The Power of Compounding

There’s a wonderful real-life story (Some say a myth) that puts the power of compounding into perspective.

In 1626, a tribe of Native Indians called the Lenape, who were the inhabitants of a city in the east coast of the U. S. sold their entire land to Dutch immigrants. They took their payment in trinkets and beads amounting to $24 (This is, of course, just a rough representation and often contested by many researchers. The U. S. did not have rules and regulations for Real Estate valuation so far back and the Dutch ones could not be applied to lands in the U. S.). The seemingly low price is justified, seeing as how the Lenape were also looking to form military alliances with the Dutch to combat rival Native Indians.

 

The_Purchase_of_Manhattan_Island
Sale of Manhattan Island (Source: Wikipedia)

 

But what happened to that piece of land now? That piece of land is now called by the name New York. The sale supposedly took place in the area now known as Inwood Hill Park. Consider the Real Estate prices and approximately evaluate the entire worth of New York city. Did the Lenape get the short end of stick? Well, no.

Let’s look at the historical interest rates in the United States. There is a chart that dates as far back as 1790 and until 2013 (222 Years), but that’s good enough for an approximation of interest rates beyond 1790. The website of the US Department of the Treasury will tell you the highest interest rates achieved between the 2013–2016 period: an average of around 3%.

 

main-qimg-6dbe9233bd0c508fd1d07f7b654d89d4-c
200+ Years of U.S. Interest Rates (Source: CNBC)

 

Given this information, let us assume that the average interest rate for the 390-year period from 1626 to 2016 is 8%. Remember that the highest interest rate in the US was 20%. So 8% is a reasonable assumption.

Coming back to the Lenape, imagine that their tribe had lived on through the generations and they were somehow able to deposit the $24 for a period of 390 years at 8% average interest rate.

While the amount compounds, let us look at the value of the modern New York City as a whole. The New York City Department of Finance releases the city’s property valuations every year. As per this report, the value of all the properties in the New York City amount to $988 Billion in 2015.

So do you think by 2016, the Lenape would have been able to buy back their land? Behold the power of compounding interest.

$24*(1.08)^390 = $260301027018004 (Approximately). That’s a whooping $26.03 Trillion.

That would have bought the Lenape 26 New Yorks. Or you know, they could have bought the entire United States and more to boot, given that the United States was valued only at $23 Trillion.

No wonder Albert Einstein said, “The strongest force in the universe is Compound Interest.”

 

This article was written by Dinesh Sairam (PGDM, Batch 21, XIME-B)

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