What did Warren Buffett say about compound interest?
Warren Buffett bought his first stock when he was just 11 years old. Aside from being an investing genius, he credits time as the critical ingredient of his success. "I started building this little snowball at the top of a very long hill. The trick to having a very long hill is either starting very young or living to be very old," he said at Berkshire's 1999 annual meeting.
The power of compounding is an investment strategy that makes your money work for you. The interest you earn on your investments is reinvested at the same rate. So, you earn interest on your principal amount as well as the accumulated interest amount. It creates a snowball effect and you end up accumulating a huge corpus. Legendary investor Warren Buffett has doubled, tripled even quadrupled his wealth with the power of compounding.
What happens when you push a small snowball down a hill?
When you push a small snowball down a hill, it continuously picks up snow. The bigger it gets, the more snow it packs on with each revolution. When it reaches the bottom of the hill it is a giant snow boulder. The snowball effect is a metaphor for compounding. It explains how small actions carried out over time can lead to big results.
Assume there are two friends, Mr. Late and Mr. Early who wish to retire by the age of 60. Mr. Early starts investing at the age of 25 with a monthly SIP of $5,000 at an interest rate of 15% per year for 35 years. Whereas, Mr. Late starts at the age of 35 and invests $15,000 per month at an interest rate of 15% per year for 25 years. The total invested corpus of Mr. Early is $2.100.000. Whereas, the invested corpus of Mr. Late is $4.500.000.
Now can you imagine whose retirement corpus is bigger? Is it Mr. Late as he invested $2.400.000 more than Mr. Early? Well, you will be surprised to know that Mr. Late only had a retirement corpus of $48.7 million. Whereas Mr. Early had a retirement corpus of a whopping $73.4 million.
The Secret of Warren Buffett's Infinite Wealth
"My wealth has come from a combination of living in America, some lucky genes, and compound interest," he once wrote.
Buffett began seriously investing when he was 10 years old. By the time he was 30, he had a net worth of $1 million, or $9.3 million adjusted for inflation. Currently, at 90, he has a net worth of more than $81 billion. A large portion of that, however, was accumulated after his 50th birthday. And $70 billion came after he qualified for Social Security benefits, in his mid-60s.
But what if he was a more normal person, spending his teens and 20s exploring the world and finding his passion. What would a rough estimate of his net worth be today if he just started investing in his 30s and retired in his 60s? Effectively all of Buffett's financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. That's how compounding works.
Jim Simons, founder of the hedge fund Renaissance Technologies, has compounded money at 66% annually since 1988. No one comes close to this record. I believe latest estimates put Simons’ average annual returns at least double what Buffett has done. However, he did not find his investment stride until he was 50 years old.
Simons has a better track record (his returns since the 70s are incredible), but he started in the 70s whereas Buffett started in the 50s. Even before the 50s, Buffett started businesses, saved and invested his money since he was a kid. So we could almost say his track record began in the 40s. Assuming both lived for another 20 years, and they maintained their past performance, Simons would catch Buffett and would for sure be better known.
Investing early for the super-power of compounding
The secret to Warren Buffett’s enormous wealth is time. He began investing and grasped the power of compounding at the age of 10. On his 59th birthday, Warren Buffett’s net worth was only $3.8 US Billion. At the age of 91 his net worth is $87.5 billion. So, his wealth has multiplied by 22 times in the last 32 years! According to Warren Buffett, the more time your investment has to grow, the greater power of compounding it will achieve.
But investing early is winning only half the game. The second most important thing is to stay disciplined. Don’t stop investing especially when the stock market is falling. Rather, a falling market is the best time to increase your investments.
How do you maximize compound interest in stocks?
If you look at examples of Buffett's portfolios, you'll notice he's mostly invested in stocks that pay dividends — which offer another form of compounding. When dividends are reinvested, they generate more dividends, and the compounding dance continues.
Whether you're saving in the short term or investing for the long haul, compound interest is your best friend. So give it a hug, and let it work for you.
