Compound Intrest for Dummies, part 892

December 3, 2008 8:30 AM

Lets say I have $20,000 that I want to become $100,000 (or more) by the year 2024. What (if any) lower risk options do I have to make this dream a reality? Assume for a moment that I really don't want to put this in the stock market because I can't afford the risk of a major loss.
posted by anastasiav to work & money (26 comments total)

I will add that I'm also talking with an investment adviser from my credit union. I am also interested in hearing your opinions, however.
posted by anastasiav at 8:31 AM on December 3, 2008

That's greater than 10% return each year, compounded. Stock market historical long term percent increase is somewhere around 8% I believe. So basically, it's not going to happen if you're not willing to risk a major loss.
posted by Grither at 8:37 AM on December 3, 2008

Just so we're clear, you're looking for a sustained annual growth rate of 11.4% or more, over 15 years, without using the stock market?
posted by Johnny Assay at 8:39 AM on December 3, 2008 [1 favorite]

If you're trying to fund college for your little one, you should look into tax free education funds (529 or something I think)....
posted by Grither at 8:52 AM on December 3, 2008

Just so we're clear, you're looking for a sustained annual growth rate of 11.4% or more, over 15 years, without using the stock market?

Lets say that the $100,000 is a goal, but the key is to not lose the original $20,000. I'm not totally ruling out the stock market (lets say "Buy five shares of Berkshire Hathaway B" could be an answer here, or a suggestion of a historically very safe stock or mutual fund) but this isn't a "just toss it in this high-risk fund and hope" type situation either.
posted by anastasiav at 8:58 AM on December 3, 2008

Note also that I am talking with an investment adviser. I'm asking you guys because I believe you're more creative than the guy in a suit at my bank. (Grither, you're correct that this is an investment for my son; we do have a 529 for him already but I want to avoid the restrictions on spending (ie: Education only) that a 529 entails.)
posted by anastasiav at 9:01 AM on December 3, 2008

The fifteenth root of 5 is 1.113, so 11.3% is the compounded annual return you will need to make your dream a reality.

Not only are you not going to find this anywhere but equities (stocks), but if you achieve it in equities, you will be beating historical averages.

Russian national debt is making about 11% now, I believe, but there is currency exchange risk - you'll be holding rubles - and in 1997 or so Russia repudiated their national debt, didn't make good on it, which is why they have to give such a high rate now to get anyone to buy their notes. They could pull that stunt again.

There is no way to do what you want to do without a significant risk of loss. If there were, every person with money in the world would try to do it, and the rate of return would come down in the ensuing auction as the price of whatever it was went up.

Economists and financiers talk about the "risk-free rate" - the rate of return you can get on your money that is thought to present no risk - none - of losing your capital. The risk free rate is used in some equations, so financiers have to find a way to estimate it. It is usually estimated to be the current yield on the 3-month US T-bill.

Right now, for your information, the risk-free rate is - wait for it - 0.01%.

That's not a typo. And no, I don't mean 1%.

I mean 0.01%. You are asking for a rate of return that is risk-free and 1,100 times as great. You may as well forget about it.
posted by ikkyu2 at 9:03 AM on December 3, 2008 [5 favorites]

Even if we assume you're discounting the effects of inflation and really want 100k (not the 2024 equivalent), that's almost 12% return on your investment!

In short, no, there aren't any low-risk investments of this type. If making money was that easy, everyone would be doing it.

Over time, the stock market has returned somewhere on the order of 8%. That would leave you quite a bit short of your goal. Keep in mind that even if the market averages 8 percent, at any given time, you may be quite a bit above or below that mark.

So your best bet is probably to invest your money in an index fund and hope for the best. If it's really, truly money you can't lose, then buy CDs and deal with the lower returns.
posted by chrisamiller at 9:05 AM on December 3, 2008

I'm down 30% on my stake in BRK, by the way, so I'm pretty %*)@ing sure it doesn't meet your criteria at all. It's going to have to go up nearly 50% from here just to get my capital back.
posted by ikkyu2 at 9:05 AM on December 3, 2008 [1 favorite]

Economists and financiers talk about the "risk-free rate" - the rate of return you can get on your money that is thought to present no risk - none - of losing your capital.

As a practical matter, the risk-free rate is what an FDIC-insured bank account is willing to pay. 3-4%? Unless you can think of a circumstance where the FDIC doesn't pay, but the T-Bill does.
posted by smackfu at 9:58 AM on December 3, 2008

One more way of looking at this:

You have two priorities: protecting your principal first, and earning substantial interest second.

As others rightly point out, nothing is risk-free. But you can protect your initial 20K at relatively low risk pretty easily. Carve out a chunk of it to invest in CDs calculated to reach 20K in 15 years. It's hard to predict what CD rates will be in 10 years, but you can get a 10 year CD today at about 4.5%. At that rate, 10K in CD savings would be just shy of 20K in 15 years.

In this example, that leaves you with 10000 to invest more aggressively. Now, you'd have to achieve a roughly 14% rate of return to turn that 10K into 80K. But with your initial nest egg protected, you may feel freer to invest in higher-risk, higher-reward opportunities.
posted by j-dawg at 10:05 AM on December 3, 2008 [2 favorites]

There are some things you can do. Make sure you don't use part of your money to pay somebody who isn't very good. No commissions. Recognize that the economy is in a very bad place right now, but it generally doesn't stay down indefinitely, although many people think it will take a number of years to recover from the mess we're in. Right now, protecting your capital and making a small return might be the best you can do.
posted by theora55 at 10:16 AM on December 3, 2008

Assume for a moment that I really don't want to put this in the stock market because I can't afford the risk of a major loss.

You need to define what you mean by a "major loss". $2,000? $10,000? The whole shebang?

Once the market bottoms out, we might see average returns that beat the historic average for a few years, but you're gonna have to get pretty lucky to get over 10% for 15 years.
posted by mr_roboto at 10:48 AM on December 3, 2008

I would second the 529 recommendation with the caveat that 529's are market-based investments, though the risk is spread across many thousands of investors. I opened a 529 for my one-year-old and contribute like $600 to $1000 per year to it. To-date it's down 10% because of the crappy economy and the yo-yo-market. I treat it more like a savings account with the possibility that the money in it could/will multiply as the market recovers ( in 1 year, 5 years, whenever).
posted by camworld at 11:16 AM on December 3, 2008 [1 favorite]

What about real estate? Let's say you used your money as downpayment on a property you could rent out. For simplicity, I'll assume that the property is worth $100,000, you put down $20,000, you get $1100/mo in rent. Let's assume your monthly mortgage is $1000 and maintenance, etc. is $100/mo so your costs are exactly covered by the rent.

Obviously this is oversimplification, and you will have to do the math yourself, but the point I am trying to make is this. Back in the good old days, prior to the housing bubble and bust, real estate appreciated at around 3-4% per year. That's 3-4% of the whole $100,000, not 3-4% of your $20,000 downpayment.

If it's appreciating at 3%, the house is worth $100,000 * 1.03 = 103,000 after the first year. Multiply by 1.03 again to see what it's worth the 2nd year. Multiply this by 1.03 for each following year - by the end of 15 years, it's worth about $156,000. You started this with $80,000 in mortgage, and have paid some of that off. So $156,000 minus the payoff amount of the mortgage is your total. It could get you close to your goal.

There are many issues to consider which I'm sure many people will be delighted to point out. These are the ones I can think of:

* You have to do a ton of homework to find a good property investment.
* You have to do a ton of work as a landlord.
* Finding tenants can be hard.
* There are taxes to consider.
* The rent might not cover the costs in the early years, so you have to have a plan for how to cover those costs until rents in your area go up enough that you can charge more.

Good luck! I am curious to hear what other options people come up with.
posted by selfmedicating at 12:09 PM on December 3, 2008

What about real estate? . . . If it's appreciating at 3%, . . . by the end of 15 years, it's worth about $156,000.

If you figure that inflation holds constant at 3-4% per year, earning three percent on your money is the same as keeping your purchasing power constant. In other words, an investment that pays 3% doesn't really make you any money.
posted by chrisamiller at 12:40 PM on December 3, 2008

It pays 3% of $100,000, not 3% of the $20,000 invested. It is a greater percentage of the amount invested. The $3,000 you make through appreciation in the first year is 15% of the $20K you invested.
posted by selfmedicating at 12:45 PM on December 3, 2008

You'll have to get closer to 15% annually to cover the taxes on the gain.

If you're looking for something safe, I'd take a serious look at State/Municipal bonds wherever you live. These are frequently state and federal tax free, and state bonds are usually called out in the state constitution as items that *must* be paid, regardless of the consequences to the budget.

Unfortunately you're unlikely to come up with anything much higher than 5.5%, but that would turn your $20,000 into $50,000 in 16 years, with no tax consequences at all. I'd argue that it's the best you're going to do and stay relatively safe.
posted by tkolar at 12:48 PM on December 3, 2008 [1 favorite]

1300 shares of BAC.
posted by troy at 1:11 PM on December 3, 2008

My problem with the real estate idea is that it only works due to the rental, and managing a rental seems like more of a job than an investment. A job that pays you $5k a year.
posted by smackfu at 1:17 PM on December 3, 2008

Jeez Louise. We are BRAINSTORMING here, people.

Resourceful 30somethings with $20K in cash become comfortable 40 or 50somethings with $100k in cash all the time. This is by no means the most ridiculous question I have heard on askmefi.

If she'd asked "How do I construct a 50-foot dog out of toothpicks and meat?" I'm willing to bet there'd be a flood of suggestions. Let's get with the creativity, people!

Oh, and I agree with smackfu - the real estate idea basically is a job. The only ways I can imagine turning $20k into $100k involve luck, risk, crime, or working your ass off. Assuming options 1-3 are off the table, you basically have to do a lot of work.

What about investing in a small business? Starting a business? Do you have any special skills or resources?
posted by selfmedicating at 1:32 PM on December 3, 2008 [1 favorite]

You are on crack if you expect to do this without risk. You are a skilled investor if you can do it with the stock market.

I recommend getting into the drug business, preferably a few notches up the food chain.
posted by charlesv at 1:33 PM on December 3, 2008

Can You Trust Your Financial Adviser?
5 Best Places to Stash Your Cash
posted by theora55 at 3:13 PM on December 3, 2008

I'm asking you guys because I believe you're more creative than the guy in a suit at my bank.

There are more other options than "the guy in a suit at my bank" and Metafilter. The usual suggestion is a fee-based financial adviser. (The guy at the bank may be one, but I'm assuming he's paid by the bank, not you)

we do have a 529 for him already but I want to avoid the restrictions on spending (ie: Education only) that a 529 entails.

Personally, for my kids, I can't come up with a need for them to definitely (read: low-risk) have a large chunk of money at age 18 or so, apart from education. Any scenarios I can come up with (just for example--a house), can all be flexible on the time period. What I'm saying here is that if you can be flexible on the date you want the money you can choose when to sell stocks and take away a lot of the risk. If, in 2024, you can afford to say "market conditions aren't right, I haven't met my target", then you can simply invest in stocks. Assuming prudent choices, a flexible time horizon does a lot to mitigate your risk here.
posted by RikiTikiTavi at 4:14 PM on December 3, 2008

If I needed to do that, I'd diversify. Put $10k into risk-free CDs. At the end of 15 years, you will have your $20 grand- principal is not lost. Put the other $10k into some kind of brokerage account, and buy high risk/reward funds, or maybe if you have the stomach for it, 5 or 8 stocks in each of the different sectors. Research these companies, and buy and sell as these various companies ebb and tide- if you make a nice gain on one stock, sell some of it and find some other stock to try. With luck and research and a little intuition, you will beat the market. The trick is taking profits (selling) when they are "good enough" and not getting greedy and waiting for the absolute tops.
posted by gjc at 5:22 PM on December 3, 2008

Unless you can think of a circumstance where the FDIC doesn't pay, but the T-Bill does.

The FDIC payment could well be delayed, resulting in the loss of a certain amount of time-value-of-money.

It's also worth noting that the amount of money that has been spent in 2008 to bail out banks that were about to fail far exceeds the value of the FDIC's bailout fund. I mean, that's great and all, but it doesn't exactly reinforce the idea that the FDIC is capable of mitigating all risk.
posted by ikkyu2 at 8:18 AM on December 4, 2008