Don't Invest Like My Relatives

While cleaning out my desk last week, I found a savings bond given to me when I was born. It was only a $50 denomination, but I figured with the interest added on I'd be able to take the wife out for a nice steak dinner.

Turns out, my internal exponential calculator was a little off.

The awesome power of compounding interest
The bond, which my aunt and uncle only paid $37.50 for, had earned nearly $230 more in interest when it matured in 2005. Looks like we'll be able to bring the kids with us when we go out to dinner.

That averages out to about $7.63 in interest per year over the 30 years it earned interest -- an amazing 20% of the original price. But of course the bond didn't have an interest rate anywhere near 20%. The value continued to grow exponentially because the government added interest twice a year. By letting the investment sit there, I was earning interest on the interest added in previous years. Time is a newborn's best friend.

That's great, but ...
Unfortunately, inflation works the same way. The rising prices of goods and services are compounded annually on top of previous increases. My relatives' original investment is worth about $150 in today's dollars. The bond beat inflation, but not by a whole heck of a lot. No one said loaning your government money could be profitable.

If instead of buying a savings bond, they had purchased stock with that $37.50, look at how much better I would have been off:

Source: Yahoo! Finance. Returns include dividends.

In fairness to my relatives, $37.50 couldn't have bought a single share of most of those companies; buying partial shares probably wasn't an option like it is today, and besides, the broker's fees would have eaten much of the return. But even if they had waited until my 21st birthday back in 1996 when discount brokers were more prevalent, they could have come out ahead of the original savings bond with a $37.50 purchase in any of these well-timed investments.

Source: Yahoo! Finance. Returns include dividends.

A chip off the old block
Of course, I could have cashed in the bond at any time and invested in stocks. If I had, I'd be able to include the extended family -- and then some -- in our steak dinner.

But it actually gets worse. Savings bonds only earn interest for 30 years, which means I've been loaning my money to Uncle Sam interest free for nearly five years now. I wouldn't have stuck $270 underneath my mattress -- or in the now-clean desk -- but that's essentially what I did by not cashing in the savings bond when I was 30.

You may not have any savings bonds in your desk that need cashing in, but how about an old 401(k) from your previous employer? Is it really earning the best possible returns? Now's as good a time as any to roll it over into an IRA and take a little more control of your finances.

Your relatives hope you read this section
There are three things you should have learned from my endeavor:

1. Time and compounding returns are your best friends. Invest early and often.
2. Invest for maximal returns. If have a 30-year time horizon, taking on more risk can result in substantial rewards.
3. Don't forget about your investments. Make sure they're as appropriate today as they were when you -- or your relative -- first made them.

Learn from my mistakes and you may have your whole clan dining on caviar in a few decades.

"Finding good companies and holding those positions tenaciously over time can yield multiples upon multiples of your original investment," writes David Gardner.