It is said that the best time to start investing is yesterday.
What if you could harness the power of compound interest before you even know or understand what a retirement account is?
Billionaire hedge fund manager Bill Ackman once proposed a creative solution to America's retirement crisis. It would give every child born in the United States a $7,000 investment account.
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In a 2023 interview with Harry Stebbings on the podcast “The Twenty Minute VC,” Ackman explained why this idea could have many benefits.
$7,000 birthday gift
Ackman's plan is for the U.S. government to put $7,000 into an account created for every child at birth. To be clear, this is not a cash grant. He believes withdrawals from the account should be restricted and even tax-free.
That money should be invested in an index fund and left to compound until the baby is old enough to retire, Ackman said. He estimates that these accounts could be worth $1 million each in 65 years. Although he didn't mention expense ratios, which reduce long-term returns, he likely meant low-cost index funds.
Based on these numbers, Ackman appears to be assuming a compound annual growth rate of 8%. This more or less corresponds to the historical average of the US stock market. The S&P 500 returned an average of 10.5% per year from March 1957 to March 2024.
As for the cost to the government, Ackman believes it will be minimal and “no big deal.”
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With 3.6 million babies born in the U.S. in 2021, such a program would cost the government about $25 billion annually, assuming stable birth rates. By contrast, federal spending for transportation, commercial and housing finance, social security, and defense in fiscal year 2024 is $60 billion, $65 billion, $715 billion, and $433 billion, respectively.
Ackman did not say whether such a plan would be funded through additional taxes or government borrowing. But it seems unlikely that he would want to finance this program with even more borrowed money, given the fact that he bet on U.S. Treasuries in 2023 because of the federal debt. . Mr. Ackman has been a vocal critic of the carried-interest tax loophole that allows wealthy wealth managers like himself to lower their taxes, so he is likely to support tax increases.
In any case, this hypothetical birth subsidy program shows how important time is to compound growth.
power of compound interest
Most investors try to maximize their returns and starting capital, but have little control over the time period. According to his 2021 research from Personal Capital cited by Bankrate, the average American starts investing at the age of 33. This means that a typical investor has less than 30 years to save for retirement.
Even if an adult starts saving and investing at age 25, they are missing out on more than 20 years of their youth. For example, if a 25-year-old puts his $7,000 in his S&P 500 index fund and earns an 8% annual return, he will have about $150,000 by the time he turns 65. This is significantly less than his $1 million that investors would take home. They would accumulate under Mr. Ackman's plan, which assumes they leave their accounts untouched and do not add to them as they earn and save. However, this example shows the benefits of starting early.
Babies who receive this grant will have approximately $48,000 saved for retirement when they turn 25.
“Because of the law of compound interest, you can't wait until people are 25 or 30 or 35 to start creating an IRA or 401(k),” Ackman said. “His additional 25 years are very significant.”
In addition to securing the economic future for many young Americans, Ackman believes such programs will ensure that all new citizens inherit a share in the economy. “It will start giving every baby in this country a piece of this country's success,” he said.
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