It is the most important factor in wealth accumulation.
It matters in life.
It is the biggest reason that anyone should be careful about taking on debt. If compounding is on your side, it is your greatest friend. If you are on the wrong side of compounding, it will bury you.
It is really true that there is no greater power on earth than compounding.
I recently came across a fantastic article on the power of compounding that was written by Morgan Housel entitled "The Freakishly Strong Base" who had some great observations on compounding.
Housel makes an important point that I had not considered before regarding Warren Buffett. Most consider Buffett to be the greatest investor of all time.
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| Warren Buffett |
However, did you realize that 97.6% of Buffett's net worth of $81 billion today is attributable to what he had saved by the time he was age 30!
Without the base of assets he had accumulated by age 30 (and which he then produced compound returns on) his net worth today would only be $1.9 billion rather than the $81 billion he has. The fact that Buffett literally started investing as a teenager and saved up a $1 million by the time he was age 30 gave him a greater investment advantage than anything else he did in his entire life.
More than 2,000 books are dedicated to how Warren Buffett built his fortune. Many of them are wonderful.
But few pay enough attention to the simplest fact: Buffett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child.
$80.7 billion of Warren Buffett’s $81 billion net worth was accumulated after his 50th birthday. Seventy-eight billion of the $81 billion came after he qualified for Social Security, in his mid-60s.
Did that sink in for you?
Buffett is 87 years old today but all but $300 million of his wealth was accumulated after he was age 50.
He has grown his net worth from $3 billion to $81 billion since he was age 65.
Those are impressive increases in his later years. However, more impressive is that if he did not have that $1 million base at age 30 (and instead had $24,000), and still did everything else the same over the remainder of his life, he would have only had $1.9 billion today.
$1.9 billion is nothing to sneeze at. However, if that is all that Buffett was worth today there is a good chance that you would have never heard of him. He also would likely have had about two books written about him rather than those 2,000 that attempted to detail his investing genius.
This is why I always stress to young people on how important it is to start early on their savings and investing. If you do that on thing and stick with continue doing it, it is almost impossible not to become wealthy due to the power of compound returns.
Housel makes the point that age 30 is a critical point in which you want to be able to differentiate yourself from your peers. Therefore, it makes it critical to begin saving and investing in your teens and 20's.
Thirty is an important age, a time when ambitious workers break free from entry-level jobs and can begin saving real money. The distribution of net worths isn’t particularly stratified for those in the teens and 20s, but starts to spread around age 30. An extra $100,000 of net worth can push someone in their 20s from the 50th to the 95th percentile. By age 30, you need an extra $390,000 of net worth to make that jump.
Of course, we know very few young people are doing this today or have done it in the past. Therefore, it is not surprising that very few people have much in the way of savings which will undoubtedly also be the same in the future.
It also goes without saying that a good number of people reading this blog post are beyond the age of 30.
Is there hope for you? The simple fact is that it is not going to be any easier tomorrow. Work on increasing the base you are compounding from today.
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| When is the best time to plant an oak tree? Credit: Britannica.com |
There is no mistaking the fact that the best time to plant an oak tree was 30 years ago. However, the next best time is today.
The unassumingly strong base is rooted in the same thing: Compounding is not intuitive, so it’s systematically overlooked and underappreciated.
Michael Batnick once explained it. If I ask you to calculate 8+8+8+8+8+8+8+8+8 in your head, you can do it in a few seconds (it’s 72). If I ask you to calculate 8x8x8x8x8x8x8x8x8, your head will explode (it’s 134,217,728).
It is so easy to overlook how powerful it can be to take something small and hammer away at it, year after year, without stopping. Because it’s easy to overlook, we miss the key ingredients of what caused big things to get big. How can most of Buffett’s success be attributed to what he did as a teenager? It’s so crazy, so counterintuitive. And since it’s crazy and counterintuitive we overlook the right lessons.
Physicist Albert Bartlett put it: “The greatest shortcoming of the human race is our inability to understand the exponential function.”
Read the entire article by Housel and pass these lessons along to someone you love.
To start accumulating a strong investment base you first need a strong base of knowledge. This is a good place to start.
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