This is the second in my Present Value series, and the first in which I’ll be looking at other’s claims which seem to make sense at first glance, but are terribly misleading under closer examination. I pick these examples not to prove others wrong, but because taking present value into consideration substantially changes the terms of the debate. My first post elucidates on the concept, and how to calculate it.

Vanguard seems to be one of the better thought-of investment management companies — they’re client-owned, low-cost, have high customer satisfaction, and seem to be the most honest of the options. I’d agree with all the previous points; it’s where I have most of my money.

So I was surprised when I came across their Power of Compounding flash video which completely ignores present value, and therefor presents a much more positive picture of compounding, benefiting, of course, Vanguard.

Vanguard’s Power of Compounding


Vanguard’s example gives us two people, Dawn and Dave, who are both 25. Dawn starts investing $2,000 a year for 10 years, until she’s 35. Dave doesn’t invest until he’s 35, but then invests $2,000 a year until he’s 65.

At 65, Dawn — who invested only $20,000 over 10 years — will have $314,870. Dave — who invested $60,000 over 30 years — will have $244,692. That’s just 78% of Dawn’s nest egg.

But, of course, that’s not entirely true. Dawn’s last investment, when she’s 34, is only worth $1,405, which means that Dave’s first investment is worth $1,351 — and they only go down in value from there.

Assuming a 4% rate of inflation, Dawn invested a present value of $16,871; Dave put in $24,298, only $8,000 more than Dawn. Still a bad deal considering that Dawn ends up with so much more money in retirement than Dave.

Vanguard Present Value Calculations

It’s interesting, though, how inflation affects this figure. If inflation were just 7.97% over the entire period, and the rate of return didn’t rise, Dawn and Dave would end up equal — Dave will have invested just 78% of the amount Dawn invested. Granted, these are very unlikely in the US over the course of 40 years, but it’s a good illustration of the fact that inflation is compounded, just like returns are. (My worksheet, with calculations and the ability to play with inflation rates, can be downloaded.)

So what’s the point of investing now, then? I think I just came up with an even more compelling way of seeing what investments can do given maximum time to compound. And that’ll be the next post.