8th Wonder of the World

"I'm sure every student or practitioner in the world of pro finance has been fascinated by the compounding of interest. Never did I imagine the mathematics of compounding ever being translated into practice. How can compound interest happen at the institutional level? Einstein called it the 8th wonder of the world, and this is coming from the man that invented Physics. Yet, this exponential curve of interest has yet to be made a weapon of choice for a F.I. portfolio manager. Let me explain:

Compound interest achieves maximum compounding at n = 252. DTC paper settles every business day, excluding weekends and holidays. By dropping enough bonds in each of the 252 buckets in the 365 calendar year, you can lock in the portfolio at maximum compounding speed. This is a rare occurrence in the world of finance, especially with large sums. In fact, it is almost continuous, as it comes very close to e = 2.71.

The diversification of purchasing over 500 different issues will bring the weighted average return to a stable range by taking advantage of a historical 1% or so default rate among high grade (BBB or higher) corporates and other income producing securities. Another way to accelerate the compounding effect is to inject capital at strategic points along the curve through corporate bond issues or other related investment product (hopefully the manager can obtain a AA+ or higher credit rating on the issue). The key is to issue a bond at simple interest (like a traditional corporate bond) and take advantage of the compounding speed to increase the spread between interest payments and debt payments. Simple Finance 101.

Furthermore, the compounding engine would be, with enough time, inflation proof. This is due to the ability of the portfolio to constantly reinvest at the market rates. At further down time (t), a larger and larger percentage of the cost basis will pay interest, thus creating a turnover effect that increases the W.A.R. ever gradually, insulating the snowball from the melting effect of inflation (I get creative with the images). For the most part, the rate of inflation has historically been priced in to market rates. (T-bill rates are rarely ever lower than the inflation rate). If this inverse relationship it ever plays out again, a portfolio such as this one would simply wait for the market to adjust.

I can envision a SPE that is able to achieve pure, uninterrupted compounding. This would be done by filtering out all expenses related to running the portfolio to a separate entity. Leaving only interest and bond repayments as the only transactions. A mathematician's fantasy. No selling, only buying, and no redemptions. Investors liquidate shares in the secondary market at NAV.

I have read that a portfolio like this may be dangerous to the economy after a certain amount of years (a looooong time) due to the Malthusian catastrophe. The reinvestments will simply exhaust all aggregate demand, creating a steady stagnation. The entity would have to be structured to cease reinvestment at the point where it becomes difficult to draw on market liquidity. For the best interest of investors.

My guess? 250-300 years. I would need to model the curve, although it'll only be a very rough estimate. Some financiers will quickly point out that we'll all be dead by then! Who cares, right? This nearsighted mentality did not stop NASA engineers from launching probes that will take decades to reach its destination, for the sake of scientific study. Its the same concept that inspired Ben Franklin to launch this financial oddity across many generations, for the benefit of his country. Out of a need for sound financial/fiscal decisions. He failed. However, that was before computers, globalization, tax shelters, and complex financial markets."

PV * (1+r/252)^252(t)

300 year trust?