Learn to invest with Buffett

Chapter 56

Chapter 9 Compound Interest, Harnessing the Value of Time

Chapter 9 Section 1 Buffett's biggest investment secret - compound interest

Compounding interest is a bit like rolling a snowball down a hill. It starts out small, but rolls down long enough and sticks fairly tightly that it eventually becomes very, very large.

--Warren Buffett
To understand Buffett, the progressive concept of compound interest is extremely important.This concept is easy to understand, but in investment theory, for various reasons, this concept is often downplayed.Buffett believes that the theory of progressive compound interest reigns supreme.

In 1962, in the annual report of Buffett Partners, Buffett calculated how amazing the result would be if the Queen of Spain invested $3 at compound interest instead of supporting the Columbus voyage!He wrote:
"Based on incomplete information, I estimate that Isabella's initial financial support to Columbus was about 3 US dollars. This is the minimum amount required to ensure a reasonable and successful use of expedition funds. Regardless of the spirituality brought about by the discovery of the New World It needs to be pointed out that the consequences of the whole incident are not another IBM. After a rough estimate, the initial investment of 3 US dollars is now worth 4 trillion US dollars at an annual compound interest rate of 2%. "

If you want to use compound interest to achieve the effect of rolling money, the first element is that the higher the rate of return, the better.The second key factor is time.The curve drawn by the compound interest effect is exactly the same as the kite curve. If the calculation is based on the principal of 1 yuan, you can see the different curves at different rates of return below.

From the figure above, we can see that compared with the rate of return of 20% and 30%, the difference between the principal and interest after 20 years of accumulation is dozens of times, which shows that the higher the compound interest, the steeper the curve of the kite, and the accumulation of compound interest In the figure, every 1 yuan is calculated with annual compound interest of 10%. After 15 years, it will only increase to 4 yuan, but after another 15 years, this 1 yuan will become about 18 yuan.In the same 15-year period, the growth rate of the total amount of interest plus interest is more than 4 times that of the former. This is the charm of compound interest. After the take-off period, it can soar into the sky.

The magic stone of compound interest can turn lead into gold, money will increase in value, money can make money, and money can make more money.The gap created by compound interest is staggering. Assume that there is a deposit of 10 yuan, and the rates are 10%, 20%, 30% and 5% over 10 years, 15 years and 20 years respectively, regardless of the tax cycle. Accumulation is carried out under the condition of progressive compound interest, and the final progressive value will have an astonishing gap.

The difference between just 5% and 10% can have a surprising impact on the overall return on investment. 10 yuan will be worth 10 yuan after 10 years through tax-free compound interest calculation at an annual return rate of 259374%. If the return rate is increased to 20%, then 10 yuan will increase to the total value after 10 years It is 619173 yuan, and after 20 years, it will become 3833759 yuan.If the annual rate of return of 10 yuan tax-free is 20%, the value will grow to 30 yuan for 23737631 years, which is a considerable profit.

If 10 yuan is calculated at a tax-free annual rate of return of 5%, after 30 years, it will be worth 432194 yuan.However, if the annual rate of return is 10%, after 30 years, 10 yuan will be worth 1744940 yuan. If the annual rate of return increases by 5%, that is, with 15% progressive calculation, after 30 years, the 10 yuan will become 6621177 yuan, if it is increased from 15% to 20%, 10 yuan is progressively increased by 20% every year, and it will increase to 30 yuan in 23737631 years.So it's surprising how little percentages can make a difference over a long period of time.When it comes to long-term investing, no factor is more influential than time.Over time, compound interest will play a huge role in realizing huge after-tax gains for investors.

If you set up a new company and only issue 100 shares at $10 each, the company's net assets are $1000.One year later, the company's profit is $200 and its return on equity is 20%.These profits are then reinvested into the company, which at the end of the first year has a net worth of $1200.The company's return on equity for the second year is still 20%, so that the company's net worth at the end of the second year is $1420.Running this way for 79 years, the original investment of $1000 would eventually turn into a net worth of $1.8 million.

The difference in the two factors makes the value added by compound interest also very different: the length of time will have a huge impact on the final value, and the longer the time, the more value added by compound interest.The rate of return has a huge leverage on the final value. A small difference in the rate of return will make a huge difference in the long-term value. Based on an annual rate of return of 6%, the initial value of 1 yuan will increase to 30 yuan after 5.74 years. Based on an annual rate of return of 10%, the initial value of 1 yuan will increase to 30 yuan after the same 17.45 years. The small difference in the return rate of 4% makes the final value difference as high as three times.

Investment motto:

"Time creates money, and money creates freedom." If you want to get rich through investment and strive for financial freedom, the earlier you invest in financial management, the more you can create a high-growth kite curve. If you use investment tools with higher return on investment correctly, Give full play to the benefits of compound interest, and you will have the benefits that will surprise you.

(End of this chapter)