While there may be some confusion across the States over Presidents' Day (or is it President's Day? Or Presidents Day? 2 Presidents, 1 Day?), we at MoneyTips want to use the holiday to illustrate the power of compound interest.
When you make a bank deposit that earns interest, the interest can be added to the principal value of your deposit and so earn additional interest itself, which is called compound interest. For example, a $100 invested at 10% would yield the owner $10 interest every year. If the owner received his interest as an annual check, at the end of 20 years, he or she would have 20*$10=$200+their original $100 for a total of $300. However, if he or she were able to reinvest the interest every year, they would wind up with $110 after one year, $121 after two, and a whopping $672.75 after the two decades. Additionally, if that same interest compounded 12 times a year instead of just once, the investment would be worth $732.81 . That’s a lot of dead presidents.
Speaking of which, if George Washington's parents made a $100 investment in 1732 on behalf of newborn Baby Georgie with interest at 5% annually compounded, it would be worth $2,628.35 by the time he died in 1799. That would buy a boatload of wooden teeth!
If this hypothetical investment passed on to his heirs, then by the time Babe Lincoln was born in 1809, Washington’s would be worth $4,281.30. Let’s say to mark his birth, Lincoln’s parents made a new $100 investment at 5% annually compounded. By the time The Rail-Splitter took office in the U.S. House of Representatives in 1847, his investment would be worth $638.55, dwarfed by Washington’s at $27,338.17. By 1861, when Lincoln became the sixteenth President of the U.S., his investment would be worth $1,264.28, while Washington’s would be at $54,127.70. And at Lincoln's death four years later, the gap would only have grown between his $1,536.74 and GW’s $65,792.56. This clearly illustrates the benefit of starting your savings as early as possible! (It also shows why Republicans hate the estate tax, but that’s another story.)
With the Father of our Country’s 77-year head start, and his ability to earn interest from beyond the grave, The Great Emancipator would never catch up. Only if his parents had started the investment with $4,281.30, the amount Washington’s investment was worth at Lincoln’s birth, would he have been able to keep pace. It’s no wonder Lincoln is on the penny, while Washington’s mug graces the quarter, the only coin worth bending over and retrieving if dropped accidentally.
If both investments continued earning interest, by 1900, George’s would be worth $362,912.76 compared to Abe’s $8,476.69. By 2000, $47,723,485.03 and $1,114,695.18. And by the end of 2014, $94,489,236.05 and $2,207,020.21 . No matter what year we look at, Washington’s total would be nearly 43 times Lincoln’s.
What if Honest Abe had gotten in on the ground floor of a better investment than Washington had? If instead of 5%, he had received 6%, Lincoln still would not have caught up until the 23rd century. Even an investment yielding 10% annually compounded interest would not have enabled Lincoln to catch up to Washington's investment within his lifetime, as Abe's investment would only have reached George's in 1890. It would take an interest rate of 12.3% compounded annually for Lincoln's investment to catch up to Washington's before his death in 1865. If Lincoln had started an investment with those terms in 1809, it would be worth $2.1 trillion by the end of 2014. Those trillions could help reduce today’s national debt!
Abe shouldn’t feel too badly, as some historians believe Washington was our richest president ever. According to the Georgetowner, at the time of his death, Washington’s land, slaves, house, horses and personal belongings were worth about $525,000, which has been estimated to be worth $525 million today. Washington’s salary as president was 2% of the 1789 federal budget; if Obama got that, he’d be pulling down $78 billion a year!
If you want to explore the power of compound interest, open a new interest-bearing savings account today. Sadly, with interest rates at banks paying 1% or less, the numbers won’t change as dramatically as in our Presidential hypotheticals. Just another example of the rich getting richer….
Happy President’s Day!