The Power of Compounding

Photo by Markus Spiske / Unsplash

I recently saw stories featuring Charlie Munger (Warren Buffett’s 99-year old business partner) and “one of the best investments he ever made.” One of the recent headlines reads: Charlie Munger pockets $70,000 a year from a $1,000 investment he made in 1962 – and has likely raked in over $1 million in total.

This sounds too good to be true. You put in $1,000, and 60 years later, the investment proves to be worth $1 million dollars! 

But it isn’t magic, and it isn’t some obscene annualized return. $1,000, continuously compounded at 13% for 60 years, would leave you with about $1.5 million.

More interestingly, Berkshire Hathaway has had annualized gains of 19.8% per year from 1965 through the end of 2022 (see page 1 of the annual letter to shareholders). If Munger had taken that same $1,000 and put it in Berkshire Hathaway stock, it would be worth more than $35 million today. If he had put it in the S&P 500, earning annualized returns of 9.9%, it would only be worth a measly $238k.  

Why do I bring this up?

Because humans have a very hard time comprehending compound growth over long periods of time.  $1 million compounded over a 30-year retirement at 4% is worth $3.2 million. That same money compounded at 8% is worth more than $10 million. Twice the interest rate but roughly three times the ending value. 

If we define risk as the likelihood of running out of money, quite often, the biggest risk a retiree can take is focusing too much on minimizing short-term volatility at the expense of long-term growth and the magical powers of compounding.