Downton Abbey, Compound Interest and teaching children to be Rich

Downton-AbbeyI’ve been watching the TV show Downton Abbey.

Although its fun to watch, those of you who haven’t seen it shouldn’t worry too much. The melodramatic plots are only slightly more realistic than Dallas or Dynasty (remember these 80s classics?) and the acting is about as subtle as a course of waterboarding at Guantanamo Bay.

Downton Abbey portrays life in a grand English country house in the early years of the 1900’s, showing the lives of those above stairs (the aristocratic family) and below (the servants).

What is striking to the modern viewer is how regimented life was back then. If you think that the old days were the good old days, you might describe the lives of the family and staff as reassuringly well ordered.  But you might equally describe the routine and formality as stifling and soul-destroying.

In a very English way, everyone is emotionally retarded, repressed and puts on a brave front. It was an age where if you got post-traumatic stress disorder fighting in a World War, you would be told to pull yourself together. If you broke a leg, you might be told to just run it off for God’s sake man!

In Downton, status and position in the pecking order are everything. It is hilarious to see how upset people get over tiny nuances of rank and routine. Its not just the toffs that are obsessed with social rank; things really kick off below stairs if the first footman is asked to do a job that is more befitting of the second footman. Of course, we modern humans would never get worked up about such trivia.

Or would we? If you’ve worked in a corporate environment, you may realise how little has changed. At work, I watched grown men and women fight over seating plans, parking spaces, office sizes, who got copied on emails, the order names were listed in, who should be invited to meetings and so on.

My policy throughout this nonsense was always to try to remember the underlying purpose of work…which was to fund getting the fuck out as quickly as possible. People forget that the primary purpose of business is to make money.  In the endless negotiations that make up corporate life, I was always happy to surrender points of ego or personal status…just not at the expense of my (or my client’s) money.  My advice to anyone in the corporate environment would be to pick your battles wisely.  Let everyone else obsess about status….just focus on doing the best job you can, as ethically as you can, and getting paid properly for it.

The other thing that is striking about Downton is how set in their ways the people are. The narrative arc shows social mobility starting to increase but the pace of change looks incredibly slow to the modern viewer.  This is reflected in the ingrained attitudes, habits and limiting beliefs of the servants who are, for the most part, blind to the extent of the opportunities opening up elsewhere.

I have to resist the urge to shout to the staff on the TV:

Wake up!  Stop polishing his Lordship’s bedpan and get the hell out! Go to London, to America, Australia / NZ, Canada or anywhere with some decent opportunities. The world is yours…but you have to choose to escape to freedom!

The Escape Artist is no aristocrat but did have the occasional peek into the world of old money when growing up in rural England.

For most of the first 10 years of my life we lived in a tiny village. In terms of social structure, the village was little changed since The Domesday book of 1086. At the top of the village hierarchy, there was the landowning family who lived in their country mansion set in parkland.  The family had lived there since their Norman ancestors crossed the English Channel looking for opportunities for rape and pillage.

I was always struck by the contrast between my highly leveraged middle class parents with salaried jobs and the aristocrats with a shitload of assets that generated passive income for them.

I could see that there was a division of ownership:

  • The posh family owned hundreds of acres of farmland, a mansion, farm equipment, equities, antiques, art, fine wine, gold, silver and horses.
  • We owned a mortgage, a 14″ black and white portable television and two cats.

The cats were very nice but I couldn’t help thinking that maybe I was on the wrong side of the fence here. Money isn’t everything but I sensed the aristocracy had the better financial strategy. Interestingly, despite being loaded, they mostly seemed frugal in their spending.

The aristocratic way of getting rich is that one generation (preferably one a long time ago) does something out of the ordinary. Like starting a business, marrying into royalty or winning a land war. The founding generation takes some risks, lives frugally and builds wealth, focussing on growth and accumulation rather than consumption.

With the right investment strategy and tax regime, that family can remain rich for many subsequent generations. As long as the family stay invested in real, wealth generating assets and don’t exceed a safe withdrawal rate, the money need never run out. Compound interest can then work its magic and grow wealth prodigiously over the decades.

The aristocracy may have got rich initially by war, marriage or dirty deeds but most then got richer over time thanks to compound interest.

As a child I was always fascinated with the concept of compound interest. Compound interest is the interest earned on interest, over time. Compound interest plus time is a big part of how Warren Buffet was able to accumulate billions of dollars of wealth, growing like the proverbial snowball rolling downhill.

Growing up, I loved those illustrations of compound interest that said if one of my peasant ancestors in 1487 had saved just one penny – one lousy penny! – and achieved a 5% return each year then this would have turned into £393 million pounds in 1987.

I was 17 years old in 1987 and looking to buy my first car. Frankly those £393 million pounds would have come in handy at that point. So I was a bit annoyed that none of my ancestors had actually put aside that 1p for me.  How selfish of them to have spent my inheritance! It didn’t occur to me then that in the Middles Ages, my peasant ancestors might have needed every penny they could lay their hands on to avoid starving to death in winter.

So The Escape Artist was forced to go out to work to achieve financial freedom which was no doubt a whole lot better for me in the long run.

Being brought up “below stairs” meant that instead of going to Eton, I went to a state school where more of the alumni probably ended up in jail than going to Oxbridge. This meant that I received a secondary education that might be described, if we were being kind, as “mixed”.

For example, my maths teacher at school was a nice guy and incredibly hard working. Its just that he just worked hard on things other than teaching us maths. As well as being a maths teacher, he ran a small farm.  He never set us any homework, although I suppose if you spent as much time looking at pig shit as he did, then marking the homework of future juvenile delinquents would have been the last thing you’d want to do of an evening.

But whilst the standard of maths teaching seems to have improved since then, most schools don’t teach children anything useful about money or finance. And maybe that is not their job anyway?

So I think we parents have to take responsibility for teaching our children the basics of saving and investing. Our children inherit a money blueprint from us and others around them.  So we should think consciously about the messages they are picking up and try to plant the seeds of good financial habits that will take care of them over a lifetime.

Unfortunately, the way of the Prison Camp is for the inmates to spend all their time at work whilst paying other people to teach their children, cut their lawns and cook their food. But The Escape Artist believes that some things should not be outsourced.

All this explains why I have just taught my 14 year old daughter about compound interest myself. To do this I used a simple but powerful illustration of the maths of retirement investing which I lifted from Richard Russell’s classic article Rich Man, Poor Man.

In order to visualise the power of compounding, imagine 2 friends with similar earning power.  Both leave sixth form college at 18 and get similar jobs. A year later, the first (Early Bird) opens an investment account at age 19 and starts to save. For seven consecutive years she puts £2,000 into her pension and achieves an average growth rate of 10%*. After seven years Early Bird makes no more contributions — she’s finished.

The second of the 2 (Late Starter) makes no contributions until age 26 (this is the age when Early Bird finished her contributions). Then Late Starter continues contributes £2,000 every year until he’s 65 (at the same assumed 10% rate of return).

At age 65, both of them have a nice nest egg of just under a million pounds to add to their state pension. But what is truly amazing is that Early Bird’s stash was all created based on a rather modest £14,000 of contributions that stopped aged 26.

Remember The Laws Of Learning…we learn best with active learning. Reading is not enough. So to help embed the learning points, I got my 14 year old daughter to create the following killer table in Excel.  I think she nailed it.

*10% per year nominal would be 6% real after inflation of 4% per year.  It so happens that over the last century, the UK and US equity markets have delivered annualised returns of about 6% real but there are obviously no guarantees this will continue into the future 

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24 comments

  1. I totally agree that we, as parents, should be educating our kids in financial matters. I do think schools should include this type of education too, but everything starts at home. Not only does the money blueprint come from home life, but a child’s perceptions on everything will be coloured by our influence/speech and actions.

    By the way, I miss ‘upstairs downstairs’, much preferred it to downtown.

  2. You can’t beat compounding, but I agree with M that it starts at home.

    If you buy your kids smartphones and iPads they can’t be expected to learn the importance of saving. Ditto if you buy all your own stuff on credit cards.

    Mike

  3. fibrarian · · Reply

    The buck definitely stops with the parents when it comes down to educating their children but I think think there is certainly room for some finger wagging at our education system as well. Financial literacy is such a huge component of everyday life yet is never even touched on at school for the vast majority of students outside the occasional business studies lesson.

    Most people make financial mistakes when they are young, that’s to be expected, but with a lot of people those early mistakes like credit card debt and overdrafts become ingrained into their psyche as “the norm” and will persist throughout theirs and their children’s lives. Perhaps if schools spent a couple of hours a week teaching kids about personal finance rather than Congo Basin river systems some of those early mistakes could be easily avoided altogether. I really have no idea why there is no appetite for this from Government considering our often touted ridiculously high levels of consumer debt. I’ll leave that one for the conspiracy theorists out there.

    Great job instilling these values in your daughter at such a young age.

  4. I liked the MMM concept of providing your kids with a parent managed ‘bank account’ that paid 10% interest. Make the whole thing a bit more concrete than looking at numbers in the abstract.

  5. @Fib, they have started teaching financial education in schools now, but it’s pretty basic as far as I know (certainly not anywhere along the lines of what you could expect to achieve if you bothered to save a decent proportion of your money from an early age)

    @ben – 10% per year, yes another one of MMMs ridiculous things. It’s so unrealistic, even though perhaps useful for a *very* young child. Why not be a bit more realistic and use 5% instead? It’s pretty close to what one could expect to achieve, based on the long-term average for UK investments…

    1. i think the idea is to make it very attractive for the child to save, hence the high interest rate. I don’t think the idea is to provide that rate in perpetuity. Just as an exercise while they are young

  6. Hey Mr TEA,

    Spot-on article, you really crack me up on pointing out the ridiculousness of the corporate circus, I used to shake my head in wonder at the status anxiety induced bun-fights. The same people probably went home & rebuked their kids for watching the various ‘wrestling’ clown shows for being a waste of time on a crock of sh*t that dissolves brain cells. [straight after their playground, sand-pit wars at ‘work’ on the in-thing of the day]

    You’re right on education & that’s the best favour you’ll ever do your kid – I can trace the origin of my own freedom now to my mother teaching me the value of saving, patience & delayed gratification through pocket money subliminal messages as well as direct example with household budgeting. Kids aren’t stupid, they may listen to what their parents are advising, but they also pay attention to what they actually do – so if you give sage advice, then (to borrow your own comical example) go ‘Frankie Fk’wit in the casino’ next weekend, they clock the inconsistency & have no respect for your future advice – at least on that topic.

    I suspect the reason standard education at school is relatively poor on finance as well as other practically useful issues in the real world that can really change your life, [sex education] is that the point of current state schools is to churn out obedient workers for corporations, not independent creatures capable of free thought – that’s hard to control. I remember learning matrices in maths & thinking when the fk will I ever do anything useful with this in my life, graduated with quite good grades …….& no understanding of pensions, mortgages or insurance !

    As for your childhood/upbringing, 2 cats, luxury ! we could only afford rats; the rats were very nice but I couldn’t help thinking that maybe I got a raw deal compared to the horsey set 🙂

    1. Loving the Monty Python reference Survivor….

  7. Very interesting post! Enjoyed the Dallas and Dynasty mention too. Yes, very reminiscent of those over-the-top, “me generation,” lifestyles-of-the-rich-and-famous shows.

    Every time we see another great illustration of compound interest and why we should have saved more in our early 20s–instead of going full throttle in late 40s–we hang our heads in shame. It’s not that we were (too) terribly wasteful, but we were certainly not very smart in saving aggressively. We still hope to retire by/around 50, but we wish better luck to younger readers. Pay attention to those charts…

    1. I wouldn’t sweat it too much, I think compounding is a little overated, I fall into the ermine camp on the subject, i.e. http://simple-living-in-suffolk.co.uk/2014/05/why-compound-interest-wont-help-you-retire-early/. We just don’t live long enough and earn money at the wrong times.

      1. Thanks @ben for the link. In our household, we’ve just recently discovered both Simple Living and The Escape Artist, so we still have quite a bit of reading to do. Ermine’s post was interesting. So essentially, earlier saving DOES help in terms of benefits of compound interest, but since we plan to retire by/around 50 (we hope!) anyway, those compounding interest benefits (nice as they are) wouldn’t have kicked in early enough to enable us to retire much earlier. Interesting.

        In any case, since we can’t go back anyway, we’ll just move forward. Thanks!

      2. I would say the typical FI model is to smash away a stack of money, usually over a decade or so to get assets to hit the SWR, say 25+ times expenses. This is done by earning a lot and spending beggar all. The take-home message is overwhelmingly that it is the difference between income and expenses, i.e. savings, that is the main driver of growth to the target, not investment returns.
        Hence my two-penneth that compounding is overated. It isn’t what makes the difference in practice – the crucial thing is that discipline to save vast % of income, I don’t think many can do it, it takes a certain personality type to to pull it off (i.e. INTJ). Also, what is sometimes refered to as the inconvenient truth of FI is that the whole thing becomes much more realistic if you are a high earner, almost all that have got there seem to have had a job in finance, IT, upper management etc. paying several times average salary.

      3. Ben, I agree that for someone like Jacob/MMM going the “crash course” route of doing their saving in a decade or less, compounding is not the main driver to get to the point of quitting. But there is more than one path to FI. I was slower to get there (at 43) and compounding was important for me.

        Compounding and investment returns matter hugely over the course of a lifetime. Compounding is the gift that keeps on giving: long after getting to FI. Now that I have quit, my aim is not to eke out my money in retirement. My secret plan is to allow compounding and above-market investment returns to work their magic so that my stash grows bigger than Dr Evil’s secret Volcano HQ.

      4. haha for sure returns do matter hugely if you can consistently bag and compound outsize returns as is spectacularly true for your good self. If you wallow around the lower end of the spectrum then that hockey stick graph looks different, certainly over the first few decades. It is likely true to say that most will prob only see < 5%, maybe closer to 3% real return, not double digits. There are a million ways to skin an FI cat, but I have just noticed the one I outline seems more prevelant (admittedly biased to those willing to write about it). I am also starting to question the fundamental premise that making work optional is important to happiness. FI kind of hinges on accepting this as being true. Maybe another route is working on the self introspection to choose meaningful work and also working on perception of work to make it more positive. In other words the goal could be finding/making/refining the ideal job rather than accumulation of assets to allow the whole issue to be bypassed if need be. This could be a cheaper route (in pounds and pence) to a similar level of happiness? (possibbly more expensive in the intellectual effort required) Haven't really fleshed out these ideas properly yet – just starting to put them out there..

  8. Great post. I have to admit, I love Downton Abbey as well. But you are right: get the f**k out!

    1. Thanks!….I can only imagine how quaint / bizarre Downton looks from over there in the US!

  9. Mark Curtis · · Reply

    “My policy throughout this nonsense was always to try to remember the underlying purpose of work…which was to fund getting the fuck out as quickly as possible. People forget that the primary purpose of business is to make money.

    This statement sums up my entire mentality in working for a larger corporate. First and foremost you are there to earn money. This comes above career ambition, pride, long hours and squabbling. Do your job well, hold your head up high and invest those pay cheques. Don’t waste time on the bickering, but spend time accumulating.

    1. Yes! Glad it’s not just me…

  10. […] have flatter hierarchies now, the levels in the pyramid are further apart. And anyway, TEA gives it to you straight between the eyes […]

  11. We should start a blog to track “Corporate Lunacy We Have Witnessed”. I once had to listen in to a Director shouting down the ‘phone to the Office Manager that his whiteboard was not as big as the new one a colleague had just had installed and that the situation better be rectified….and don’t even start me on staff car parking.

    1. Jim…thanks….love the whiteboard story and would be great to read about some more corporate lunacy stories on your blog!

  12. @Mark Curtis …..Spot on, running the gauntlet of psychopaths, sociopaths & narcissists for years in a corporate environment has a high health price that is not always obvious, so you need to have an exit strategy in your survival plan for sure !

    @TEA …..Although there is definitely overlap, maybe there is some misunderstanding in the differing perceptions of the power of compounding issue. I don’t see it as simply ‘The magic bullet that every putative FIRE aspirant should dream of’, vs ‘Irrelevant in the grand scheme of things’. I see it as just one tool in the box, albeit extremely important to the user, without which they would really struggle in their aim. But all the other tools are at least cumulatively as important & the more tools you have in your kit, the better the performance you can produce, most likely faster too.

    As for the again related but separate issue of education, using compound interest to train or open up curious minds can only be useful, it at least introduces the concept, so that the aspirant can at least recognise opportunities if they appear in life & as importantly, then know what to do about it. Then with multiple actions, such as adding any spare savings annually, any wage increases that come along, any unexpected bonuses of any description that can be spared …..these can all add to the stash. I think that a good % of the general population can still get a stretch of their working lives where they are paid enough to do some serious saving without any pain & as you have proved, with a balanced investment portfolio, it is possible, not even unusually so with enough effort, [even just self-educated] to get a 10% return.

    Modelling compounding [via Monevator’s excellent calculator] shows that yes, if you are not investing well & have modest or poor returns on your savings, the effect does seem over-rated. However if your overall strategy is more holistic/multi-pronged & for example you simply add any savings annually, (of course with the huge caveat that you are able to do so in the first place) & have a half decent interest rate, it then makes a huge difference & the reputation deserved.

    I actually know [sadly not in the biblical sense] several individuals just in my relatively small circle who have inherited enough, call it at least 6-figure amounts to be able to make an appreciable difference to compounding/investing …..& I’m sure I’m fairly average by social context. Yes, they almost all blew it asap, but that’s beside the point 🙂

    1. Survivor – yes, I completely agree.

  13. […] Investing classes from Downton Abbey – The Escape Artist […]

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