World-renowned investor, Warren Buffett, bought his first stock at the tender age of 11…
But apparently, he regrets not starting earlier.
This may come as a surprise for the beginner investor.
But since Buffett understands the power of long-term investing, he realised that he has missed out on the compounding effect by not starting way earlier.
The Beauty of Investing Early
Physicist Albert Einstein once said that compound interest is the eighth wonder of the world.
So what’s compound interest? Great question that you asked.
Compound interest is simply the interest that accumulates on your initial capital and the accrued interest thereafter.
Compound interest allows a principal amount to grow at a quicker rate than simple interest. It’s like interest on steroids!
For example, the table below shows how a $100 investment that earns 6% per year on a compounded basis grows:
|Year||Amount at the beginning of the year||Interest for the year||Amount at the end of the year (including interest)|
|1||$100||6% x S$100 = $6||$100 + $6 = $106|
|2||$106||6% x S$106 = $6.36||$106 + $6.36 = $112.36|
|3||$112.36||6% x $112.36 = $6.74||$112.36 + $6.74 = $119.10|
|4||$119.10||6% x $119.10 = $7.15||$119.10 + $7.15 = $126.25|
|5||$126.25||6% x $126.25 = $7.58||$126.25 + $7.58 = $133.83|
The beauty of compound interest is that the earlier you invest, the longer the runway is for your money to grow and then double, quadruple, and so on.
Using the Rule of 72, you can know how long it takes for your initial capital to double.
For example, if your investment return is 6%, it would take 12 years for your money to double.
A Tale of Two Investors
The benefit of compounding our money early over the long-term is shown in one of the Dow Theory Letters, entitled Rich Man, Poor Man.
Say there are two people, Ah Tan and Ah Lee.
Ah Tan starts investing at the age of 19. He invests $2,000 every year from age 19 until 25 and stops thereafter. That means he has put $14,000 into the stock market.
On the other hand, Ah Lee starts investing only at the age of 26. From age 26 until 65, he invests $2,000 annually in stocks. By the time he turns 65, he has contributed $80,000 to his portfolio.
Assuming both investors can generate 10% yearly on their portfolios, whose portfolio would be larger at age 65?
Most would think that Ah Lee would have a bigger portfolio. Yes, Ah Lee indeed has a larger portfolio at $973,704 while Ah Tan’s portfolio would be worth $944,641.
However, here’s the fun part.
Ah Tan wins overall as he has a higher profit of $930,641 versus Ah Lee’s $893,704. Remember that Ah Tan had only put in $14,000 over seven years, while Ah Lee contributed $80,000 over 40 years.
Pictorially, this is how it looks like (Ah Lee is Investor A; Ah Tan is Investor B):
The article also mentioned the following about compounding (emphases are mine):
“Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately, anybody can do it. To compound successfully you need the following: perseverance in order to keep you firmly on the savings path. You need intelligence in order to understand what you are doing and why. And you need a knowledge of the mathematics tables in order to comprehend the amazing rewards that will come to you if you faithfully follow the compounding road. And, of course, you need time, time to allow the power of compounding to work for you. Remember, compounding only works through time.”
Time helps to accelerate the growth of our money, as can be seen from the formula for compound interest:
FV = PV × (1+r)n
where FV = Future Value; PV = Present Value; r = annual rate of return; n = number of periods
As shown, the longer the period, n, the more compounding can occur, creating a larger ending amount, FV.
Why You Should Start Investing At Year 0
Since the earlier we start investing, the better it is, it is always best to start investing at year 0.
But obviously, a newborn doesn’t know anything about anything, less so about compounding and investing.
Once the child turns 18, parents can choose to transfer the ETFs or shares held under their Central Depository accounts to their kids’ for them to continue the compounding.
Parents can consider robo-advisors to grow their children’s money as well.
As we have already seen, the longer the timeframe, the larger the potential is for our money to grow.
This is also why everyone should start investing at a very young age for the power of compounding to take effect.
…And that is probably why Warren Buffett regrets not investing before hitting 11.
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Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any stock.