You probably know at least a few of Warren Buffett's tips for investment success. Only invest in businesses you understand. Focus on long-term value, not short-term stock price. Buy with the intention to hold -- otherwise, don't buy.
You probably also know that approach has made him extremely wealthy; as of this writing, Buffett is worth $96 billion.
Buffett started investing when he was 10 years old and by age 30 had amassed a net worth of $1 million. (In today's dollars, approximately $10 million.) Not too shabby -- but a far cry from $96 billion.
By age 50, Buffett was worth $300 million. A whole lot less shabby -- but $95.7 billion less than he's worth today.
By age 65 (his Social Security retirement age), Buffett was worth $3 billion. The farthest thing from shabby -- but $93 billion less than the 91-year-old is worth today.
Now, just for fun, let's pretend Buffett had lived a normal young adult life -- and by "normal," I definitely mean "mine" -- and knocked around working various jobs while he figured out what he wanted to do. And somehow, by age 30, had saved $25,000 he could invest. (Which is definitely more than I had when I was 30.)
Now imagine that Buffett was somehow able to earn the same rate of annual return on his investments -- unlikely, since he wouldn't have two decades of education and experience and accumulated wisdom under his belt -- and then retired in his 60s, like most people of his generation hoped to do.
What would Buffett be worth? $11.9 million. Absolutely not shabby.
But $95.989 billion less than he's worth today.
If we assume Buffett had the same level of financial savvy, investing skill, and discipline and effort and focus, why such a huge difference in results?
The Power of Compounding
According to Alice Schroeder's The Snowball: Warren Buffett and the Business of Life, a young Buffett was sometimes heard muttering things to himself like, "Do I really want to spend $300,000 for this haircut?" (H/t to this Wall Street Journal article by Jason Zweig.)
Warren Buffett obviously never spent $300,000 on a haircut. The remark instead refers to the power of compound earnings over time, something Buffett later called "the Methuselah Technique": the financial advantages of a long life, a high rate of return, and as Buffett wrote in his 1965 Buffett Partnership letter, "a combination of both (especially recommended by this author)."
Of course, he's right: Where building wealth is concerned, time is your friend. Say you invest $5,000 and receive a relatively conservative 6 percent return. Over time, here are the gains on that $5,000:
- 5 years: $1,691
- 10 years: $3,954
- 15 years: $6,982
- 20 years: $11,035
- 25 years: $16,459
- 30 years: $23,717
- 35 years: $33,430
- 40 years: $46,428
Clearly, time is your friend.
And so is effort.
The Power of Early Effort (or Starting Now)
While it's fun to assume differently, most of us aren't Warren Buffett. We have relatively little control over the rate of our investment returns. The difference we're able to make in our investment returns tends to be small.
But what you can control is how much you save -- and the faster you build your savings, the faster you achieve a critical mass of wealth and the greater the effect even marginal gains in investment return will have on your principal.
That's where Buffett's $10 million net worth at age 30 paid such huge dividends. The same is true for his $300 million at age 50.
Double your money when you're worth $10,000, and you have $20,000. Handsome rate of return, sure, but in actual dollars not life-changing.
Double your money when you're worth $10 million, and you have $20 million. Handsome rate of return and a huge jump in actual dollars.
The Power of Time
The same principle holds true for many decisions. Hiring a great employee is a form of compounding; that one decision can pay dividends for years.
So is finding the right location. Finding the right business partner. Finding the right vendors and suppliers. Spending a little more on equipment that will do the job both now and for years to come.
Expedient decisions are sometimes necessary, but whenever possible think in terms of compounding. What is the long-term effect? How will this pay off not just today, but well into the future?
The biggest key is to start now: to start solving for the future by making decisions that take full advantage of the power of time and return.
Do that, and you won't settle for hiring a decent job candidate; you'll hold out until you find the perfect person to fill your opening.
Do that, and you won't keep spending money on expedited shipping to meet delivery dates. You'll spend a little money on fixing the process so you don't have to overspend on shipping.
Do that, and you won't decide to put off developing a new service. You'll start today, because waiting means it will take you longer to start earning revenue from that service.
Worse, waiting decreases the odds you ever will.
That's the true power of time: making decisions that will hopefully pay off for the rest of your life.