Compound Interest
Tae Kim

Tae Kim

The Secret To Wealth Is…Time? | Compound Interest Explained

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Albert Einstein called compound interest the 8th wonder of the world.

He’s a pretty smart guy. So if someone as smart as Einstein labels something the 8th Wonder of the World – I like to pay attention.

So in this post, I want to talk to you about the secret sauce to really building wealth. Time.

And how compound interest can use time to blow up your banking account.

99% of Warren Buffet’s $100.5 Billion Net Worth Came After His 56th Birthday

There are literally hundreds of books written about Warren Buffet – the Oracle of Omaha.

They all try to dissect his success.

What is the secret formula to his investment strategy? What companies and industries he is investing in? How is he still alive after eating all that junk food!?

At the time of this video, Warren Buffet is worth $100.5 billion dollars.

That is a lot of money.

However, an interesting fact that a lot of people overlook, is that 99% of the 100 billion actually was accumulated after his 50th birthday.

Warren Buffet didn’t earn his first $1 billion until he was 56 years old.

People clamor all over Buffett’s investing strategy. However, what most people overlook is that his success didn’t come primarily from his investment strategy alone, but the fact that he’s been investing for three quarters of a century.

The curious child that he was, at 11 years old, Warren Buffet was already buying stocks.

By the time he was 21 years old, he already had a net worth of $20,000.

The simple fact is this. Warren Buffet’s $100 billion net worth isn’t due to just being a good investor, but being a good investor since he was a child.

I’m not saying he doesn’t have great investing skills – because I wish I had half the financial acumen that he has. However, we all miss the point when we attribute all his success to his investing skills.

Warren Buffet is worth $100 Billion today because he’s been a great investor for 70 plus years.

He is a skilled investor, but his secret sauce is time.

That is how compounding works.

Compounding Is Not Intuitive

If you don’t believe me, let’s dive into the math and see compound interest in action.

When you are first introduced to a compound interest table, something doesn’t feel right. It’s hard to wrap your head around it.

Or it could just be me.

Anyways, you can intuitively understand linear math. But not so for exponential math.

To give you an example, let’s play a little game.

Let’s say I came up to you and offered you two options.

  • Option 1 – I give you $1 Million Dollars. Right now, in cold hard cash.
  • Option 2 – I give you a penny. But this isn’t just an ordinary penny. But a magic penny. And this magic penny will double every day for the next 30 days.

Now, what option would you take?

At a first glance, it’s an easy choice.

Take the $1 million dollars. It’s a lot of money and it definitely feels a lot more than the penny, even if it doubles every day for the next 30 days.

But, what if I was to tell you, you would be making a serious mistake if you pick the one million dollar payout.

Why? Because of the power of compounding. Can you guess what that penny will be in 30 days?

Are you ready for it?

$5 million dollars.

The compounding effect is small initially. You barely hit a hundred dollar range half way through the month.

In the final 7 days, you go from around $80,000 to $5 million.

It’s really hard to wrap your head around this type of math, but it’s right there in front of you.

And this was how 99% of Warren Buffet’s fortune was made after his 50s. If Warren Buffet had started investing much later in life or stopped investing at a certain point, I doubt we would know who he is today.

This is the primary reason why Einstein called compounding the 8th wonder of the world – because it really is a wonder.

Double Edged Sword

But this wonder is also a double edged sword for many people.

Because it is hard to wrap our heads around it, many people ignore its power and focus on growing their net worth through other ways.

Compound works its magic when we can maintain a solid, consistent return for a long period of time.

This is what Warren Buffet did.

And a good low cost index fund like VTSAX, provides that solid consistent return for people like you and me. We just need to hold on to it long enough for the magic of compounding to work.

However, people are inpatient and compounding is not just intuitive enough.

So many people instead spend all their energy trying to beat the market and earn the highest investment return possible.

That’s why so many books are dedicated to trying to understand Buffett’s investing methods, but hardly any of them highlight the most obvious secret to his success – time.

Resist The Urge To Beat The Market

The main takeaway here is that you need to resist the urge to devote all your efforts to trying to beat the market.

Trying to find the right stock or the right mutual fund. You end up dancing in and out of the market, chasing after the latest investment fads.

If you happen to be one of the few in the world that can have consistent high returns like Mr. Warren Buffet, kudos to you. But, a mere mortal and a Sandwich Generation like me, I’d prefer to let time do the heavy lifting and spend my energy on other more important things in life such as my family and the people I love.

Good investing is about earning pretty good returns at a low cost that you can stick with for a long period of time. It’s not about earning the highest returns, because high returns are like one-time Broadway hits that can’t be repeated consistently.

Allow time to do it’s magic.

If you want to know more about my favorite investment that I plan to hold onto forever, check out my article about VTSAX here.

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