Einstein and Personal Finance

Published: April 7, 2013 at 9:31 am

Last Updated on

He never said it!  Said what?

  • “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
  • “The most powerful force in the universe is compound interest”
  • “Compounding is mankind’s greatest invention because it allows for the reliable, systematic accumulation of wealth.”

Einstein’s discoveries influence every  (believe me, every) conceivable aspect of human existence. He however never said anything about compounding. There is no record of it. These are yarns spun by financial gurus to catch peoples attention. To lend credibility to their claims. Over time these claims have compounded to different forms! Do you need a genius to sell commonsense? Unfortunately yes!

Wonder if he actually said this!Source: http://www.signsfunny.com/2013/02/14/albert-einstein-about-his-quotes/
Wonder if he actually said this!
Source: http://www.signsfunny.com/2013/02/14/albert-einstein-about-his-quotes/

Compound interest is not even high school math. It is lower-middle school math. Easy enough to remember and misunderstand. In its simplest avatar it reads:

Future value of a sum = (Present value of a sum) X(1+return)(No of years invested)

The (no of years invested) has been ‘raised to the power’. (The power of compounding!)

Consider this:
(1)2 = 1X1 =1
(1)5 = 1X1X1X1X1 =1
(1)100 = 1X1X …. =1
(1.01)100 = 1.01X1.01 … =2.7!
Or Rs. 1 invested for 100 years earning a return of 1% each year grows to Rs. 2.7. Of course you need to increase the sum invested and rate of return so that the number of years invested can come down but the idea remains the same. To maximize the ‘power’ of compounding, the number of years has to be as large as possible so one has to start early.

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Getting back to Einstein,his behaviour in the latter part of his career resembles that of many retail investors. Having made extraordinary strides in understanding the nature of our universe (relativity, quantum mechanics  to name just two), Einstein focused his attention on developing a ‘grand’ theory. A single framework which will explain all physical phenomena. He never succeeded. A grand or optimal theory is possible only if we have discovered everything that can be discovered which is of course never!

Many retail investors share Einstein’s obsession of finding the optimized solution and spend an inordinate amount of time doing so. This could be the ‘best‘ life insurance or health insurance or mutual fund. They are never sure of their choices. Always asking for opinions from everyone ending up more confused than ever before.  If someone spends six months searching for a term insurance plan, in the eyes of most insurers he/she has aged by one year! This of course means more premium. Every day lost in searching for the best mutual fund chips a little away from the advantage of beginning early (assuming one does so in the first place). At least this is the wrong strategy with the right product. Those who search for the ‘best’ child plan or pension plan get both wrong!

Optimal solutions are rarely possible. All one can do is look at ones personal situation, consider the points to remember while choosing a product and just go for it. A reasonable choice is all that one can come up with most of the time. The crucial thing to remember is education doesn’t stop with making the choice. You continue learning, make course corrections as and when necessary. This is how science progresses. This is how a retail investor can and should achieve financial goals.

Note:

  • Einstein’s approach may have been wrong but he could afford to be wrong and waste time. He was tenured for life. Meaning he earned (a pretty decent amt) all his life without having to worry about the underlying assumptions of a retirement calculator 🙂
  • While we are it, might as well add that an apple never fell on Newtons head!
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Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
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13 Comments

    1. Thanks. Newton and the apple are part of a rural myth. Newton was fascinated with gravity because of existing data at that time. He made all calculations and promptly put it someplace. His contemporaries convinced him to publish it and he had do it all over again. Btw I am sure you must have read about Newton’s experience with the stock market in the ‘Intelligent Investor’.

  1. The most uncommon thing is asking some one to use his/her common sense. People are too much busy in looking for 100% perfect product & in the process forget the very basic. god save all these people. Amen.

    1. Not ‘might not have’. He never did. There is no record.
      Calling compounding interest an 8th wonder of the world is utter nonsense. It is trivial middle school math. If it is the 8th wonder, commonsense is the zeroth wonder.

      Options have always been there. MFs have existed since 1960s. The trouble is asking wrong questions. Where should I invest for retirement or my child’s education is a stupid question. Diversification is the key. ‘How much should I invest where? is the question to ask.
      Thanks for sharing the infographic. It is pretty good.

  2. Searched the net to verify if Albert Einstein did or did not say. Found this link on what is called as Quote Investigator http://quoteinvestigator.com/2011/10/31/compound-interest/ Quoting from it
    QI hypothesizes that an anonymous advertising copywriter initiated the idea that compound interest was the world’s greatest invention or man’s greatest invention.
    QI was unable to find any support for the attachment to Einstein, and QI believes that it is very unlikely that Einstein made this remark.

    Sometimes a comment is attributed to a famous individual to increase the prestige and believability of the comment. Also, a quotation from a famous person is often considered more interesting and entertaining. Inaccurate attributions are readily propagated.

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