Comments on: Problems with Constant Compound Interest

By: Mark

Mark — Wed, 17 Jun 2009 05:46:04 +0000

Yep, my baby boy was born in 2007 and a baby girl in 2009. We are doubling our family size every two years. At this rate, there will be more people in our family in several decades than there are Chinese people today.

By: Mikey

Mikey — Thu, 04 Jun 2009 21:43:05 +0000

Perhaps more accurately, people don’t get the exponential function.

Retired professor Albert Bartlett has had interesting lectures regarding this topic for decades.

By: matt

matt — Thu, 04 Jun 2009 20:45:42 +0000

Adapting all of the constant rate models to use, for example, binomial or path dependent (Monte Carlo) models is that they (like the simplified models) rely on the accuracy (prescience) of the inputs. I haven’t seen any empiracle evidence to suggest that complex models are more accurate ex post than simple models. You’d need a crystal ball for that to happen, I think.

(Someone with statistical prowess should pick this up, as I suspect that studies in this area were largely passed over due to the computational intensity required that is only now becoming available).

I’m very interested to see where this is going.

By: Gary

Gary — Thu, 04 Jun 2009 18:49:21 +0000

Here’s another compounding example:

Our revenue as a country (aka GDP) has been growing around 4.5% per year over the last 40-50 years.

Government spending has grown about 8% per yer over the same period.

Supposedly learned people like Paul Krugman think the problem is that taxes are not rising fast enough. What tax rate would allow costs to rise almost twice as fast as revenue?

And for this sort of “analysis”, the guy won a Nobel Prize? (well, economics isn’t actually in Nobel’s will, but whatever)

People hear what they want to hear. Keynesian economics says the government should run surpluses in good times, and deficits in bad times — but in practice, Keynesian supporters run deficits all the time.

GDP oscillates, sometimes gaining and sometimes falling, but averaging 4.5%. Government spending rises by a very consistent 5% every year, no matter what the economy is doing.

So even though the “average” spending increase and “average” GDP increase are very similar — the geometric compound return of government spending grows much faster than GDP.

A portfolio that loses 10% and then gains 11% does not keep up with a portfolio that gains 1% both years.

California often leads the nation on many things… the out of control government spending is not isolated to just California. The next 10 years are going to be about the country living with less (within our means, and perhaps slightly below our means to pay off some debt). This will have profound implications on all the unfunded promises that politicians have made over the years

Never mind life insurance or stock portfolios… the mother of all portfolios — the US economy — is about to learn a hard lesson in compounding

By: Tom Fisher

Tom Fisher — Thu, 04 Jun 2009 12:03:39 +0000

It will be interesting to see where you go with this, David. It seems as though the problem is a consequence of the fact that we can’t know the future. We’d like to make a decision using a simple calculation, yet we know that such a calculation will likely give the wrong long-term answer. Monte Carlo modeling is one attempt to address this problem, but that has its own problems, and doesn’t give a “simple” answer, either.