Power of Compounding

 

In the annual report of 1998, Warren Buffett stated the following:

         Over the 63 years, the general market delivered just under a 10% annual return including dividends. That means 1000 would have grown to 405,000 if all income had been reinvested. A 20 % rate of return, however, would have produced 97 million. That strikes us a statistically-significant differential that might, conceivably, arouse one’s curiosity. (The Essay of Warren Buffett,3rd Edition, selected and arranged by Lawrence A Cunningham, pg 92).

         I was curious and worked out the compound interest and found it to be accurate. Most of us just can’t imagine the power of compounding!

 

 

 

 

 

Compound Interest

 

FV = PV (1+i)^n

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

n

PV

 $1,000.00

 

 

 

 

 

 

 

i

 

5%

7%

8%

10%

15%

20%

 

 

 

 

 

 

 

 

 

5

 

 

$1,276

$1,403

$1,469

$1,611

$2,011

$2,488

10

 

 

1,629

1,967

2,159

2,594

4,046

6,192

15

 

 

2,079

2,759

3,172

4,177

8,137

15,407

20

 

 

2,653

3,870

4,661

6,727

16,367

38,338

25

 

 

3,386

5,427

6,848

10,835

32,919

95,396

30

 

 

4,322

7,612

10,063

17,449

66,212

237,376

40

 

 

$7,040

 

 

$45,259

 

$1,469,772

50

 

 

$11,467

 

 

$117,391

 

$9,100,438

63

 

 

 

 

 

$405,265

 

$97,368,505

 

 

 

 

 

 

 

 

 

 

Charlie Munger states the following:

 

”Understanding both the power of compound return and the difficulty of getting it is the heart and soul of understanding a lot of things.” 

 

The success of sit on your ass investing is driven by a company’s ability to successfully compound shareholder equity at an attractive rate over the long-term --- if this isn’t possible, the strategy won’t work and it’s easier to buy low and sell high.

 

“Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result.”