out to be over 196,000 dollars!
So now I want you to look at the car – do you think that car is worth $196,000 dollars?
Going one step further I said, now your friend just got a $20,000 car. Do you know what that is worth when she is 65?
It’s over $392,000 bucks!
Now again, we all need cars. But if you had $20,000 to spend on a car, but only spent $10,000 and invested the rest – you could be 196,000 richer down the road.
The point is friends, is that compounding is almost like magic, it’s pulling dollars out of a hat instead of rabbits.
It’s free, it too never sleeps as it works for you 24-7 365 and never takes a break.
Then I said, what if you could buy the car AND still keep your money compounding?
What she said, how do you do that?
I said, well that will have to wait for another lesson because we are out of time on this podcast.
Be sure to tune in and learn how to continually compound – and use your money too.
In the meantime, if you have any question – shoot me an email at email@example.com