Higher interest in bigger goalsLegendary American stock market investor Peter Lynch said that investors should have confidence in the power of compound interest. He used the example of the historical rumor that American Indians sold the island of Manhattan to Dutch settlers for $24 in 1626.
Many people thought that the natives who sold the land at a such cheap price must have been naive, but that could not be the case, according to Lynch’s calculation.
Let’s suppose that the natives deposited the sum in the bank at a compound interest of 8 percent per annum. Lynch calculated that it would have multiplied to $30 trillion by 1988. That number was about 500,000 times larger than the land price of the whole Manhattan area at the time, which was $56.2 million. If it was still in the bank earning interest this year, the sum of $24 would have multiplied to become $151 trillion.
Compound interest is interest that is added to the principal, and the interest that has been added also itself earns interest.
But it is a two-faced system. For a depositor, it is beneficial, but for a debtor who could not pay back the principal, the interest rate can be excessively high.
Albert Einstein is reported to have said that the strongest power did not emanate from a nuclear bomb, but from compound interest, and that compound interest is the greatest invention in history.
I am not sure he actually made such remarks, but his observation certainly more than sums up the power of compound interest.
No one doubts, though, that it is a difficult calculation to make, but rules for mental calculation exist. If you know the “Rule of 72,” you can calculate how long it takes for an investment to double at a given interest rate.
So, brace yourselves. To find out how long it will take for a sum of money to double at the rate of 6 percent per annum, you just divide 72 by six to get 12. This means it will take 12 years for a sum to double at this rate.
The Rule of 72 was conceived by an Italian mathematician called Luca Pacioli in the 15th century, but he presented the rule as a method of estimation of the doubling time without explaining the principle.
Therefore, it is assumed that the rule predates Pacioli by some time. It was later developed to the more precise “Rule of 69.3” with the development of mathematics.
But people still use Rule of 72 because it easily calculates an approximate value. The “Rule of 114” for estimating an investment’s tripling time and the “Rule of 144” for estimating quadrupling time are similar inventions.
Samsung Electronics announced on the occasion of its 40th anniversary that it will increase its total sales volume, which was $110.3 billion last year, to $400 billion by 2020.
It is approximately quadrupling sales volume in 12 years. At a glance, this doesn’t seem feasible, but it is attainable if the company increases its sales by 12 percent annually, according to the Rule of 144. And according to data on 500 of the world’s leading businesses published by Fortune magazine, there is a precedence of increasing sales volume by six times in 10 years.
It is necessary for everyone to set higher goals at times, and if we move ahead believing in the power of compound interest, it will not be as difficult as we have thought.
The writer is a deputy business news editor of the JoongAng Ilbo.
By Hoh Kui-seek