In this post, I hope to explain why I invest and why you should consider investing yourself. (Assuming you don't do so already.) It can be boiled down to a single word: compounding.
Compounding involves constantly reinvesting the interest earned from an investment. Over a long period of time, this interest on interest adds up to a great deal. Because we are all impatient, compounding is deeply under appreciated.
When Buffett started his partnerships in 1956, at the age of 26, he was already independently wealthy — having about $174,000 in personal savings, $1.6 million in today's terms. When you consider that the Buffett partnerships — of which Warren was the largest investor — compounded at 29.5% between 1957 and 1969, and that shares in his subsequent investment vehicle, Berkshire Hathaway, compounded at 20.8% between 1965 and 2016, it is unsurprising that he is now one of the richest men in the world.
While we obviously aren't going to be able to touch Buffett's record, we can still take away a few important things from his success. There are three important parts, which the table above helps illustrate. Firstly, to best take advantage of compounding, we need to start early. (In the womb, if possible.) To maximise our wealth, we need to try to compound it at the highest possible rate. Finally, like Buffett, we need to live a long and happy life.
All of this brings me to another important question: why invest in stocks? Over the long-term, Australian stocks have compounded 8–10 per cent per annum, depending on which dates you look at. Over the last 20 years, the gross return (i.e. before tax) has been 8.5%. Unlike property — unless you are very rich — you don't need to borrow to get started, either. If we assume that rate stays the same, $1,000 invested now will grow to $60,000 over the next 50 years. If we can invest better than the market — either through a good fund manager or our own stock picks — and boost the compounding rate to 11%, that $1,000 turns into $184,500.
Something to remember next time you're considering a big purchase.
Albert Einstein is said to have described compound interest as the "most powerful force in the world". As Jason Zweig points out, we should be concerned about the veracity of this quote — nevertheless, compounding is very powerful.
Warren Buffett provided the table below to his early investment partners in the 1950s and 60s. It shows the gains from a $100,000 investment compounded at different rates over 10, 20 and 30 years.
4%
|
8%
|
12%
|
16%
|
|
10 Years
|
$48,024
|
$115,892
|
$210,584
|
$341,143
|
20 Years
|
$119,111
|
$366,094
|
$864,627
|
$1,846,060
|
30 Years
|
$224,337
|
$906,260
|
$2,895,970
|
$8,484,940
|
Compounding involves constantly reinvesting the interest earned from an investment. Over a long period of time, this interest on interest adds up to a great deal. Because we are all impatient, compounding is deeply under appreciated.
When Buffett started his partnerships in 1956, at the age of 26, he was already independently wealthy — having about $174,000 in personal savings, $1.6 million in today's terms. When you consider that the Buffett partnerships — of which Warren was the largest investor — compounded at 29.5% between 1957 and 1969, and that shares in his subsequent investment vehicle, Berkshire Hathaway, compounded at 20.8% between 1965 and 2016, it is unsurprising that he is now one of the richest men in the world.
While we obviously aren't going to be able to touch Buffett's record, we can still take away a few important things from his success. There are three important parts, which the table above helps illustrate. Firstly, to best take advantage of compounding, we need to start early. (In the womb, if possible.) To maximise our wealth, we need to try to compound it at the highest possible rate. Finally, like Buffett, we need to live a long and happy life.
All of this brings me to another important question: why invest in stocks? Over the long-term, Australian stocks have compounded 8–10 per cent per annum, depending on which dates you look at. Over the last 20 years, the gross return (i.e. before tax) has been 8.5%. Unlike property — unless you are very rich — you don't need to borrow to get started, either. If we assume that rate stays the same, $1,000 invested now will grow to $60,000 over the next 50 years. If we can invest better than the market — either through a good fund manager or our own stock picks — and boost the compounding rate to 11%, that $1,000 turns into $184,500.
Something to remember next time you're considering a big purchase.
No comments:
Post a Comment