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Thursday, September 22, 2016

The miracle of compound interest

A lot of slightly educated people believe technology alone has made the modern world. The truth, as always, is considerably more complex. Four other factors have played a major role: ideology (think, for instance, of democracy and socialism – as society changing powers, they are hardly three centuries old), organization (think factory system and corporate structures, which divided risk, vastly increased and standardized production scales, and put millions into regimented employment), advertizing (hundreds of millions are simultaneously, daily, constantly told what to buy, from soap to processed food to education to healthcare to entertainment, lifelong, until they quite forget what it means to make independent choices) and the miracle of compound interest.

Few middle class people from non-business families really understand the power of sustained saving. Here’s a sample of what it can do for you. At 8% annual rate of interest (that’s roughly what you get at present from the PPF, income-tax free), compounded quarterly, you get Rs. 52,485 on an initial deposit of Rs. 1,000 after 50 years. Check out the figures for yourself here. Imagine, now, you are depositing Rs. 1,000 – yes, just 1,000 – every month for fifty years, and I leave it to you to figure out the kind of money you will have at the end of that time. A serious saver will put aside much more than a mere Rs. 1,000 rupees a month. And other kinds of savings are far more profitable. The BSE Sensex has grown 280 times since its inception in 1980. Which means that someone who invested Rs.100,000 in it at start has Rs. 28 million now.

Of course, interest rates will not always be 8%, and they might be compounded half-yearly, or even yearly, in which case the yields will be considerably less. On the other hand, there are times when yields are much higher – in the 1980s, when I started saving in a very small way, the Indian banks were offering interest as high as 14% on long term fixed deposits. Admittedly, that was a very special period; interest rates have never again been so high anywhere in the last 250-odd years. In fact, during the time when many people got seriously rich by saving and investing – say, the merchants in Europe during the early middle ages, or when the British-Indian government was raising funds to build the railways – the long-term interest rate on ‘safe’ investments ranged between 3 and 5 per cent. But that didn’t stop long-term savers from getting rich.

Why did relatively so few people get rich over time, then? Well, partly because too few of them ever had anything to save – historically, 90%-plus of populations lived from hand to mouth – and partly because of those who did, only a tiny fraction ever bothered to save in a sustained, long-term manner (that is just as true today as it ever was!), and some were unfortunate enough to have their lifetime savings washed away by accidental disasters, such as disease and war and hyperinflation. The key is time and diligence. Very few people with the ability to save do save month after month, year after year, for entire lifetimes, especially knowing that with humble beginnings, that process has to carry on for several generations for families to get seriously rich. But that does not change the fact that, apart from those who strike gold, only long-term savers get rich. These days, for obvious reasons, people are fascinated by the stories of those who became wealthy almost overnight, the sports celebrity- and Rowling and Zuckerberg types, but the fact is most of the richest folks in the world are those who ancestors have been saving assiduously for centuries. What fascinates me is the story of the Medicis, Fuggers and Rothschilds, or the Indian Chettiars in the south who financed Rajendra Chola’s expeditions to Sri Lanka more than a thousand years ago, or the great Jain seth who hedged his bets by lending to both Rana Sanga and Babur before the battle of Khanwa. Their descendants are still among the richest people on the planet, though, unlike the insecure and attention-hungry nouveau riche, they avoid hogging the headlines. Such men can truly paraphrase the poet and say ‘Kings may come and PMs may go, but we go on forever!’ And it’s all due to the miracle of patience harnessed to compound interest. Ask the Marwari community elders. Of course, looking at the way their descendants are burning money now, it’s a safe bet that many of them will be out on the streets pretty soon. There are laws of history that you defy only at your peril. You can do your own research on this.

So it frightens me to think that economic basics are going awry in a historically-unique way all over the world. And as with almost everything else that is bad, it’s America that has shown the way. Interest rates have dived so far that in some countries the banks not only don’t give you any interest at all on savings, they actually charge a negative interest on it, meaning you are penalized for saving. Simultaneously the credit card economy has led millions of not-too-well-off people to live far beyond their means, saddling individuals as well as whole nations with such enormous debt burdens that no one knows how it will ever be repaid. The motto seems to be ‘sacrifice the future for the sake of today’ – carpe diem pushed to a monstrous extreme. It reminds me of a horror story written, if I remember correctly, by Isaac Asimov, about a man who borrows so much that he has exhausted his credit limit, but he is so addicted to living the high life that he cannot stop splurging, and the bank persuades him to carry on, provided he signs off his son’s future too: the son will be born with an inherited debt burden, and spend perhaps his whole life trying to pay it back. That’s the story of bonded labour all over again, and repeating itself in a highly ‘advanced’ society! The long term implications are mind-boggling, and not just at the individual level. With China buying up trillions of dollars of U.S. debt, there may soon come a time when the Chinese own a significant enough portion of the American economy for major political decisions on behalf of Americans to be taken not in Washington D.C. any more but from Beijing. It will then probably be the first bloodless conquest of a major nation in history since Ashoka’s dharmavijaya of Asia began…

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