# The Magic of Compound Interest

March 6, 2013

To be sure, when compound interest works in your favor, it is a blessing. When it works against you, it’s a curse!
-Jeffrey Saut, managing director, Raymond James

There was the King who held a chess tournament among the peasants and asked the winner what he wanted as his prize. The peasant, in apparent humility, asked only that a single kernel of wheat be placed for him on the first square of his chessboard, two kernels on the second, four on the third – and so forth. The King fell for it and had to import grain from Argentina for the next 700 years. Eighteen and a half trillion kernels, or enough, if each kernel is a quarter-inch long, to stretch to the sun and back 391,320 times. That was nothing more than one kernel’s compounding at 100% per square for 64 squares.

... The Money Angles, by Andrew Tobias

When compound interest works in your favor, it is a blessing. When it works against you, it’s a curse! That is a “Jeffreism” I learned the hard way back in the bear market of the early 1970s when I was working for a \$100 per week in this business and consequently had my credit cards levered to the “max.” The interest rate at the time was 18%. Now consider this from the same Money Angles book:

Say you borrowed \$1000 from a friend and paid it back at the rate of \$100 a month for a year. What rate of interest would that be? A lot of bright people will answer 20%. After all, you borrow \$1,000 and pay back \$1,200, so what else could it be? FORTY percent? No, MORE! If you’d had use of the full \$1,000 for a year, then \$200 would, indeed, have constituted 20% interest. But you had full use of it for only the first month, at the end of which you began paying it back. By the end of the 10th month, far from having use of the \$1,000, you no longer had the use of ANY money. So you were paying \$200 in the last 2 months of the year for the right to have used an average of \$550 for each of the first 10. That comes to a bit more than 41.25% effective rate of interest. (Trust me).”