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Finding future value

Marcus Burns  |  26 Feb 2013Text size  Decrease  Increase  |  

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Marcus Burns is a senior portfolio manager with Schroders.

 

As money managers, we clearly have a vested interest in trying to persuade clients to save more of their money and preferably invest a large chunk of that in our funds. Therefore, having declared our interest at the outset, I bravely push on to consider spending today versus investing for some future benefit.

Most of us broadly have some idea of the power of compounding - Einstein even called it the eighth wonder of the world. Small initial amounts, invested even at relatively modest rates will, over time, compound into seemingly enormous amounts of cash. We all remember the story of that clever Dutchman, Peter Minuit, who bought Manhattan for $24 worth of axes, kettles and beads from the Lenape Indians in 1626.

Since none of us are 387 years old I'll consider a more recent example. Consider the case of an early forty-something male tempted to spend some of his money on a ... oh, I don't know ... a Porsche. Let's pick a 928, which was considered a pretty sexy car in 1987.

Back then, a new Porsche 928 cost an impressive $211,856 in dollars of the day. This sum would have bought you almost two median-priced houses in Sydney (1.75 houses to be exact) or a reasonable chunk of stock in the All Ordinaries. What was the underlying value of these "investments" over time?

Today, your Porsche 928, if kept in reasonably good condition, would be worth around $20,000. Sorry Mr Porsche. The median value of a Sydney property has increased to $642,000, so your 1.75 properties could be worth $1.12 million. If we include rental from the property returns, that figure could now be an impressive $2.25 million.

In case you think I've picked a high-returning asset class to compare with the poor old porsche, I've included a parcel of shares in BHP Billiton (BHP) (current value approximately $5.4 million; compound return 13.8 per cent per annum, based on the same initial investment amount of $211,856) and a parcel of shares in National Australia Bank (NAB) (current value $4.5 million; compound return 13.0 per cent per annum) over the same time frame - which have actually done better than the median Sydney property.

Recently, the original Adam West 1966 Batmobile was sold at auction for an impressive US$4.2 million - apparently the atomic turbine engine and rocket launchers aren't real - but notwithstanding this rather large letdown, the car sold well at auction.

That car was purchased for US$15,000 in 1966 and the recent sale price represented a compound rate of return of 12.7 per cent per annum over 47 years. So not ALL cars are bad investments. Just make sure they are one-of-a-kind, black, and with bat fins!

Two points from this bear further discussion. The first is that small differences in compounding rates add up to large differences over time. A difference of just 3 per cent per annum over the 25-year period results in a total return figure that is twice as large - look at the Sydney median property prices with rental returns ($1.2 million) versus just the capital appreciation figure ($640,000).