Some of us remember when Fed Chairman Paul Volcker raised interest rates to 20% — a level unimaginable today. For the leveraged, it was devastating; but there were some benefits.
Thirty-nine years ago, my youngest daughter, Ashley, was born during similar inflationary times to today. She experienced nearly 40 years without seeing inflationary times, but I remember them.
THE EIGHTH WONDER
I started farming around 40 years ago, after leaving a corporate job and earning my MBA degree at night. It was during my night classes I learned what Einstein said was the eighth wonder of the world: compounding interest rates and what they can do for you and against you.
I also learned the concept of the present value of future money. College expenses were in my future. How could I amass $20,000 for Ashley’s college expenses? How much would I have to invest at 7% compounded to be worth $20,000 in 20 years? The answer was about $5,200 from a present value of futures money calculator (search Google for the calculator).
With one investment I had covered the education cost with a guaranteed government bond that was not in harm’s way of my management abilities.
As we look to the uncertain future for interest rates, the reverse thought process is valid using a future value of current money as a guide. In other words what will the cash value of money today be worth down the road at 5%, 6% or 7%, especially if made with borrowed money?
Per my calculation, a $500,000 capital investment at 8% (cost of capital) for seven years will have cost $856,921.77, including $356,821.77 in interest.
There is, of course, a big difference in paying cash for an asset or leveraging money to do so. Private investments need to earn at least 2% more than guaranteed government income to help offset risk.
Some will say high interest rates caused the ag recession in 1982, but how does $3,000 per acre farmland at 9% compare today with $12,000 per acre land at 7% interest? With 50% down in either case, principal payments are far greater today. I bought some of that $3,000 land in 1982 and it took 20 years before it hit that level again.
YOUR DECISION
Ignoring reality results in financial problems. Having high debt at the wrong time can make life miserable.
You can be self-sufficient and even debt-free. A small return on a large amount equals ample income without taking high risks. Compound interest can either work for you or against you; the decision is yours.
Disclaimer: There is substantial risk of loss in trading futures or options, and each investor and trader must consider whether this is a suitable investment. There is no guarantee the advice we give will result in profitable trades. Past performance is not indicative of future results.
