Tapping the Power of Compound Interest.

Author:Moore, Stephen
Position:Brief Article - Column

Imagine that, back in 1926, your grandparents scrimped and saved and placed $100 in a trust fund where the money would accumulate for their grandchild and that the money remained in the fund for over 70 years earning the average rate of return of the stock market. How much would you, the grandchild, have today from that initial $100 investment?

The answer, incredible as it may sound, is $266,139. That $100 gift from your grandparents would allow you to retire at age 65 and draw down the investment with annual payments that would match or even surpass what you can expect from Social Security.

Or, consider this scenario: Back in 1950, when they were just starting out in life, assume your parents placed $1,000 in a mutual fund. Let's say they retired in 1998 at age 69. That single deposit of $1,000 would now be worth $217,630.

Let's go back to your grandparents. What if they and then your parents had put $100 every year into an account for 72 years? At the end of 1998, that account would have been worth $2,360,000. Now that's a retirement nest egg. If, starting in 1950, your parents had put $1,000 per year into a stock fund paying an average rate of return, they would have $1,860,000 today. Odds are that they paid much more than $1,000 a year in payroll taxes, but won't get anywhere near $1,860,000 in Social Security retirement benefits.

Long-term trends

When Tom Kelly, director of the Savers and Investors Foundation, showed me the above data (check out their spreadsheet at www.savers.org), I was in a state of disbelief. Kelly found that, regardless of "the mutual fund's volatility over time, the fund's total return from any start year (i.e., 1930, 1950, 1970, etc.) to 1997 was virtually always 11% per annum."

To verify whether that rate of return could possibly be right, I consulted Jeremy J. Siegel's Stocks for the Long Run, where I found basically the same conclusion. Siegel reports that, for roughly the past 200 years, the average annual rate of return in the stock market has been more than 10%. There never has been a 40-year period in American history when the markets have deviated significantly from that long-term trend.

It often is said these days that lower- and middle-income Americans should avoid the stock market because it is so "risky." The facts suggest that stocks are not very risky at all if held for the long term. Over time, even the poorest Americans can accumulate substantial wealth by investing. My favorite example is...

To continue reading