COMPOUNDING THE SOLUTION
MOORE, STEPHEN
COMPOUNDING THE SOLUTION by Stephen Moore ALBERT EINSTEIN IS PURPORTED to have once remarked that the most powerful force in the universe is compound interest. My favorite example of the power of...
...he asks in perplexity...
...There I found basically the same conclusion...
...The incredible answer is $263,000...
...The tax code punishes us for thrift...
...If starting in 1950 your father had put $1,000 every year into a stock fund paying an average rate of return, he would be very rich today...
...No, this is not a misprint...
...Stephen Moore is director of fiscal policy studies at the Cato Institute...
...of course, the power of compound interest is most relevant these days when it comes to managing our personal finances...
...but if they were in the 15 percent tax bracket, their nest egg shrinks to $973,000...
...It doesn't take a village to raise a family, but it may take a smarter tax code—one that taps the power of compound interest...
...Not surprisingly, IRA expansion plans are proliferating...
...What if they paid a combined federal and state income tax rate of 50 percent, as many Americans do today...
...It is entirely true that in the short term the stock market has all the volatility of Dennis Rodman's prickly personality...
...Taxes would have confiscated 89.9 percent of the return...
...IRAs and privatized Social Security accounts would allow Americans to save more and take more control of their own destinies and those of their families...
...he lost his head...
...The double and triple layers of taxation on saving imbedded in our income tax system claim up to 90 percent of the rewards from saving and investing...
...And that assumes he never saved an additional penny for the rest of his life...
...The clever inventor did not gain all the rice in China...
...Under a Roth IRA, you pay tax on the money when you place it in the account, but you never pay tax on the equity build-up in the fund or when you eventually take the money out...
...To verify whether that rate of return could possibly be right, I consulted Jeremy Siegel's indispensable bible on the financial markets, Stocks for the Long Run...
...Economists and political pundits in Washington sermonize that Americans should save more...
...When Tom Kelly, president of the Savers and Investors League, showed me the data (check out their spreadsheet for yourself at www.savers.org), I was in a state of disbelief...
...capital markets are about the most reliable, risk-free place to put your money other than under your mattress—and you're going to get a much nicer return with stocks...
...Then the nest egg would be not $1.85 million today but just $188,000...
...Let's say in 1997 at age 68 he retired...
...This is an ingenious backdoor strategy for privatizing these activities...
...The findings from Kelly and Siegel's research also blow some pretty impressive holes in many conventional myths about financial markets...
...These findings demonstrate why Social Security is such a terrible deal for workers...
...Presidential candidate Dan Quayle has proposed super IRAs, or "Freedom Accounts," in which the annual contribution limits would be raised to $10,000 per person...
...Siegel finds that there has never been a 40-year period in American history when the markets have deviated significantly from that long-term trend...
...We are rewarded for purchasing as many VCRs, Nintendos, cellular phones, and Sony entertainment centers as we can possibly stuff in our homes...
...The Quayle plan, for example, would allow workers to take funds out of IRAs to pay for education, health care, and, of course, retirement...
...Over the long run even minimal investments can accumulate into substantial wealth...
...to 1997 was virtually always 11 percent per annum...
...The best children's program that Washington could possibly devise is one that allows Americans to build up wealth for their own kids and grandkids...
...Psst, don't tell any liberals, but if Breaux had his way we would finally have the tax reformer's dream: a consumption tax...
...My favorite real life example is Theodore R. Johnson who, according to a recent Chicago Tribune profile, never made more than $14,000 a year working at United Parcel Service...
...Social Security's pay-as-you-go benefit structure—a scam in which the payroll tax money is spent on retirees virtually the same day it is collected from workers—robs Americans of the awesome power of compound interest...
...Recall that with no taxes applied, they now have $1.85 million...
...Why don't Americans save...
...The brief answer is: Why should we...
...From a mere $100 gift you could draw down that account upon retirement in the form of annual payments that would virtually match or even surpass what you can expect from social security...
...The most prevalent fallacy is that the stock market is a "risky" place to park your retirement funds—particularly if you are a low-income worker...
...if the trust fund earned the average rate of return of the stock market, how much money would you have today from that initial $100 investment...
...No, I'm not talking about the White House's brainstorm of a new means-tested entitlement program whereby the government deposits a free check in Americans' bank accounts each month...
...But he plowed every penny of savings he had back into UPS stock (he really should have diversified), and when he reached the age of 90 he shocked his relatives and friends by announcing that his net worth was a cool $70 million...
...The fallacy here emanates from a failure to distinguish between the short run and the long run...
...Siegel reports that, from the day the New York Stock Exchange opened its doors through the end of 1997, the average annual rate of return on stocks has been more than 10 percent...
...If Congress would allow taxpayers to build up more wealth in untaxed IRAs, Americans could be weaned from paternalistic government programs, like Social Security, Medicare, unemployment insurance, and student loans...
...And imagine that the principal and the interest had remained untouched for the next 70 years...
...But over the long run, say 25 years or more, the U.S...
...Who needs Social Security...
...There is no compounding effect from your Social Security payments, because there is no money actually being saved...
...The inventor replied that he wanted one grain of rice on the first square of the chess board, two grains on the second square, four on the third, and so on through the 64th square...
...Congress should build on the popularity and success of the Roth IRAs, begun last year...
...or consider this scenario: Back in 1950, when he was just starting out in life, assume your father had placed $1,000 in a mutual fund...
...In a New York Times article earlier this year, Lester Thurow of MIT thumped Americans on their knuckles with his ruler for having "negative savings rates in late 1998...
...Up until now we have forgotten about our friend, the IRS tax collector...
...There is a logical policy prescription: Universal Savings Accounts...
...Kelly found that regardless of "the mutual fund's volatility over time, a fund's total return from any start year (1930, 1950, 1970, etc...
...The unwitting emperor immediately agreed to the seemingly modest request...
...Let's go back to the example of your parents who conscientiously placed $1,000 a year in a mutual fund starting in 1950...
...But two to the 64th power is 18 million trillion grains of rice—more than enough to cover the entire surface of the earth...
...What we need is Congress to make tax-free Individual Retirement Accounts much more widely available to all Americans regardless of their incomes...
...The stock fund would be worth $1.85 million...
...My favorite example of the power of compounding effects was recounted recently by George Gilder: The emperor of China was so excited about the game of chess that he offered the inventor one wish...
...That $1,000 would have grown to $217,630...
...Now for the bad news...
...imagine for a moment that back in 1927 your grandparents had placed $100 in a trust fund for you...
...When liberal do-gooders tell low-income Americans that stocks are unsafe for building up wealth, they are perpetuating a pernicious lie that keeps poor people poor...
...Democratic senator John Breaux of Louisiana has a terrific bill that would allow unlimited tax free deposits in IRA accounts...
...Your parents could have a higher income just by living off the interest from this account than from their Social Security checks, and they could leave the entire $1.85 million to their children...
...Even at this lowest income tax rate, taxes would snatch 59 percent of the gain...
...Today, more than 25 million Americans have IRAs...
Vol. 4 • April 1999 • No. 29
