Ben Franklin’s Trusts: A Lesson in the Power of Compounding

Wesley Gray |

Ben_Franklin_Statue.jpg

Back in 1790, Ben Franklin created his Last Will and Testament, and set forth his wishes for the disposition of his property:

…I devote two thousand pounds sterling, of which I give one thousand thereof to the inhabitants of the town of Boston, in Massachusetts, and the other thousand to the inhabitants of the city of Philadelphia, in trust…

In his youth, Franklin had been the beneficiary of loans that enabled him to prosper in business, and he wanted to return the favor to future generations. He further stated in his will that the capital should be lent at a rate of 5% to citizens who had “served an apprenticeship” so that they could finance their own businesses.

He also stated that after 100 years, the cities could use a portion of the capital for public works, and that after 200 years, the balance would be distributed.

Franklin’s two thousand pounds sterling represented approximately $8,800 (about $225,000 today’s dollars), representing $4,400 for each city. Over the 200 year period, the value of Boston and Philadelphia Trusts grew to about $5,000,000 and $2,000,000 respectively.

A Compounding Quiz

In general, humans are poor intuitive statisticians, especially when it comes to compounding. Let’s take a test to see if we are affected.

Fact: Philadelphia compounded at approximately 3.1% over the period, and Boston had higher returns.

Quiz Question: What was the compounded return for Boston, which enabled it to earn $3 million more than Philadelphia?

  1. 3.6%
  2. 4.1%
  3. 4.6%
  4. 5.1%

Before we give you the answer, it is worth noting that one reason Philadelphia earned lower returns was that it attempted to live up to the spirit of what Franklin wanted and loaned the money to individuals, while Boston tried to maximize returns. So you might argue that Philadelphia was more faithful to Franklin’s wishes.

…scroll down for the answer…

The answer to the question above is #1, or 3.6%, representing about 50 bps of yearly outperformance for Boston. Yet after 200 years, the Boston Trust was worth two and a half times the value of the Philadelphia Trust!

Make Sure your Return is Worth the Fees

If you stop and think about it, this spread of returns, in the 3-4% range, might be a reasonable expectation for market returns going forward from today. Now consider that there are mutual funds out there that charge 150+ bps – triple the edge Boston earned over Philadelphia. And so while you’re probably not going to compound for 200 years, in today’s low expected return environment it still makes a lot of sense to focus on making sure that the fees you pay generate enough outperformance to justify the expense.

We’re sure that Franklin would agree!

 

Written by Alpha Architech Managing Member David Foulke. For more market anaylsis from Wesley R. Gray and his team, check out his blog at Alpha Architects here.

 

 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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