July 17, 2008

The Magic of Compounding

IN THE DEAD OF WINTER in 1921, The New York Times published a fascinating article that looked deep into the history of the city of Philadelphia. It did not look at monuments or administrations or public officials, but rather the links "between the present city of the quick and the old city of the dead." Specifically, it looked at the bequests which prominent Philadelphians had given to the city over the centuries, and found what had happened to them over time. The headline sums it up well:

Unforeseen Future Has Made It Impossible
to Comply With Wills of Early Philanthropists

As it happened, Benjamin Franklin had set aside a good sum of money (£1,000) to loan to young married artisans, mechanics and other craftsmen who had served as apprentices in the city, but in the early 20th century his money was idle. The practice of apprenticeship had long died out, and the interest rates set forth in Dr Franklin's will were no longer the attraction they once had been.

But Dr Franklin was not the first to do such a thing, as the Times relates, nor was he the only one to guess wrong. In 1739, the will of William Carter declared that an annual rent of £6 -- which would be paid for through hiring out his indentured servant, Nathan Stanbury -- would be used to buy "a dole of good bread for ye said poor people" twice a year. (By 1919 the trustees of Mr Carter's bequest had grown the money to $1,574, and apparently were still buying bread). In 1802, John Bleakly left £1,000 to help the poor who had been quarantined in hospital after contracting yellow fever; by 1921, effective treatments against the pestilence had been devised, and in 1937 a vaccine to eradicate it had been developed.

Despite the headaches and unforeseen circumstances -- which I do think could be worked around from the get-go with a bit of elasticity in the writing -- this is a really cool idea. Take some money, set it aside, use half the proceeds for relief and half to grow the bequest. Franklin's bequest, before it was distributed per his will, eventually grew into the millions; it is not inconceivable to think that future small bequests could grow into the billions given enough time.

True, there may be hiccups along the way. Recall Woody Allen's movie "Sleeper," in which Mr Allen's character wakes up in the far future and realizes, "I bought Polaroid at seven! It's probably up millions by now!" Sadly, of course, Polaroid got its ticket punched back in 2001. But if one could avoid the pitfalls of war, terror, plague, famine, inflation, stagflation and myriad other disasters, the results could be outstanding. I once heard a finance writer say that if one penny from AD 1 had been invested and compounded over time, the net proceeds would today be worth something like two trillion dollars. That is not a bad goal to have, even if one starts small.

Posted by Benjamin Kepple at July 17, 2008 08:14 PM | TrackBack
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