The Magic of Compounding Interest

In the first two installments of this column I discussed the disastrous consequences of debt and unfunded commitments. On the individual level, personal bankruptcy can be humiliating and depressing. On the national level, money spent to service debt is money that can’t be used to pay for government services and may eventually lead to a situation now being experienced in Greece — massive unemployment and a shrinking economy.

In today’s column, we will discuss the flip side of these disasters and talk about good news — the virtue of saving and investment. Compound interest makes debt even more painful, but it also makes savings and investment incredibly beneficial. Benjamin Franklin said that compound interest is the Eighth Wonder of the World. I, too, have been fascinated by the concept of compound interest. I love the idea that you can save money once, and have something else paid for forever. For example, for his Eagle Scout project, my son raised money for the Southeastern Family Violence Center that will provide for a new book bag and two new books to be given to every child who comes into the center for them to keep.

Compound interest is very simple to understand, but many people are not aware of its profound implications. Book ‘Em speaker Dr. Bruce Blackmon, father of local residents Elizabeth Jobe and Annette Burke, has written a concise booklet entitled “More Cash Less Taxes — World Peace” that heralds the benefit of compound interest. To understand these benefits, we have to take a long-term view. In Blackmon’s booklet, he includes benefits that will accrue in 400 years. Now that’s a long-term view. The basic idea behind compound interest is that the interest multiplies. After one year, there is interest earned by an investment. After two years, there is interest earned by the investment plus interest on the interest earned in year one. After three years, there is interest earned by the investment plus interest on the interest earned in year one plus interest on the interest earned in year two. You can see where this is going. After year 10, there are nine “pluses.” Compound interest is a virtual cycle of wealth creation that goes on forever. Anyone who builds wealth through investment does so because of this principle.

About seven years ago, some friends and I co-founded the Robeson County Community Foundation. The purpose of this non-profit is to create a long-term funding mechanism for the charitable needs of our county. The entire premise of a community foundation depends on compound interest. One board member calculated how a charity would benefit if it put $5,000 into an endowment. Assuming an 8 percent annual growth rate, after 30 years that endowment, without another dollar contributed, would grow to $50,313 and it would provide $2,516 that year for the charity to spend. The numbers become mind boggling if we look at what happens in 50 to 100 years. In 100 years, the $5,000 becomes $10,998,806 and it generates $540,940 for the charity that year with an increasing amount every year after that forever. Blackmon outlined a plan for governments to establish endowments so that we can pay less taxes decades from now. The RCCF allows donors to fulfill their charitable intentions forever. Individuals can set aside money that will benefit their children, grandchildren, and future generations forever.

Compound interest requires two ingredients. First, some money has to be saved and invested. Then, time has to pass as the compounding works its magic. To take best advantage of that time, the time to start is now.

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