I consider Warren Buffett to be one of my mentors.
While I haven’t had the pleasure of speaking with him, I have read his biography Snowball, I read his annual letter to shareholders, and I read any news article where he is quoted.
After all, he is the most successful investor in the world.
58 years ago, Buffett and his partner Charlie Munger started their company, Berkshire Hathaway. In that time, the company has provided shareholders an annual return of 19.8 per cent per annum compound.
For context, if you invested $100 with them in 1965, your investment would now be worth more than $3.5 million.
These days a single share in Berkshire Hathaway costs more than $500,000!
Warren Buffett attributes his wealth to “a combination of living in America, some lucky genes, and compound interest.”
Living in America refers to the phenomenal economic growth in America during his 58 years in business. Australia has a similar recent history.
Lucky genes refers to Buffett’s exceptional ability to focus and practice discipline.
Compound interest is Warren Buffett’s secret sauce to investing and he’s been sharing it with anyone who will listen for decades.
The effectiveness of compound interest, or compound growth, is results amplify over time. In investment terms, the longer you hold an asset, the more it grows in value.
In Buffett’s 2022 letter to shareholders, he references two of his most successful investments – Coca Cola and American Express (Amex).
In 1994, Buffett invested $1.3 billion in 400 million Coca Cola shares. The dividend Buffett receives has grown from $74 million to $704 million annually. What’s more, the $1.3 billion investment is now worth $25 billion.
Amex is a similar story. Buffett made significant investment in Amex in 1995 which, coincidentally, also cost $1.3 billion. Annual dividends received have grown from $41 million to $302 million and Buffett’s $1.3 billion investment is now worth $22 billion.
The shareholdings in Coca Cola and Amex both increased by 11 per cent per annum compounding.
The dividends alone work out to be an impressive 54 per cent and 23 per cent per annum.
But the most important aspect of these investments is Buffett owned them for 28 and 29 years respectively.
The mistake I think most investors make is not allowing time to work for them. Or more specifically, they don’t submit themselves to allowing compound growth to happen, which requires time.
If you bought a house in Melbourne in 1994 for the median house price of $146,000, it would be worth north of $1.6 million today. What’s more, the rent would have increased from $120 per week to $850 per week.
How does it compare with Coca Cola and Amex?
The value on Melbourne property has increased by 9 per cent per annum (versus 11 per cent for Coca Cola and Amex) and the rent would provide an annual return of 30 per cent (versus 54 per cent and 23 per cent for Coca Cola and Amex).
When you factor in a possible actual cash investment of only 20 per cent plus costs, the returns are likely even better than those of Coca Cola and Amex.
But how many people who bought a house in Melbourne in 1994 would still own that house today?
Well, Corelogic say the average property investor holds their property for just 8.9 years.
Compound growth is the secret sauce of investing, but it requires time. And time requires focus and discipline.
