When I was still on my own personal financial ‘seeking journey’ …
[AJC: This is the journey that you may be on right now; you know, the one where you read Every Available Book And Blog on Personal Finance Looking For the Mythical And Magical Secret To Financial Success But End Up Settling On Becoming A Miser Disguised As A Debt-Free, Frugal-Saver]
… I remember being very impressed by a tape set [AJC: Yep, that’s a cassette tape set] about a guy who had a ‘system’ to guarantee that your children could become billionaires in their own lifetime.
I no longer have the tape set, but it was all to do with putting aside $x per week (and, adjusting for inflation) and relying on the power of compounding (sic) to allow the sum to run up to $1 billion.
Sounds simple, so I ran a few numbers on my own, and here’s what I came up with:
– Put aside $5 a day, beginning the day your children are born
– Increase by 5% each year and keep up for 40 years
– Vest the sum into your children’s names when they are 80 years old
Then they will each have $63 million dollars!
Not exactly $1 billion, but not a bad sum, right?
Now, it’s really a Grandchildren’s (or, Great Grandchildren’s) Plan, because your children may not even be alive at 80, but if they do the same for their children, and so on, it’s a reasonably smart and easy Generational Wealth Plan and your progeny will thank you for it (well, you won’t be alive, but take my word for it).
But, there are (other) problems:
– Your children have to wait until they’re 80 to ‘cash out’
– You have to contribute for 40 years, starting with $1,825 year and ending with $12k a year (probably, when YOU need it more than your children do)
– And, $63 million is ‘only’ worth – a still healthy – $5.5 million in today’s dollars
Ashley Ormond (a fellow Aussie) has a more practical, shorter term plan in his book that shows you “how to give your kids $1 million each!”
It’s essentially the same kind of plan, obviously running for a shorter period, and includes interesting tweaks such as having your kids pay you back your $7k initial contributions. It also includes sensible children’s savings strategies (such as setting them up with individual ‘saving’, ‘spending’, and ‘investing’ accounts) … but, the rest of the book is Aussie-specific.
Still, all these ‘power of compounding’ books and strategies show me – after spending a LOT of time, in the service of writing this blog, playing with simple spreadsheets (and, you should do the same) – is that there is no real power in compounding at all …
… it’s just simple maths and (a lot of) time, and if you rely on it for your real wealth … well … you’ll never have any 😉
I remember my teacher telling the class that if I put $50 into a CD every weekend I would have a million dollars by the time I was 30. I was thinking “you can’t even beat inflation with today’s rate.” Just interesting to see the fallacies around money. Anyways interesting article.
It’s true that compound interest has very little to do with getting rich.
On the other hand, it is very important for staying rich. When you see multigenerational wealth, you can be reasonably sure that there are family practices to ensure a thorough grounding in compound interest is passed on to each generation. (And if those family practices fail at some point, you can be reasonably sure that the family wealth will be gone in a couple of generations.)
@ Hunter – Your teacher was PARTLY right: if you put aside $50 each weekend (and increase by 3% inflation, each year); at the end of 30 years you’ll have nearly $600k. Not too shabby!
But, at the same (conservative) 3% inflation it would ‘only’ be worth $250k. BUT, what a great gift from your parents at just about the time you’re thinking of (a bigger) family and housing!
@ Philip – Agree! Teaching our children about money has been a priority in our family (not our parents => us, but us => our children).
OK, if I build an account buy saving for
Each child by compounding who pays the taxes on these growing accounts?
The kids can’t.
If I have 3kids and save and compound
Their accounts the taxes on each account
Would bankrupt me.
@ Jane – Before starting any $billion investment, spending a couple of hundred bucks on an accountant mightn’t be a bad thing 😉
She might put you onto a 529 Plan or some other ‘tax friendly’ way of saving for you and/or your kids …