Is Manhattan worth more than $24 in beads?
Yesterday I promised you an amazing example of the power of compound interest. Today, in my first post on investing, I will fulfill that promise. It is important to note that I did not create this example; I believe I first read about in one of John Paulos’ books, but it might have been somewhere else.
Growing up I’m sure you heard the story about how Manhattan was bought for $24 in beads in 1626. Sounds like a ripoff, doesn’t it? Manhattan must be worth more than $24, right?
Well, how much would that $24 be worth today, if it had been invested, rather than spent?
Let’s see, 1626 was 383 years ago. I don’t know what the various stock markets were returning at that time, but the average annual return during the 1900s in the United States was north of 10%. Let’s just call it 10%.
So, before you read on, formulate a guess in your head. How much would $24 grow to in 383 years, assuming a 10% annual return?
The image below is just a filler to help stop you from reading ahead — don’t move on until you have a guess.
The answer is $171 quadrillion, which is the same as $171,000 trillion. If you want to be more specific, the answer is $171,241,749,947,654,000 (this answer is probably not accurate as excel can’t really calculate accurately with that many digits). This post already showed you how big a trillion is, so imagine a number 171,000 times that size.
Obviously most people, except my friend Jon who claims to be immortal, don’t have a 383 year investing horizon. But, this example shows how a little bit of money, over a long time frame, can add up to a lot of money. Maybe setting aside $50 a month for your kids’ education or your retirement is a good idea after all!
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Comments
Actually, the S&P has gone up an average of 7.78% a year since 1900. Dow about the same. So 24 bucks over 383 years comes to 69,555,887,806,951.58. That’s a little over 69 trillion. (Which goes to show you, if nothing else, what a difference a few percentage points in interest can make…)
And that’s if you compound annually. If you compound daily it comes to about 208.8 trillion.
Pocket change…
JL — my source was Ibbotson and Associates who put out a paper stating that the average return of the entire NYSE from 1926 to 2004 was 12.39%
Shiller also showed a return of 10.57% for the entire US market for the period 1900-2004.
I think the difference is that they were looking at the entire market, rather than the S&P or Dow. This is primarily due to the fact that small stocks have a higher historical average return, and these stocks are typically not part of the S&P 500 or Dow.
So, in addition to showing how much of a difference an extra percent per year makes, this also shows the importance of asset allocation. You need exposure to the whole market, not just large-cap stocks.
Hmm. You may be right: my info comes from here: http://politicalcalculations.blogspot.com/2005/08/mapping-average-stock-market-returns.html, and here: http://www.moneychimp.com/features/market_cagr.htm.
Actually, I think the S&P is a pretty good indicator the market as a whole. The difference between your numbers and mine seems to be that mine are adjusted for inflation — which in itself would cut 3-4% off.
Though, actually, I can’t quite get my head around inflation alone making a difference between 171 quadrillion and 69 trillion. Though there’s a good inflation calculator here — http://www.westegg.com/inflation/ — that suggests that maybe it does.
Cheers,
JL
Great blog! I posted some comments before anyway, because a lot of your stuff is really great. You are a verry good at this.
I’m reminded of President Bush’s Town Hall Meetings when he was trying to privatize Social Security. He kept gushing about the “miracle” of compounding interest.
Both Dave Ramsey and the textbook I use for teaching personal financial planning use the classic example of Abe, who saved for 10 years then quit, and Ben, who waited 10 years to start saving and never caught up with Abe despite saving a higher % of his income over time.