Compound growth is a concept that is not intuitive.
We get very strange intuitive answers when we try to understand three factor investment results.
Most of us never see the real effects because we don’t have a long enough time scale.
The Buffett Story
You can follow the Buffett history here. The Evolution of Warren Buffett’s Career.
It is quite interesting. From his first business adventures at age 6 to now, 80 years later. Buffett is near unique in his ability to stay excited. Proof if you love what you are doing you won’t “work” a day in your life.
There is a big payback when the time is long.
The result of compounding depends on three factors:
- The capital employed
- The time invested
- The rate of return
Focusing on rate of return by itself misleads.
At age 20 Buffett has accumulated roughly $10,000. By age 26, it is $140,000. a very attractive rate of return of 55% annually. It is likely worth noting that at this point in his career he is likely adding capital from his “day job,” so the increase is not due entirely to investment yield.
By age 30 he reaches $1,000,000. In the 60% return range and again likely with new savings.
Nineteen years later he reaches $100,000,000. Growth rate is a comfortable 27% over those nineteen years.
Just four years later, he makes the Forbes list with a net worth of $620 million. Back into the mid 50s for his growth rate in that four years.
Buffet has increased his worth by a factor of 62,000 for each dollar in the beginning. Almost 40% annually over 33 years
Thirty-three years is about half his adult career.
Today his worth is around $76 billion. His rate of return is “only ” 16% or so for the second half.
In money, Buffet made 99.2% of his wealth in the second 33 year period and with a dramatically lower rate of return.
- If you focus solely on rate of return and neglect to save (create capital) you will do badly.
- If you start late you must increase your savings. Buffet would have had the same result starting 10 years later, but where would the capital have come from. If you argue, you will save later, you automatically assume you will save more. Maybe much more. How will you afford that. Future self will be disappointed.
If you invest $25,000 for 40 years at 10% you get more than a million. It is barely over half a million in 35 years. That is a loss of $100,000 per year of waiting. Expensive!
You could get the about same answer if you make 12%, but that entails more risk. You might get nothing.
People are linear not exponential.
When I mow the lawn, I am about half done in half the time. When I invest, the last double provides as much income as all the earnings prior. We have trouble adjusting to an idea like that found in Buffett’s career. When he was half done, he had less than 1% of his eventual wealth and his growth rate was much slower in the second half.
When I cut the lawn and complete 1% in the first half of my time, I will not expect to slow down to achieve my target. When I invest, and give myself enough time, I can slow down and be more conservative.
That is valuable because I don’t like the idea of having to earn the capital more than once.
Know what the money part means.
You cannot spend yield. Only money. Give yourself the time opportunity. Pay attention to taxes. Keeping half the yield would force you to about double the time.
Learn to use a calculator. Compound growth is a little paradoxical if you do not. No one is ever going to get yield questions right without calculating the outcome.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. email@example.com 866-285-7772