Manhattan Island deal provides historic compound interest lesson

 


Stock image
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Between 108th and 109th Street in East Harlem is the Peter Minuit playground. Every day after school, kids from the nearby primary school flow through the gates expending the last bit of energy they have left. They play on the swings, chase each other around the yard and descend the slide with glee. None of the children even give a fleeting thought about the historical figure the playground was named after.

Minuit was a stout man with coarse manners. He flirted with preaching and diamond-cutting before being fast-tracked to director of the Dutch West India Company.

In 1625, he arrived in New Netherlands, a Dutch colony that stretched from modern-day Delaware into Connecticut. But it would be a year later when his place in history would be cemented – as the man who purchased the island of Manhattan from Native Americans for $24. At the outset, it seems like he paid buttons for the island, which is somewhat ironic given that the currency used was glass beads and trinkets.

Today in New York, you would be hard put to buy a decent pizza and beer for $24.

In 2014, Rutgers University economists wrote a paper estimating the land value of Manhattan to be worth $1.4trn. If Minuit was to read the paper, he would be laughing smugly – but deciding who came off better in that deal is less obvious than it first seems.

Let’s suppose that the native Americans had a good financial planner. Knowing that this cash was surplus to everyday living expenses, they took that $24 and invested it.

The type of investment isn’t important. For simplicity, let’s say this investment returned 7pc every year subsequently. Now let’s see exactly why Einstein called compound interest the “eighth wonder of the world”. Compound interest essentially means that the 7pc gain you make each year is added to the principal, making the new 7pc the following year a little bit larger. Many investments behave like this. While it might seem obvious, once you add the magic ingredient of time, you can see just how wondrous compound interest really is.

Ten years later, that same $24 gaining 7pc a year will have doubled to $48. After 20 years the original investment has quadrupled to $96. A century later (1726) and the investment would be up more than 1000 times to around $24,000.

Today that $24 investment would be worth a staggering $8trn. To put that in perspective, the entire wealth of the US is estimated at $100trn.

In the end, Minuit and friends have an asset worth $1.4trn and the Native Americans with their financial planner have an asset worth $8trn. Perhaps not such a bad deal after all.

This example is extreme and no investor has nearly 400 years, but there is great learning in it. The first lesson is that successful long-term investment is all about compound interest and time. Don’t let anything get in the way of these vital components. The second lesson is when you have savings or sum of capital, get help. There are plenty of high-quality financial planners that can assist you in finding a solution that works.

Minuit was on the way back to Europe in 1638 when he decided to detour to St Kitts for some tobacco. A hurricane struck the boat he was on and he died at sea.

There is a third lesson there somewhere for us all to figure out but, for now, let’s reflect on his inadvertent contribution to understanding compound interest.

Will Sparks is investment manager at Quilter Cheviot; quiltercheviot.com/ie/private-client

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