Thinking About Rate Of Compounding
I was reading an article about Warren Buffett's thriftyness that pointed out that when you can compound savings at 25%, every dollar you save turns into a lot of money over a couple of decades. And that thriftyness makes sense when you think about it. I'd have saved harder and earlier if I could grow the money like that. My own rate of savings has gone up as my compounding rate has improved. (And thanks to The Fool, it has improved!)
Then I got to think about negative compounding rates and suddenly something that has puzzled me for years was explained. I've noticed that my poorer friends have a tendancy to spend any windfall chunk of money quickly. One took an inheritance and opened a book store. (That went under in less than a year, leaving her in debt.) Another took a dot com payout that conservatively invested would have paid for a cushy retirement (it was about 4 years salary and he has another 30 years to work) and bought trucks, cars and a larger house with it.I've discussed this phenomina with a friend who is a pastor in a church that has a lower working class membership and the behavior is painfully common.
Now, one of the things that got drummed into my head, early and often is "Thou shalt not spend capital". So this behavior has always been alien to me. Windfalls are to be saved and invested, no matter what.
But now, suppose you have a negative compounding rate. Any capital you get will be whittled away at by sudden expenses and needs. So you have to spend it quickly if you are to feel like you got anything for it. There was a Sanford and Son episode that had exactly this pattern. Fred won a big payout playing the numbers and various relatives showed up with sob stories. The rest was stolen by a robber pretending to be a newspaper reporter. At the end, the only thing Fred had to show for it was a suit he bought right when he got the money.
Wishing you all good compounding,