"Mow your lawn, Mister?"

Harry Simms looked down at the tow-headed kid in front of him. He looked about 12. Behind him was a shiny new Toro lawnmower.

"Nice mower, kid," Simms replied. "Where'd you get it?"

"Just got it for my birthday. Pop was gonna get me a bike, but I told him I'd rather have a lawnmower. That way I could mow lawns for money and end up with both a lawnmower and a bike."

Simms smiled. He liked the kids gumption. Simms was the wealthiest man in Ford Junction, a millionaire many times over. He loved making money and admired the kid's work ethic. He'd made his money in business and owned the local mall, a few office buildings and a hotel, as well as the farming equipment retail business that got him started.

"Sure, kid," he said. "You can mow my lawn. It's a pretty big lawn. How much do you want me to pay you?"

"A penny," replied the kid.

"A penny?" laughed Simms. "You're not gonna make much money at that rate. I'll pay you twenty bucks."

"No," said the kid. "All I want is a penny. But I want a long term contract and a raise every week."

"Hmmm." Simms reflected on this. Shrewd kid, he thought. "How much of a raise do you want and how long a contract?" Simms expected the kid would want a ten dollar raise each week., which he could see would get quite expensive after a while.

The kid looked up at Simms. "Mister, I want you to double my pay every week. This week a penny. Next week two cents. The third week four cents. And so on."

Simms had a head for business, but was no mathematician. "That sounds pretty cheap," he said. "it's a deal."

The kid smiled. "A real bargain, mister. I'll mow your lawn every week from now until the middle of September, fourteen weeks in all. And then again next year, okay?"

"Sure, kid." Said Simms laughing. "A penny! Ha ha ha."

The kid pulled some papers from his pocket. "Can you sign this paper, mister?" he asked.

The tycoon looked them over. It was a contract written up in coloured ink. The script looked childish, but was quite clear. It specified a starting wage of a penny, a doubling of the pay each week and a two year term consisting of fourteen weeks each summer. "You been watching too many lawyer shows on television!" chuckled Simms as he signed. "Joey, eh? Joey Wilson. Okay Joey. You can start on the lawn now and I'll pay you your penny when you finished."

By the twelfth week Joey was making the twenty bucks Simms was quite willing to pay the first week. The last week of the summer, Simms handed the kid his $81.92 saying, "You know, kid, you're smarter than you look. You got enough money to buy that bike after all."

"Yep, " said the kid. "I made a hundred and sixty three bucks and eighty-three cents. I've been saving it and I'm going right out and buy that bike right now."

The millionaire smiled as the boy walked away. The boy turned around at the end of the walk, grinned and shouted, "See you next year, Mr. Simms!" Then it hit him. The wealthiest man in Ford Junction turned green. "If he started out with a penny a week this summer and ended up getting eighty bucks in the last week," he thought, "then what the heck is he gonna end up with by the end of next summer?"

Take a guess. By the end of the summer, how much will Joey have made all together? Over $500,000? Over $1 million? Over $2.5 million?

The Power of Compounding

The story is meant to illustrate the effect of compounding, the greatest secret of wealth production known to man. In the story, the rate of compounding is 100% a week for 28 weeks. With such a high rate of return over such a short period, an investment of a mere penny yields unbelievable wealth. Did you guess the right answer? In fact, little Joey would earn $1,342,177.28 in the last week of his contract. His accumulated earnings would be $2,684,354.55. Amazing but true.

In the real world of investing, we can't expect to make that kind of return. But we can reasonably expect to make between five and twenty percent. To determine how long it would take to equal Joey's rate of return we apply the rule of 72. This formula says you divide 72 by your rate of return to determine how many years it takes to double your money. So if you're getting a return of 12% on your money, it takes you 72/12 or six years to double your money. If you are getting a return of 24% a year, you double your money in three years. This is a rough calculation, but is close enough for a rough estimate. It doesn't work for large returns. You don't double your money in one year with a 72% return as the formula would suggest.

Let's say you can garner a 12% return, a not unrealistic goal for a careful investor. You double your money every six years. To equal Joey's feat you would have to hold an investment for 168 years to grow an investment of a penny to $2.5 million. A bit long for most of us, but then, we would invest somewhat more than a penny!

The charts below show how money compounds over time. The first shows how $1 invested grows over time at various interest rates. The second shows how much $1 a year invested grows over time at various interest rates. These charts are more exact than the Rule of 72.

Chart # 1: How $1 Invested Grows

Chart # 2: How $1 a Year Invested Grows

Source: Successful Investing & Money Management Course, Hume Publishing. (1985 Edition)

As you can see from Chart # 1, $10,000 invested at age 30 and held to retirement at age 65 with no further investing would be worth $528,000 at a compounded annual rate of return of 12%. Start 10 years earlier at age 20, and the original $10,000 investment would be worth over $1.5 million. If a smart kid like Joey worked at the local McDonald's from age 16 to 20 and managed to save $2500 a year, he could invest it in quality mutual funds and retire a millionaire without ever investing another penny. Amazing but true.

And if you invest in something that has a track record like Templeton Growth or Trimark or Berkshire Hathaway stock and they continue to perform at over 15% a year return, you can plunk in $10,000 at age 30 and retire a millionaire.

The lower the rate of return, the longer you need to hold an investment to generate the large returns. In his 1998 RRSP Guide, Garth Turner notes that few people adequately prepare for their retirement. And he also notes that anyone more than ten years from retirement shouldn't count on a dime from government in their golden years. But, he says, even someone age 45 with no savings at all can still retire a millionaire with some planning and a commitment to save now.

Looking at Chart # 2, we see that someone age 45 starting to invest now at a steady rate will have 72.05 times his annual investment on retirement if he gets a return of 12%. To retire with a million dollars, he would have to put away $13,879.25 a year. If the 45 year old can get a 15% return, he would only need to invest $9761.82 a year. (How much easier to have put away $10,000 at age twenty or thirty! Ain't it all so easy in hindsight? Younger readers, take note! Invest now!)

If the 45 year old comes into some money through inheritance or winning a lottery, a lump sum of $103,626.94 would be needed to retire a millionaire given a compound rate of return of 12%. If the investor can get a 15% return, he needs to invest only $61,087.35.

So what should a 45 year old with no savings do right now? If you can afford to start putting away $10,000 to $15,000 a year, do it now! If you can't, but have substantial equity in your home, some experts, including Garth Turner, recommend re-mortgaging your home to invest.

With long term mortgages at an all-time low, you can borrow $100,000 very cheaply. The downside to such leveraged investing, of course, is a major stock market crash. And by major, I mean one on the scale of 1929. The fact is, however, that since 1929, there has been only one significant crash, the great bear market of 1973-1974. And even riding through that bear market, Templeton Growth and Berkshire Hathaway weathered the storm and continued giving long term compound rates of return in excess of 15% for Templeton and in excess of 20% for Berkshire Hathaway. The other so-called crashes - 1987 and 1997, were tempests in a teapot compared to 1973-1974. Markets recovered to previous levels within six months both times.

Disclaimer: As with all my columns here, I should re-iterate a precaution. I am not a professional financial advisor. I am a financial journalist and editorialist. The views in these columns are my personal opinions. You should consult a professional advisor before acting if you do not consider yourself knowledgeable in the field. For the record, my own investments comprise a 50/50 mix of standard RRSP investments and leveraged non- RRSP investments.

Origins: The lawnmower story is based on a story I heard long ago about a Chinese peasant who had done a great service for the Emperor, saving his daughter or something like that. The Emperor told the peasant he could have anything he wanted. The peasant pointed to a nearby chessboard and told the Emperor he wanted a grain of rice for the first square on the chessboard, two grains for the second square, four grains for the third square and so on. The Emperor laughed, considering the peasant a fool, and agreed to the request. When the calculations were done, it turned out there wasn't enough rice in all of China to pay the man. I've tried to find the original story and have been unable to. If anyone can tell me where I can find it, I would be most grateful. Email me.

Financial Forum: I had the pleasure of spending a couple of hours at the Financial Forum in Vancouver today (Sunday, Feb. 15). I didn't get a chance to attend any of the lectures, but collected a wealth of information visiting all the booths. I'll share some of the information in future columns.

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