This is the fifth and final installment of a series on compound interest and the impact it can have to both speed and sabotage your journey to financial freedom.
In part four of this series, we reviewed how the power of compound interest creates a hidden, deadly cost of debt in the form of opportunity cost, which can effectively double the interest you pay on your credit card and easily triple the original cost of a mortgage.
Today we’re taking a break from our calculators (whew!) to determine whether the power of compound interest holds up in practice, review what we’ve covered in this series, and identify the impact of applying this newfound knowledge of ours.
We’ve crunched a lot of numbers over the course of the last three articles. It all makes sense on paper, but does it match reality? Is the power of compound interest real, or just another too-good-to-be-true concept that doesn’t hold up to scrutiny?
To answer those questions, let’s take a step back in time to 18th century America to perform a 200-year case study, courtesy of the man who invented the lightning rod.
Benjamin Franklin’s Compound Interest Experiment
Benjamin Franklin? Yes, indeed. Founding Father, statesman, diplomat, author, printer, scientist, and inventor, Franklin’s accomplishments are nothing short of inspirational.
A perhaps lesser-known fact about the man often referred to as “The First American” is that upon his death he bequeathed approximately $4,400 each in the form of a 200-year trust to the cities of Boston and Philadelphia.
One of the primary conditions of the gift was that for the first 100 years, the cities could only use the money to provide loans to young craftsmen entrepreneurs attempting to start their own businesses. After the 100 years were up, the cities could access approximately 75% of the accumulated balance to fund public works projects. The balance had to remain invested for another 100 years.
The Impact Of Franklin’s Foresight
This original $8,800 ($100,000 – $124,000 in today’s dollars) grew to nearly $6.5 million by 1990, the 200th anniversary of Franklin’s death, thanks to the power of compound interest.
This total, while large, could have grown far larger had the cities not withdrawn 75% of the accumulated balance at the 100-year mark, as permitted according to Franklin’s will. Had this not taken place, it’s possible that the trusts would have been shut down prematurely for fear that they would have simply outpaced the net worth of the entire universe.
The wise author of “A penny saved is a penny earned” was no stranger to the power of compound interest, as evidenced by the below tongue-twister:
“Money makes money. And the money that money makes, makes money.”
– Benjamin Franklin
Franklin’s belief in the power of compound interest and the resulting growth of his original investments changed the lives of many in the way of public works projects funded, educational investments made, and loans provided to fund college educations, small business start-ups, and home purchases.
A Recap: Compound Interest Lessons Learned
After reviewing the results of Franklin’s experiment, we now have historical proof that compound interest is a valid concept and that its power is real. Let’s therefore take stock of what we’ve covered on the topic to date:
- In Part 1 of this series we witnessed the phenomenal nature of compound interest, it’s life-changing potential, and a basic example of how it works.
- In Part 2 of the series we reviewed how the power of compounding accelerates over time and can serve as your Rocket to Riches, making it possible to break the millionaire barrier by simply saving and investing $46.00/week over a period of 50 years.
- In Part 3 of the series we took a look at how compound interest can act as the best double agent in history, pretending to be your friend while working tirelessly to undermine your financial freedom. Within our final case study, we saw compound interest siphon off so much money that it increased the final cost of a $100,000 mortgage by 71.9% to $171,869.51.
- In Part 4 of the series we connected the dots between how compound interest can work both for and against you by identifying the hidden opportunity cost of making purchases on credit. In this article, we discovered how an unassuming $100,000 mortgage can morph into an appalling total cost of $479,274.88.
The Life-Altering Capability Of Compound Interest
Benjamin Franklin harnessed the power of compound interest over a span of 200 years to better the lives of many. While you won’t have the same time-frame with which to work, if you apply what you’ve learned in this series you can at the very least dramatically change your own financial future.
Climbing aboard the compound interest rocket to riches, shutting down the compound interest double agents undermining your goals, and keeping a watchful eye out for the hidden costs of your debt has the potential to literally change your life.
Consider the $100,000 30-year mortgage at 4% interest scenario which we reviewed in part 4 of this series. After applying your new-found understanding of the compounding power of interest, you now know this purchase carries a total price tag of $479,274.88, nearly 5x the base sticker price.
Arming yourself with this knowledge enables you to pursue alternative courses of action such as avoiding the purchase altogether, reducing your home shopping budget, making a larger down payment, electing a shorter mortgage term, or making extra payments.
The impact of altering just one purchasing decision in such a way can be hundreds of thousands of dollars due to the phenomenal power of compound interest. This in turn can be the difference between living a life short of and stressed about money or a life which enables you to live confidently while pursuing your dreams.
Recognizing the incredible power of compound interest and employing a strategy to escape the talons of mortgage opportunity cost enabled my wife and I to pay off our mortgage in just a little over three years from the time we signed the mortgage paperwork.
Doing so saved us tens of thousands of dollars in combined interest and debt opportunity cost and was key to our ability to achieve financial freedom. A knowledge of the power of compound interest coupled with the right financial plan can do the same for you.
My goal for this series on compound interest is to inspire, equip, and empower you with an understanding of the vast difference which earning interest compared to paying interest can have on your financial future, thanks to the power of compound interest.
An educated consumer is a smart consumer. My message is not that of penny-pinching, but of being confident that you are making an informed decision when you do open your wallet or purse, comfortable in the fact that you understand the true cost of a given item or service and that it does not hinder your ability to achieve financial freedom or your ideal lifestyle.