Albert Einstein called compound interest,
"The 8th wonder of the world"
Mathematics and Compound Interest
WHEN DOES 5.25 = 8.9 = 14.83?
$1,000,000 invested @ 5.25% compound interest, for 20 years, becomes $2,782,542.
$1,782,542 annual profit over 20 years = $89,127.
$89,127 per year is actually 8.9% per year (simple nominal interest.)
What if that 8.9% yield is tax free?
The taxable equivalent yield of 8.9% (40% tax bracket) = 14.833%.
"0" coupon bonds are available in the marketplace that offer 5.25% (or more) tax free rates of return such as those described herein. "0" coupon bonds offer a way to invest and compound at a stated rate for a specific period of time. The bonds can be sold at anytime...for a profit if rates stay the same or go down...for a loss if rates go up and the bonds are not held long enough for the accreted value to make up for the loss. Some issuers may see a ratings change that could alter the value of their debt up or down relative to other securities with like qualities.
So how did we get 5.25% to 14.833% ? Simple, compound interest.
The risks? Interest rate and credit risk, of course, albeit...what investments have generated 9% over a long time frame? Not many.
If held for a long enough time, the chances of losing any money at the 5.25% level defaults to "0".
Can we find tax free zero coupon bonds that offer 5.25% yield to maturity for 20 years and at the same time carry "stable" ratings by all three services of Aa3/AA-/AA- ??? The answer is yes...at least we can as of this writing.