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The Magic of Compound Growth

When it comes to investments, nothing is more powerful than the magic of compound growth. In today’s world of incredibly low savings rates, it’s challenging to find investment options that provide any decent positive net returns after factoring in taxes, inflation, and bank or investment fees.

Low interest rate

Interest rates are close to ZERO.

Due to Quantitative Easing, Operation Twist, and numerous other financial bailouts and strategies to drive interest rates down to as close to ZERO as possible in recent years, investors today are beginning to spend more time researching investment opportunities in the real estate markets in order to generate some type of a positive net annual return.

Historically, real estate has generated 3% annual rates of returns over the past five or six decades. Yet, real estate values have plummeted significantly in many regions since the start of the Credit Crisis in the Summer of 2007.

In fact, residential and commercial property values in many areas of the country have fallen 30%, 40% or 50% + from their last market peak highs near 2006 to 2008.

Fortunately, home values have begun to increase rapidly in many prime U.S. regions thanks to a combination of near record low interest rates, a declining supply of available properties for sale, and more motivated investors in search of finding investments which offer positive net returns on their money.

In the “Old Days” When Banks Offered Positive Returns

Back in the late 1970s and early 1980s, double-digit savings account rates were common, especially back when the Prime Rate hit 21.5% in December 1980. Why risk money in stocks, bonds, real estate, commodities, or other forms of investment options when banks and many of the largest Savings and Loans were offering incredibly high annual rates?

These same high savings account rates were insured by the FDIC (Federal Deposit Insurance Corporation)  or by FSLIC (Federal Savings and Loan Insurance Corporation), which was established under “The National Housing Act of 1934.”

Tragically, FSLIC later went bust too after the insurance fund ran out of capital just like the FDIC did after bailing out Washington Mutual in September 2008. The government then bailed out the FDIC, which had previously bailed out FSLIC, Fannie Mae, Freddie Mac, and numerous banks, investment banks, and insurance companies as the financial implosion continued onward these past 5 or 6 years.

Yet, how many Americans were bailed out by the government? Besides near record low interest rates in recent years, what other ways have American citizens been financially assisted these past few years?

Or…do we need to try to bail out ourselves one way or another?

When Banks Go Bust, So Do the High Rates of Return

Sadly, approximately 747 potentially “fly by night” or unreliable Savings and Loans and many reputable and seemingly very creditworthy Savings and Loans collapsed in the mid ‘80s to early ‘90s. The failure of these 747 Savings and Loans of the approximate 3,200 Savings and Loans nationwide later led to the implosion of about 25% of all Savings and Loans nationwide.

A major reason why so many Savings and Loans failed was due to the actions of the Federal Reserve as the then Fed Chairman Paul Volker helped lead the way to increase interest rates significantly in order to allegedly “quash inflation.” Sadly for S & Ls, they typically made long-term fixed rate loans tied to short-term interest rates and money.

As rates increased, Savings and Loans could not continue to afford to pay their banking customers double digit rates of returns for their money, so many Savings and Loans failed.

When the S & Ls went bust, more money went back into the stocks markets and into real estate. If one really analyzes the rapid ascent of the Dow Jones index from lows near January 1986 (Dow Jones index near the 1,500 range) and the passage of the Tax Reform Act of 1986, which negatively impacted real estate and tax shelters, more investment capital then later flooded into the stock market.

Does the Soaring Stock Market Make Any Sense?

How does today’s 14,500+ Dow Jones index level make any sense to anyone who understands basic economic and investment formulas? Is it more of a case of too much money chasing the highest rates of returns rather than investors believing that the U.S. economy is on the verge of booming once again?

By comparison in 2013, doesn’t real estate seem like a safer investment option than the U.S. stock market?

It seems to me that more savvy investors are beginning to believe that real estate has both a better potential short and long-term investment future after seeing home appreciation rates varying between 6% and 20%+ in many regions of the country over just the past year.

The Rule of 72 + “Leverage”

The Rule of 72 is one of the simplest ways to calculate the potential future rates of appreciation for various types of investments such as real estate or stocks. The Rule of 72 is a banker’s rule that calculates the number of years it will take for a sum of money to double. You divide the number 72 by the annual percentage rate you are receiving or anticipate receiving on that sum of money.

For example, if you believe that home values will increase an average of 10% per year consistently over the next several years, then it will take 7.2 years (72 divided by 10 = 7.2) for that $100,000 home to double in value to a projected $200,000 home.

If I only invested 5% down ($5,000) to buy that same $100,000 home, and it doubles in value in just over seven years, then I have really leveraged my investment strategies in a very positive way, which is very challenging to do with most other types of investment options today. A potential increase of $100,000 in future equity off of an initial investment of a $5,000 down payment over a seven (7) year time period is not too shabby in any “boom or bust” economic cycle.

The Eighth Wonder of the World

Compound interest is such an amazing investment concept that it’s been called the Eighth Wonder of the World. The magic of compound interest can be best illustrated by answering this financial riddle:

If you take a penny and double it every day,  how much money will you have in a month?

Imagine compound with quarters instead of pennies

Imagine compounding quarters
instead of pennies!

Think about this for a minute. What’s your guess? What  has the doubling penny become after a 31-day month?

My friends and business associates usually guess a few thousand dollars or possibly even a few hundred thousand dollars. Yet, the same little almost worthless penny snowballs in the final week of the fictional month’s compound growth projection forecast to an amazing $10,700,000+ in compounded value.

If I give you a fictional penny for your thoughts, then will you turn those same thoughts into action by finding investments today which will make more money for you than for the banks or anyone else today?

As inflation continues to increase exponentially and seemingly “snowball” each and every single day, then what better asset class to benefit from high rates of inflation is there today than real estate?

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About the Author...

Check out Rick's new book The Credit Crisis: 10 Years and Counting (August 2017 publishing date) as well as The Credit Crisis Deals: Finding America's Best Real Estate Bargains.

Rick Tobin has a diversified background in both the Real Estate and Securities fields for the past 25+ years. He has held seven (7) different Real Estate and Securities brokerage licenses to date. He also writes college textbooks and real estate courses in several states for some of the largest educational firms nationwide.

Rick has an extensive background in the financing of residential and commercial properties around the U.S with debt, equity, and mezzanine money. His funding sources have included banks, life insurance companies, REITs (Real Estate Investment Trusts), Equity Funds, and foreign money sources.

You can visit Rick Tobin at RealLoans.com.

Comments

  1. Victor Taylor says:

    Excellent article. Please keep them coming. Thanks.

  2. Rick Tobin says:

    Thank you for the nice compliment, Victor. Best of luck to you with your real estate investments. I hope that you may later share with us your “magical” compound growth gains associated with your various investments. 🙂

  3. Bill H says:

    Have know about compund interest for years…more money has been made through compound interest than any other investment.

    Main reason I primarily invest in tax lien, make 15 to 18 percent per year and using the bankers rule of 72 my money will double about every four years.

    Risk, yes, there is nothing in life you can do that is totally risk free.

  4. Rick Tobin says:

    I like tax lien certificate investments too, Bill. The yields are quite high as you also noted as well. One of the biggest risks in life is not trying something new as opposed to trying and failing, from my perspective. If we fail, then it may be a great teaching experience for us. We may then make the necessary changes, and modify our investment or life strategies. 🙂

  5. Jessica Sala says:

    Great post! Thanks for all the information!

  6. Jim Ingersoll says:

    Nicely done Rick!

    Jim

  7. Rick Tobin says:

    Thank you for the kind words, Jessica and Jim.

  8. Kris Ludwig says:

    Wow!! Amazing, Rick! I’ve heard about the power of compounding interest, but compounding a penny for a month to $10,700,000!! Incredible! I have not heard of the “rule of 72” so thank you, Rick.

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