Our country’s income inequality is simply colossal. The top three percent of wealthy families own 54 percent of our wealth. The top 10 percent owns 85 percent of our wealth. This unequal distribution has been growing since the late 1990s.

Michael Schramm

We can all agree that income inequality sucks, but that isn’t going to get us anywhere. We need to talk about initiatives that each of us can begin to help bridge the gap between the wealthy and the rest of us.

While a variety of factors meld together to create a person’s wealth, one of the most influential and unused tactics involves good stock investment. The wealthiest 10 percent own 81 to 94 percent of financial assets — stocks being one of them.

I’m sure you’ve heard that investing in stocks is a wise decision, but not until you understand the mechanics behind compounding interest do you realize how crucial investment in your 20s can be.

To make sure we’re all on the same page with definitions, interest is the amount of money you receive for letting someone borrow your money. A lot of financial institutions provide interest — including stocks, bonds and banks. Let’s take banks as an example. If you put your money in a bank, you’re doing them a favor by giving them money. They actually use this money to invest in other projects to make money. To reward you, they provide compensation by depositing a fraction of your account holdings. This compensation is the interest that is added into your account.

However, not all financial institutions provide the same interest rates, and some institutions provide interest that’s pitifully low. Banks, for example, have historically only provided a 0.17 percentage annual average. That means you’d only make 17 cents per year for every $100 you have deposited in the bank.

Stock averages are much greater. Though the stock market is extremely volatile, it averages a six to seven percent interest rate per year. This is the highest average return of all forms of investment.

It’s in this percentage change that you could become a millionaire while depositing around one-tenth of that money.

The key lies in the idea of compounding interest for long periods of time. Compounding interest is similar to the idea of regular interest except that your interest accrues interest in the next year. Let’s use stock returns to elaborate on this. Say that you invest in a stock that costs $100 and, with interest, it increases by the average seven percent to $107. Then, if your stock rises by seven percent in the following year, it’ll be worth $114.49. Notice that the increase in the price was 49 cents more than the first year. That’s due to the fact that the seven percent interest in the second period applied the seven-dollar increase in the first period.

Now, this may not seem like a significant amount of money, but over decades of time, it is. If at age 20 you invested $1,000 in a stock, it grew by the average compound interest rate, and you took the money out when you were 50 years old, you would have $7,612.26. If you pulled it out at age 60, you would have almost $15,000. That’s almost 15 times the amount of money you originally invested.

Let’s make it clear that this isn’t a get-rich-quick scheme. Compound interest requires decades of time to invest, but think of how revolutionary this could be for people with low income.

Saving $1,000 in a year only requires putting $83.33 away each month. That can be difficult for those living on a low yearly income, but it’s possible for almost anyone.

If you saved $1,000 every year in your 20s and 30s, you’re estimated to end up retiring in your 60s with slightly more than a quarter-million dollars. And if you want to invest more money, you have the ability to retire with even more money.

Having this nest egg leads to an infinite amount of possibilities. You could allow the stocks to continue gaining value each year and sell off the extra value, allowing yourself a multi-thousand dollar endowment each year. You can use the money as a retirement account to have a financially sound retirement. You can will your children some of the money and allow them to spend what they want and invest the rest.

Now, this process isn’t as easy as picking a stock and waiting 40 years. The stock market is extremely volatile, and investing in bad stocks could lead to you losing a lot of money. If you’re going to invest, you need to put a lot of time into understanding the process and identifying valuable stocks.

But the time is worth it. It’s the way for the single mother putting $50 in her savings account to take control of her and her child’s financial future. It’s how the 20-year-old flipping burgers at McDonald’s has a chance at a secure future.

So go on Amazon and buy a highly regarded beginner’s investment book. Take advantage of online websites dedicated to helping investors. Ask friends for advice on getting into investment, and tell other friends about the power of compound interest. Research companies until you find ones you want to invest in. Invest, invest, invest.

Don’t avoid the stock market because you don’t know much about it. Though it’s not an immediate remedy for poverty, it’s the system that can diminish it.

Michael Schramm can be reached at mschramm@umich.edu.

Leave a comment

Your email address will not be published.