The Myth Of
Compound Interest
A Basic Lesson
In Financial Repression

Dateline: 14 December 2014

You’ve probably heard of the miracle of compound interest. It has gotten a lot of attention over the generations. I myself have pondered and marveled at how consistently saving a little, on a regular basis, over a long period of time, coupled with compounded interest, can make a person rich in later years. I’ve even expounded about this fundamental investment advice to my children, hoping they would grasp the wisdom of delayed gratification and disciplined saving.

But I must admit that I’ve always had a niggling feeling about the miracle of compound interest.  Is it truly a valid (or even desirable) approach to attaining wealth? 

Maybe some day I will discuss the desirability (or ethics) of seeking to pursue wealth by usury, but not today. In this little  blog post I’d like to address the validity of the miracle of compound interest. That is to say, does this so-called miracle really have a sound basis in fact? After giving this subject some serious thought,  I submit to you that it does not.

Theoretically speaking, it’s entirely possible to make a lot of money with compound interest. And it may be that there have been periods of time throughout history when the miracle of compound interest actually worked as the experts say it will. But I can assure you it has not been a logical or wise investment strategy for a very long time in this country. 

Furthermore, within the emerging new economic realities that we are all facing, the miracle of compound interest is a complete and total myth. As such, it is one of the worst bits of investment advice that you can follow.

Compound interest can not make anyone wealthy these days, and it has not made anyone rich in the last hundred years or so. This is the case because for the last hundred years we have experienced continual inflation, and inflation destroys the miracle of compound interest. Worse than that, inflation typically results in a negative real interest rate, which amounts to a compounded financial loss. This is known as financial repression.

For example, according to This US Inflation Calculator (as seen in the screen shot below), $20 in 1914 had the equivalent buying power of $474.87 dollars today. And the inflation calculator tells us that is a 2,274.3% rate of inflation.

In order for the miracle of compound interest to bear fruit in that hundred years, the interest earned on saved money would have to be more than the rate of inflation. There may have been periods of time when that was the case, but I don’t think it was the case very often or for very long.

The reality of compounded financial loss can be illustrated very easily by looking at today’s interest and inflation numbers. Let’s say you have $10,000 dollars in your savings account. It is probably earning less than 1% interest. To make this example easy, we’ll be generous and say you’re earning a full 1% on your money.

Now we’ll figure in the current inflation rate. These days our government tells us that the inflation rate is around 2% and that it has been around 2% for several years. But the government lies. As I’m sure you know, our government can’t be trusted to provide us with true financial numbers. By lying and deceiving us about these things, our government cheats and steals and mismanages even more of our money.

In a recent interview, John Williams of ShadowStats, says that the true inflation rate is between 5% and 9%. I heard another independent financial analyst say that he thought the inflation rate was around 6%. Suffice it to say that inflation has has been much more than 2% for many years. Let’s go ahead and assume that 6% is the number....

If the inflation rate is 6% and you are earning 1% on your savings, then you are losing 5% a year. Very few people see or fully understand that they are losing money because their bank account doesn’t show a loss. Here’s what I mean...

If you earn 1% simple interest, compounded annually, on your $10,000 savings, you savings account would show the following gains...

Year 1:  $10,000.00 x 1% interest = $100.00      
Total savings = $10,100.00

Year 2:   $10,100.00 x 1% interest = $101.00      
Total savings = $10,201.00

Year 3:   $10,201.00 x 1% interest = $102.01     
Total savings = $10,303.01

Year 4:   $10,303.01 x 1% interest = $103.03      
Total savings = $10,406.04

Year 5:   $10,406.04 x 1% interest = $104.06    
Total savings = $10,510.10

Year 6:   $10,510.10 x 1% interest = $105.10      
Total savings = $10,615.20

Year 7:   $10,615.20 x 1% interest = $106.15     
Total savings = $10,721.35

Year 8:   $10,721.35 x 1% interest = $107.21    
Total savings = $10,828.56

Year 9:   $10,828.56 x 1% interest = $108.29    
Total savings = $10,936.85

Year 10:  $10,936.85 x 1% interest = $109.37     
Total savings = $11,046.22

Thus we see that after ten years of 1% interest, an investment of $10,000 will earn $1,046.22 in interest. HOWEVER, the reality of the situation is that, even though the $10,000 has grown by 1% a year, and it shows an increase in money in the account, the purchasing power (the true value) of the $10,000 has actually DECLINED by 5% a year (as I explained above). So let’s look at the same account, showing the true, compounded loss of 5% a year.

Year 1:   $10,000.00 x 5% inflation loss = $500.00
Total purchasing value = $9,500.00

Year 2:    $ 9,500.00 x 5% inflation loss =  $475.00
Total purchasing value = $9,025.00

Year 3:    $ 9,025.00 x 5% inflation loss =  $451.25
Total purchasing value = $8,573.75

Year 4:    $ 8,573.75 x 5% inflation loss =  $428.69
Total purchasing value = $8,145.06

Year 5:    $ 8,145.06 x 5% inflation loss = $407.25
Total purchasing value = $7,737.81

Year 6:    $ 7,737.81 x 5% inflation loss = $386.89
Total purchasing value = $7,350.92

Year 7:    $ 7,350.92 x 5% inflation loss = $367.55
Total purchasing value = $6,983.37

Year 8:    $6,983.37 x 5% inflation loss = $349.17
Total purchasing value = $6,634.20

Year 9:    $ 6,634.20 x 5% inflation loss = $331.71
Total purchasing value = $6,302.49

Year 10:  $ 6,302.49 x 5% inflation loss = $315.12
Total purchasing value = $5,987.37

As you can clearly see, when we look at what is actually happening to the value of the $10,000 savings account over ten years, with a 1% interest rate, and a 6% inflation rate, there is no net gain in value at all.

The owner of the savings account may look at the total of his account and think the value of his $10,000 increased by $1,046.22, but it actually declined in value by $4,012.63.

That is a significant loss. Almost half of the investment has been lost. If that person worked, scrimped, sacrificed and saved $100,000 (instead of the $10,000 example) for their retirement years, their money would have lost $40,126.30 in purchasing power.

This little mathematical exercise reveals the wickedness of inflation. Some people refer to inflation as a ‘hidden tax,” but it is not a tax. It is government sanctioned, premeditated theft. 

Knowing this, the question arises. What can a person do to preserve the value of his hard-earned savings? That is a difficult question that I think about quite a bit. There are no easy answers that I know of. But I may try to offer some suggestions in the future. If you have any solutions, feel free to share them in the comments below.


Herrick Kimball said...

My thanks to Jon S. in Indiana who pointed out a mistake in my math shortly after I posted this blog. I have made the correction.

Jon also says ...

"One other piece of math in support of your post is that in a traditional savings account, we must pay income tax on each year's earnings, so that 1% interest will actually result in about .75% interest available to compound next year."

Good point. Financial repression is a harsh reality.

Anonymous said...

I have been thinking a lot about the same subject lately: how can we not lose the value of our meager savings. And have come up with a few ideas. Hope to see more posted by other folks. One is to buy whatever I need in bulk when it is priced right. Stocking up at today's prices will most likely save a lot on future needs. Must be NEEDS tho, not an excuse to just go buy "stuff." Prepay or pay cash whenever there is an incentive to do that, like the dentist gives 5% off for cash. I would like to do a few improvements around our place that would save us $$. Another possibility is to buy a cheap rental house with my little savings. The rent payment will make my house payment. Will be putting the $$$ to work instead of just sitting in the bank waiting for the banksters to take it or the govt. to inflate it away.

Leigh said...

Excellent post. Very well explained, I reckon this is why Dan and I invest everything in our homestead.

Anonymous said...

The #1 problem in inculcating a true biblical worldview (to include sound money & usury) is the failure of leadership of Christian churches.

Modern "church leaders" have embraced a pre or amillennial woldview which largely ignores the Old Testament law and Genesis dominion mandate. Instead, they have proclaimed an emotional equalitarianism and dualism (matter bad, spirit good) which unsurprisingly retain little power for correction, reproof, or instruction in righteousness.

They oft misquote 1Tim6:10, "For the love of money is the root of all evil: which while some coveted after, they have erred from the faith, and pierced themselves through with many sorrows.", by stating that money itself is evil.

Pastors need to point out the truth of Deuteronomy Chapter 28 (blessings and curses for obedience or disobedience of the biblical law) and that the Lord who reigns NOW in unspeakable glory chose to describe the blessings in 14 verses and the curses in 54 verses (when is the last time your pastor preached on Deut 28?)

Some ways to isolate extra funds from the ravages of rampant inflation due to an abrogation of Proverbs 11:1:


1) Financial support of godly church leadership
2) Creation of a hard money inheritance for your children (and children's children if God blesses your obedience like Job)
3) Support of the poor, widowed, and stranger that they may glorify God
4) Ammunition and guns
5) First aid supplies
6) Livestock & equipment
7) Long term food storage
8) Land (in proportion to the taxes levied on it)

Mrs. G said...

My husband always advises people to invest in tangible goods and avoid 401Ks like the plague. It takes some convincing, but once the light dawns in their understanding most people don't look back.

Anonymous said...

In addition to the fine list posted by Anonymous which started with ELIMINATE DEBT, I would add LEARN SKILLS. Learn to repair a car and save a TON on labor charges. Learn to garden and grow your own food and save a TON on the cost of groceries. Learn to build your own house and you save enough to buy a larger piece of land to build it on (which can aid you in growing more of your own food.) An added benefit of gaining real skills is their barter and income value. Any of these skills are in demand and can be additional income streams. Additional income streams can help overcome inflation loss.

Patrick K said...

Another insightful post, Mr. Kimball.

A couple things to add to your comments. Whenever someone is trying to sell you on the value of compound interest, they always use mathematical examples that are 'generous' or overly optimistic. Also as you pointed out, compounding can go in the other direction. Taxes on investments and the fees on your 401K (which are legalized robbery) gouge out huge chunks of your savings and investments.

I just started reading Tony Robbins' new book on money called 'Money:Master The Game' In it he does the math on how just a 1%-2% increase in the fees on your 401K or your investment accounts will cost you literally hundreds of thousands of dollars over your career, and how brokerage companies legally hide the real level of fees on their 'investment products.'

tannachtonfarm said...

oh my goodness, you guys are making this WAY too hard. if you don't earn money or invest wisely, the guvment will give you money. problem solved. ;-). The only point i might haggle with anonymous is that it may not be the 'church's' fault or responsibility. Most people can read, but very few can understand the Scriptures. They simply believe what others tell them. (i was that way at one time, too). Good information, thanks for posting and for the comments. Now, i'll just go buy more cows.

RonC said...

We're putting all our savings into an old farmhouse and 10 acres of land so we can sell the house we are in and get out of debt. Definitely doesn't pay to save anymore. We're working so as to keep continuous compounding from working AGAINST us.

I also agree with learning skills every opportunity you have. I would hate to have to depend on learning gardening, canning, and livestock in a do-or-die situation. That's too much to learn and too much equipment to acquire all at once.

PioneerPreppy said...

Quite frankly there isn't any real way t protect your wealth at this time as long as you value it in dollars.

Real Property runs the risk of rising property taxes as does other chattel and tangibles depending on your current location. This risk has become reality in several locations as well so it isn't just a risk.

Precious metal markets are completely detached from reality with prices pushed down artificially.

As long as you look at things in a dollar value nothing in the system is going to retain its value. The only hope you have is limiting the rate of decrease until the entire system shuts down. This in fact is the hardest time of surviving the collapse. The time of wealth destruction. If you can manage to hold on longer than whatever percentage it takes to topple the system you win.

Anonymous said...

I think you noted the math error but 1% of $10,000 is $100 per year but the theory still holds even with the error. If the inflation rate is higher than the interest rate you are loosing money.

Herrick Kimball said...

Hmmm. You're right. My math is incorrect in both examples.I multiplied by .001, not .01. A decimal point can make a big difference. I'll have to refigure the numbers and make a correction. Thank you!

Herrick Kimball said...

Okay. I have refigured and posted the new numbers. The example is much more dramatic!. Nearly half the value of the investment of $10,000 is lost after 5 years of 5% inflation loss.

Thank you again for pointing out my math error. If someone wants to double check my calculations (I refigured pretty quickly), please do so. I'll correct this again if need be.

Anonymous said...

Finally, there seem to be but three Ways for a Nation to acquire Wealth. The first is by War as the Romans did in plundering their conquered Neighbours. This is Robbery. The second by Commerce which is generally Cheating. The third by Agriculture the only honest Way; wherein Man receives a real Increase of the Seed thrown into the Ground, in a kind of continual Miracle wrought by the Hand of God in his favour, as a Reward for his innocent Life, and virtuous Industry.

Benjamin Franklin, Positions to be Examined, April 4, 1769

Provided by Mike Snow

Herrick Kimball said...

Great quote. I put that in my book, "Writings of a Deliberate Agrarian" (page 82). Thanks for posting it here.

Jonathan Sanders said...

The inflation calculator link is interesting. You can learn how inflation is an average, not an across-the-board value. In my lifetime, minimum wage and the price of gasoline track pretty closely with the calculator. However, college tuition at a state university is not even close. Things like that get masked over by the Chinese labor market that has given us a false sense of prosperity. I paid $325 for a 13" TV in 1981 - you could buy something like that for less than $100 today.
The other thing that intrigues me is that from 1914 to today, silver prices fit closely (.65 to $15.50(actual is about $17)). Gold was fixed at $20/oz in 1914, but is nearly $1200 today...

Herrick Kimball said...

I have that inflation calculator bookmarked and go there often to plug in various prices and dates. It provides financial perspective that many people don't fully understand.

Herrick Kimball said...

Thank you to everyone who has commented here on this blog post. I've thoroughly enjoyed your perspectives and your comments have added a LOT of good information to the discussion!

Anonymous said...

Proverbs 19:17 He that hath pity upon the poor lendeth unto the LORD; and that which he hath given will he pay him again.

emmer said...

an easy way to calculate "earnings" on savings is using the "rule of 72" divide your interest rate into 72 to get the number of years until that lump of $$$ is doubled. it's easy, so it gives you a sort of "red flag" to notice when you make a decimal point error. ex,if you are getting 2%, and your math show you double you money in 20 years, you def have an "oops", as that ought to take 35 years.

Sanity Claus said...

Sorry Herrick, you're all wet, the arguments you make are nonsensical. To say that compound interest does not work anymore is like saying that the law of gravity has been suspended.

The mathematics of compound interest merely state what happens to money when left to grow at a particular interest rate. One dollar at 6% will double in 12 years. I don't know about you, but if my father had put $10,000 into a stock account for me when I was born 55 years ago and left it to compound untouched until today, it would be worth 1,385,913 dollars. That seems pretty magical to me. I would take it.

If you're saying that investment rates are less than the rate of inflation. Well that is true depending on how informed you are. There are currently plenty of investments that safely yield 4,5,6 per cent or more. But, yes, it is true that money market accounts are not paying much these days.

You wrote: ," $20 in 1914 had the equivalent buying power of $474.87 dollars today. And the inflation calculator tells us that is a 2,274.3% rate of inflation."

This is totally INCORRECT 2,274 is the cumulative rate of inflation- which is absolutely not the annual rate of inflation. The annual inflation rate for the last 90 years, if this information is correct (which I doubt) is a reasonable 3.52%. Which is not far from the current OFFICIAL rate of inflation the government puts out of 1.32% annually. You can choose to believe some guy telling you that it is really 6% if you want, but I prefer to deal with facts not ideological stupidity.

So, let's see, based on your numbers:

$20 item would cost $478.87 today 90 years later
$20 invested in 1914 in the Dow jones Industrial Average and compounding at the average annual rate of 9% equals $63,927.72 in todays dollars. You be the judge whether compounding beats inflation.

Herrick Kimball said...


I'm familiar with that rule, and it surely works. But it would be interesting to know if there is a formula that takes financial repression into effect, showing, for example, how long it takes to lose half the buying power of your investment when, as a result of inflation, your interest rate is, essentially, in the negative numbers. In other words, you are earning more money in your account, but it is buying less as a result of inflation.

Herrick Kimball said...

Sanity Claus,

I never said that compound interest does not work.

What I was trying to communicate in this essay (and apparently did not communicate very well) is that when inflation is high and interest rates are low, money invested in an interest-bearing account does not gain in buying power. It actually loses buying power.

A person can think they are earning money (interest) because their account will show that they earned money (interest), but their money is not gaining more buying power. It is losing buying power.

Has this always been the case in history? No. Has it been the case in recent years and today. Yes. Will it be the case in future years? I don’t know.

If you can find an investment that pays sufficient interest to beat inflation, you can come out ahead. But this has not been happening for the average person for some time. And many retirees, on fixed incomes, who thought they would have enough in retirement to live comfortably, can attest to this.

In other words, the numbers lie. They may tell you that you are earning interest and getting ahead, but if you are losing buying power, you haven’t gained anything. You have lost. Financial repression is so subtle and devious at taking money from the masses, that few people understand the concept.... and they tell those who do that they are all wet.

Thanks for the comment.