Rule #1 Finance Blog

With Investor Phil Town

Advice from J.D. Mullane’s Old Man: Compound Interest

I always feel like such a pathetic speaker when a good writer decides to rip me after an appearance!  J.D. Mullane, writing for a Philadelphia paper, wasn’t exactly overly impressed with me.  So, by way of apology, I wrote this to him :

Hi J.D.,

How did I miss getting out the message that compound interest is, indeed, and as your old man said, the key to great wealth?  I gotta do better.  I’m not sure what "investment wonkery and world class gobbledygook" is exactly, but it can’t be good and it sure wasn’t my intention.  Sorry, man.  I let you down and I regret it.  Let me try again here.

My old man taught me the same thing that your old man taught you compound interest and don’t be a sucker.  But 90% of retirees are either living below the poverty line or living off their kids and most of them learned what we learned, so something must be missing from the lesson.

The problem with "compound interest" as advice all by itself (and I assume that’s what you were offering up with the best of intentions) is how to get it high enough to make a difference.  I thought I pointed out that $50,000 is what the average baby boomer has to retire on and compounding that at 4% (the current 10 yr t-bill) will double it in 20 years — hardly enough to retire on in 2025 when a Ford Taurus is expected to cost double today’s prices.  So that isn’t going to work, is it J.D.?

How ’bout those mutual funds?  Remember the sideways stock market from 1905-1942?  1965-1983?  2000 – ?  Compounding at zero for 20 years like my old man isn’t going to cut it either.

So most people are stuck between a rock and a hard place: the "rock" being low long term bond rates and the "hard place" being a long sideways or down stock market.  And if whatever people were doing was working for them, they probably wouldn’t even show up to listen to me talk….  And LOTS of people are showing up.  From that we are gonna have to conclude that the idea of compounding all by itself, while both correct and critical, is, for Baby Boomers at least, not sufficient as investment advice to handle the problem. 

So here’s what I recommend:

  1. You can get a wonderful 18% per year rate of return just by eliminating credit card debt.  Start there.

  2. Invest in two key asset groups: real estate for long term appreciation and cash flow and stocks for high rate of return, cash flow and all-important liquidity

  3. Follow Rule #1 in both asset groups:  Don’t Lose Money … which means to invest to not lose money instead of investing to try to make money.

  4. Learn.  I’ll mentor you here.  Start by reading the books on the Rule #1 Recommended Reading list.  Read the posts here.  Read Buffett’s letters to investors at Berkshire Hathaway. 

I couldn’t agree more with your old man, J.D..  Compounding at high rates of return is Buffett’s secret weapon. I’m a Buffett student.  So get on my site, write me and I’ll help you follow your old man’s advice.

Phil