They say the best time to start investing was yesterday.

What if you could harness the power of compounding even before you understood it or knew what a retirement account is?

Billionaire hedge fund manager Bill Ackman once proposed a creative solution to the U.S. retirement crisis: give every child born in America a $7,000 investment account.

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In a 2023 interview with Harry Stebbings on the "The Twenty Minute VC" podcast, Ackman explained why this idea could have many benefits.

$7,000 birthday gift

Ackman’s plan is for the U.S. government to place $7,000 into an account created for every child at birth. To be clear, this isn’t a cash grant. He believes the account must be restricted from withdrawals and also tax exempt.

The money must be invested into an index fund and left alone to compound until the baby is old enough to retire, says Ackman. He estimates these accounts could be worth $1 million each after 65 years. He doesn't mention an expense ratio, which would reduce long-term returns, but we can assume he means a low-cost index fund.

Based on these numbers, it seems Ackman is assuming a compounded annual growth rate of 8%. That’s more or less the historical average of the U.S. stock market. The S&P 500 has delivered an annualized average return of 10.5% from March 1957 through March 2024.

As for costs to the government, Ackman believes it would be minimal and “a nothing thing.”

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There were 3.6 million babies born in the U.S. in 2021, which means that such a program would cost the government around $25 billion a year assuming the birth rate stays steady. By comparison, federal spending in fiscal year 2024 on transportation, commerce and housing credit, social security and national defense has been $60 billion, $65 billion, $715 billion and $433 billion, respectively.

Ackman doesn’t mention if such a plan would be funded by additional taxes or more government borrowing. But given the fact that he bet against U.S. treasuries in 2023 because of federal debt, it seems unlikely he would want this program funded by more borrowed capital. Ackman was a vocal critic of the carried interest tax loophole which allows wealthy money managers like him to lower their tax bill, which makes it likely he would favor tax hikes.

Regardless, this hypothetical birth grant program illustrates how important time is for compounded growth.

The power of compounding

While most investors try to maximize returns and starting capital, they have little control over their time horizon. The average American starts investing at 33 years old, according to a 2021 study by Personal Capital cited by Bankrate. That means a typical investor has less than 30 years to save for retirement.

Even if an adult starts saving and investing at 25, they’ve lost over two decades of their early life. For instance, a 25-year-old who deposits $7,000 into an S&P 500 index fund and earns an annual rate of return of 8% would have around $150,000 by the time they turn 65. That’s significantly lower than the $1 million nest egg an investor would accumulate under Ackman’s plan — but this is also assuming they leave the account untouched and don’t add to it as they earn and save. However, this example demonstrates the advantage of getting an early start.

A baby who receives the grant would have nearly $48,000 saved for retirement when they turn 25.

“We can't wait until people start creating an IRA or a 401(k) by the time they're, you know, 25 or 30 or 35 ... Just because of the laws of compounding,” Ackman said. “That extra 25 years is very, very material.”

Besides securing the financial future of many young Americans, Ackman believes such a program would allow every new citizen to inherit a stake in the economy. “It would start to give every baby in this country a piece of the success of this country,” he said.

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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.