Imagine a parent today who wants to teach her kids the Old School virtue of saving. She might be interested in this ad, which appears on the website of a local bank:
Good financial habits last a lifetime, especially when they start early in life. Minor Savings provides a great opportunity for young people to learn the value of interest as a reward for saving. Open a Minor Savings account for your child today – with no minimum deposit and interest on all funds above $0 – and watch their financial know-how grow with their money!
The Miracle of Compound Interest
The bank even provides a nifty financial calculator so that she can show her kids how their savings will grow over time. This will come in handy. There’s no record of any five -year-old who actually wanted his birthday money swapped for a savings deposit, but this calculator will show the reluctant little saver just how much he will be able to spend in the future. The miracle of compound interest is about to be revealed.
What interest rate should Mom use for her calculation? Well, the “Rates” page of the website shows that the current rate on a basic savings account is 0.02%. Is that supposed to be 2%? No? It’s 0.02%. That’s . . . let’s see – two hundredths of one percent.
Ah well, let’s put that in the calculator and see how it grows over time. Even seemingly small additions grow enormously over time. The kids will be amazed when they see this.
OK, Junior is five years old. Let’s be dramatic. Let’s see how much $100 will grow to be when he’s old enough to go to college in thirteen years. At 0.02% for 13 years, the calculator shows that $100 grows to be . . . $100. That can’t be right. Let’s try that again. What?! It’s really $100? OK, they must be rounding to the nearest dollar, but the total should be bigger, shouldn’t it?
Wait . . . what?
Well, let’s see what it will be in 17 years, maybe after college, when it will be nice to have some extra money to pay back student loans. So, 0.02% interest rate for 17 years will total . . . $100? That can’t be right. Let’s make sure the calculator is really working. Let’s try some other numbers, maybe 2%. Yes, that result seems more reasonable. But that means the calculator really is working.
Uh . . . well, how long will it take to make one whole dollar on a $100 deposit at a rate of 0.02%? Let’s try 20 years . . . No. How about 22? . . . 24? No and no. Really, does this calculator not work? I’ll try one more . . . 25 years. That’s it! It takes 25 years to make one dollar of interest.
And that’s not even a dollar that has the purchasing power of a dollar today. Inflation is running at 1 or 2% now, well above the 0.02% rate on the savings account.
What happened to the miracle of compound interest? What happened to that old story that said if the Indians who sold Manhattan Island to the Dutch had invested the trinkets they got at a rate of 5% for a few hundred years, they’d have enough money to pay the national debt or something?
I’m From the Government, and I’m Here to Help
Well, that was then and this is now. Government policymakers of all stripes have had their way, and 5% is not the going rate for a savings account.
Did policymakers know that super-low interest rates would teach kids that saving is an absurd thing to do?
You might want to label this an unintended consequence of the low-rate policy, but it’s not, really. Sure, no one is targeting the saving behavior of children, but policymakers do have the objective of discouraging savings by the public and encouraging spending. They think such manipulation will help the economy grow.
This policy will eventually fail and be abandoned. There’s a reason that parents through the ages have taught their children that saving – not spending – is a virtue. The future is uncertain. It’s not going to be made less uncertain by manipulation. “Save for a rainy day,” an old expression that isn’t heard much these days, will make a comeback.
Barry Dunaway, CFA®
Executive Vice President & Director of Research
America First Investment Advisors, LLC
This post expresses the views of the author as of the date of publication. America First Investment Advisors has no obligation to update the information in it. Be aware that past performance is no indication of future performance, and that wherever there is the potential for profit there is also the possibility of loss.