Be aware when someone preaches you on compound interest

Happy April Fools' Day!

I read an article on another blog yesterday titled "The Unrelenting Power of Compound Interest", I almost fell off my chair! I thought it was an April Fools' joke. The article has good intention explaining the power of compound interest, however, the examples in the article are totally base on fabricated, unrealistic assumptions which mislead its readers.

Young investors, be aware of the magical 10% compound example
Here are several quotes from the article:

"Assume you deposited $1,000 in a one-year bank CD that paid simple 7% per year interest..."

"He deposited it in an IRA investment account that earned 10% interest."

"She also earned a 10% compounded return on her savings."

Why 10%? Why not 100%? Why not -50%??? 10% is the magic number salespeople use: small enough to be believable to show the investment's "potential", but not big enough to alarm you as unrealistic, and yet not too small to loose your attention. Investors, especially young ones, if you hear or read advice that "assumes" a 10% return, you can pretty much guarantee that the person who gave that advise:

• Has no idea what the real return is
• He/She has something to sell you
• He/she is just plain lying
  

I have nothing against compound interest but I have problem with "advisors" using the magical 10% to explain investment return or using it to plan your retirement. Investments simply do not grow on a compound line. In addition, those "advisors" usually conveniently leave out or skimp over the risk/lost factor. However, if you factor in potential lost and how long it would take to recover the lost (read my other post "Will the market and your investment ever recover? Do the math."), your investment return will most likely be flat or at a lost. Bye bye year-over-year 10% gain!

Ability to weed out bad advice is a great defense asset on your road to riches (so consider I just put some money in your pocket :), and that ability applies to other parts of life as well.

Well, here is a problem for you if you are bored: what is the difference between 10% (unreal) and 3% (a little bit more real) compound on $5000 over 30 years? Try that on your advisor and do not become an April Fool.