Investment Choices: Part 1, Interest

I'll have you all know that this is one of the first posts that I set out to write.  It's been shelved time and time again, for the simple reason that I haven't been able to figure out how to introduce the topic.

There are two ways to get money: earn it by working for it; or earn it by using it to make more of it.  Investment is the second one.

If money were rabbits, investment would be easy.

That's pretty broad statement, and basically means that everything could be an investment.

My plan, the plan that I'd been working on for months, was to define and describe all of the different investment mechanisms that I could think of.  A quick search of the internet revealed that other people already wrote definitions of investment mechanisms.  You can find a few choice examples here, here and here.  

Giving financial definitions isn't really my specialty, anyways.  I'm better at stories.  Today I will tell you a story about interest.

***

My mom had a limited patience for picture books, particularly if she had to read them.  

"One fish, two fish, red fish, f*** this."

As a result, by the time I was 7 or so, bedtime stories for me and my older sister involved a wide selection of books that an adult could find interesting.  We read the entire collection of Calvin and Hobbes, we read Beverly Cleary, we read For Better or For Worse.  On one notable occasion, we read "A Wrinkle in Time" by Madeline L'Engle and I understood none of it.

“Qui plussait, plus se tait. French, you know. The more a man knows, the less he talks.” 

“You mean you're comparing our lives to a sonnet? A strict form, but freedom within it? Yes. Mrs. Whatsit said. You're given the form, but you have to write the sonnet yourself. What you say is completely up to you.” 

My mom, my sister and I could all agree on the Little House Series, by Laura Ingalls Wilder.  It is a curious thing as a kid imagining that people older than you might have ever been kids themselves.

Maybe.  But probably they only saw in black and white.

'Farmer Boy' is a book about Laura Ingalls-Wilder's husband's childhood.  Reading it, it's hard to miss that money is a theme.

Take for example this description of Almanzo's father:

"Almanzo's father was an important man.  He had a good farm.  He drove the best horses in that country.  His word was as good as his bond, and every year he put money in the bank."

"He was a man of the soil, if by soil you mean money."

Later in the book, Almanzo receives a $200 reward for finding and returning some really rich guy's wallet.

Pictured: the rich guy (left) willingly giving a reward to kind young Almanzo.

Almanzo's father takes 9-year-old Almanzo to the bank to deposit the $200, whereupon he spends a few paragraphs rhapsodizing on the wonders of the interest that Almanzo will earn on this investment. 

"Because you'll have $200 in the bank, they'll pay you interest each year.  At 5%, that's $10 in the first year."

"In the second year, that's $10.50."

"...and after 10 years, supposing the interest rate stays the same and that you don't deposit anything further, you'll have $325.77!"

The book is very specific; but alas, I don't own the book anymore and the internet isn't giving me the answers that I need.  Let's say he earned 5% (based on this source)

At 11, I wondered how much money Almanzo could have expected to earn on his investment in the long term.  I pulled out my calculator and started multiplying.  I wanted to know when his investment would double. 

There are two ways to calculate interest, depending on whether the interest is simple and compounding.

Simple interest uses simple math:

Compounding interest uses complicated math:

This isn't how I did my calculations when I was 9.  One physics degree later, I have a few more tools in the mathematical tool kit.

Using either calculation, young Almanzo would have needed to wait for decades to turn his money into anything approaching a retirement fund.  


After my analysis, I was left wondering if interest was a good way to earn money in the long term.  I decided then--and in this era of sub 1% interest rates am even more convinced--that leaving money in a bank account is not a good investment.