He’s been preaching this for six decades, and it’s made him a billionaire. And it’s something every investor can copy.
Beginning in 1956, Buffett spent 14 years as general partner of Buffett Partners Ltd., the hedge-fund-like entity he ran before dedicating himself fully as Berkshire Hathaway Inc.’s BRK.A, -1.03% BRK.B, -0.88% chairman and CEO. This also marked the beginning of his side career as a teacher.
Buffett has always liked writing letters to teach investing principles. Using his typical wit and easy-to-understand style, he started his first lesson on compound interest to the inventors in his partnership by humorously calling into question the soundness of Queen Isabella’s decision to fund Christopher Columbus’s expedition to find a new route to Asia. “Aside from the psychic income associated with discovering the New World,” he wrote in a letter in 1963, “it wasn’t exactly another IBM (a stock that was doing very well at the time).”
As he figured, had the queen opted instead to invest the $30,000 at 4% instead, it would be worth over $7 trillion today. Such is the remarkable power of compound interest, which Einstein called the eighth wonder of the world. Even modest amounts, when allowed to compound at relatively low rates but over long periods of time, add up to really staggering sums.
Buffett was intent on pounding this idea into his partners’ understanding of what matters in investing.
His second story on compound interest takes a look at King Francis’ decision to commission the Mona Lisa in 1516. The math works out to show that Ferdinand’s $20,000 would be worth well over a $1 quadrillion if he’d only manage to invest it at a 6% annual rate instead.
Buffett said he hoped this figures would “close the discussion of art as investment in our home” (his late wife was a collector and gallery owner for a time).
In yet another humorous letter on compounding, Buffett inspects who got the better deal, Peter Minuit or the Manhattan Indians, who sold their island for $24 In 1626. When he wrote the letter in 1965, Buffett figured the land value of the island was roughly $12.5 billion, which worked out to a 6.12% compounded annual gain. Not bad. However, had the “Tribal Mutual Fund” managed to earn 6.5% instead, their $24 would have been worth $42 billion. If they could have squeaked out yet another half-percentage point a year and get 7%, the value jumps to $205 billion.
This is Buffett’s way of demonstrating the enormous impact from even modestly higher rates of compounding over long periods of time. An extra percentage point a year may not seem like a lot when viewed in isolation, but as you can see from the example, the cumulative impact of a minor change can be enormous.
Acting rationally, consistently, while harnessing the power of compound interest over a very long period of time is what has made Buffett perhaps the most successful investor of all time. Why not harness it for yourself? Start early and think long term.
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