Compounding: The Silent Hero in Your Investment Portfolio

When is the last time you heard an expert on a business channel talk about the power of compounding over time? And yet, it might be the most important concept in investing and growing one’s wealth. Yes, the returns you generate are important, but for most investors, average to below-average returns are likely due to a myriad of factors. However, compounding and time are something you have control over and may be far more important in the growth of your money. It was something on Berkshire Hathaway’s website that got me thinking of us—more on that and Buffett below—but here are some stories and examples on the incredible power of compounding.

Compounding In Nature

Popular blogger Morgan Housel wrote a great piece on compounding here. But he starts out telling how the Earth has entered multiple ice age periods that scientists know about. It was once thought that the ice age periods were a result of multiple years of winters that ultimately resulted in a frozen planet. However, as Housel points out, it’s not the winters at all, it’s the summers. Specifically, summers gradually became cooler, which resulted in some residual snow being left on Earth. Over the thousands of years, as more and more snow compounds, it ends up bringing on an ice age. An example of something that starts off very small, practically unnoticeable, that can change the trajectory of a planet.

Buffett and Berkshire

Warren Buffett represents the epitome of long-term compounding when it comes to investing. According to estimates, Buffett’s net worth crossed the $1 billion mark somewhere in his mid-50s. If Buffett were to have just sunsetted into retirement and put his money in bonds, the world may never have seen Buffett as such an incredible investor (although his track record was still amazing then). Instead, he’s continued to run Berkshire and keep his wealth tied to the stock. Buffett is worth $112 billion today, so this means $111 billion (99%) of that came after he turned 50.

In 2006, Buffett made a pledge to give most of his wealth away to a handful of causes and foundations. In June of this year, Buffett announced the charitable disbursement of $50 billion of Berkshire stocks. As he pointed out in the press release, the $50 billion in stock being donated in 2023 is more than Buffett’s entire Berkshire stake of $43 billion in 2006 when he initially made his commitment.

Power in Starting Early

Here is another powerful example of compounding.

Here is another powerful example of compounding. Let’s say you have two investors: Investor A saves $1,000/year from the ages of 22 to 30 and then no more from age 31 to 60. Investor B saves $1,000 a year from ages 30 to 60. Both investors achieve an 8% annual return on their investments. Who do you think ends up with more money? Spoiler alert: the power of time and compounding wins, and at 60, Investor A has $135K, and Investor B has $133K, but Investor A only invested for 8 years while Investor B invested for 30 years. See the results here.

Let It Work For You

While not at the forefront of investors’ minds or the news headlines, it’s compounding that stands as a silent hero within one’s investment portfolio. Often overlooked or underestimated, its power quietly works behind the scenes, steadily building wealth over time. Whether it’s the gradual accumulation of snow leading to an ice age or the remarkable growth of Warren Buffett’s net worth, the principle of compounding remains a fundamental force in building wealth over time.

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Originally Posted July 19, 2023 – Compounding: The Silent Hero in Your Investment Portfolio