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Compound Interest is the Biggest Half-Lie That Most Americans Believe

Compound Interest is the Biggest Half-Lie That Most Americans Believe
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Compound growth is generally a great idea. It makes perfect sense to invest in something, see it snowball into something much larger, and reap its returns.

Even Einstein himself was quoted as having said that “The eighth wonder of the world is compound interest.” (This quote was attributed to him by the New York Times, but it’s not certain that he actually said it.)

Who wouldn’t want to put money into an investment account, buy and hold an asset for the long term, and compound it into a vast fortune of, say, a Million or more dollars? There’s no easier strategy than this.

But there’s a problem: when it comes down to compound growth, you are focusing solely on your investment and the compounded growth of your money in nominal terms.

In other words, you are not focusing on the other danger that lurks within the process. Johnny Carson (remember him?) had a few enlightening words in the early 1980’s during his Tonight Show.

He said: “Scientists have developed a powerful new weapon that destroys people but leaves buildings standing — it’s called the 17% interest rate.”

Yes, inflation.

We are not even close to the levels seen in the Great Inflation, but inflation has been rising on average at a rate of 3% since the 1920s.

Is 3% even a big deal? As a famous financial adviser (not to be named) often states, if you expect to require $50,000 a year to cover your annual living expenses, then in 30 year’s time, you will need around $120,000 just to have the same purchasing power as you did 30 years prior.

In other words, your $50,000 expense now will be equivalent to a $120,000 expense thirty years from now. That’s inflation progressing at only a 3% rate!

So, yes, it’s a big deal.

And when inflation hits, when the next financial meltdown takes place if you happen to be in debt like many Americans, then no amount of compound interest can save you.

Currently, the average interest rate payments you receive from even high-yield savings accounts in the US is practically worthless. It’s nothing.

Perhaps you are inspired by the stories of people holding meager jobs and investing in a company, collecting and reinvesting dividends to make millions at the end of their lives (like the janitor who invested in Exxon in the 1950s and compounded that savings to around $90 Million).

These stories are true and they do happen. But they don’t happen to the majority of hard-working Americans who invest their money.

To be clear, inflation will always rise faster than money sitting in a savings account. You cannot just save your way to wealth.

Another thing to be cognizant about is that you cannot reinvest your way to wealth. Warren Buffet reinvested his way to wealth, but he also charged fees to those whose money he managed initially. He got a booster, in other words.

So by itself, compounding may not be sufficient. Compound interest is good, but it’s not an adequate solution. And if you rely on it, it would be like chasing the end of the rainbow to find the pot of gold. You won’t find either.

Warren Buffett has two investment rules that have become very famous:

  • Rule 1: Never lose money.
  • Rule 2: Never forget Rule 1.

This is a defensive rule. Don’t lose money.

Let’s take this a step further. Losing money can mean “losing money” in the markets, perhaps the most common interpretation of these rules.

But losing money also means losing your money’s purchasing power. That’s what inflation does.

Here’s something to think about:

From 1972 to 2018:

  • The US Dollar’s purchasing power declined by 84%, while...
  • Gold’s purchasing power increased by 394%!

Holding a diversified portfolio of stocks, bonds, and cash may help you generate compound growth. It’s actually a smart thing to do in the long run.

But there’s only one asset class that can preserve the capital you earn through your stocks, bonds, and cash. And that asset class is precious metals. Gold and silver.

Gold and silver is the defensive anti-inflation play that preserves your purchasing power. Since 1972, gold’s purchasing power increased by 394%, while the dollar fell by 84% due to inflation.

Compound interest alone is a half-truth and a half-lie. But with gold and silver in the picture--to protect compounded dollar-based growth--both metals complete this idea, making compounded growth whole, more sound, in other words, a truth you can trust and rely on.

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All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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