“Compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn’t, pays it.”---attributed to Albert Einstein
“Time is your friend. Impulse is your enemy. Take advantage of compound interest and don’t be captivated by the siren song of the market.---Warren E. Buffett
We were all taught simple and compound interest in grade school.
But we weren’t taught that compounding money over a lifetime gets you rich. And debt compounded over a lifetime keeps you poor.
So here are ten great secrets of compound interest you weren’t taught in grade school:
Secret I Compound Interest Dons a Cloak of Invisibility
“The greatest shortcoming of the human race is our inability to understand the exponential function.”---Albert Allen Bartlett, Physicist
“Sometimes nature guards her secrets with the unbreakable grip of physical law. Sometimes the true nature of reality beckons from just beyond the horizon.---Brian Greene, Physicist
“Look deep into nature and then you will understand everything better.”---Albert Einstein
Like Harry Potter, compound interest dons “a cloak of invisibility.”
Compound interest is not intuitive and must be learned, remembered and applied.
You don’t have to know the mathematical formula, just this open secret:
If you don’t know compound interest, a penny doubled every day for a month is a bag of pennies.
If you do know compound interest, a penny doubled every day for a month is $10,737,418.23.
“Do it yourself and prove it to yourself.”---Alfred Wolf, Chemist
Note well that compounded wealth, like its evil twin, bankruptcy, arrives “gradually, then suddenly.”
“’How did you go bankrupt?” Bill asked. ‘Two ways,” Mike said. ‘Gradually and then suddenly.’”---Ernest Hemingway
“Time in the market beats timing the market.”---Kenneth Fisher
“My life has been a product of compound interest.---Warren E. Buffett
Secret II Never Too Young To Begin Compounding
“Charlie [Munger] always says that the big thing about it is we started building this little snowball on top of a very long hill. We started at a very early age in rolling the snowball down. And, of course, the nature of compound interest, behaves like a snowball of sticky snow. The trick is to have a very long hill, which means either starting very young or living to be very old.”---Warren E. Buffett
Follow the compounding penny and observe that big returns come at the end of a long, slow climb, like the Millennium Falcon of “Star Wars” entering “hyperspace.”
Like a pot of water slowly coming to a boil
Like the accumulated wisdom of old age.
Thus the earlier you begin, the sooner your wealth will compound mightily.
Concomitantly, it’s the earliest deposits that compound the most.
Thus a 14-year-old on a summer job, who deposits $1000 in an IRA invested in an S&P 500 index fund, compounding at 10% per annum, without further deposits, would have $276,801.49 at the RMD- mandated age of 73, without ever making another deposit.
Secret III Be Constant
“The first rule of compounding. Never interrupt it unnecessarily.”---Charlie Munger
“The thing about a compounding record—by its very nature, each link in the chain is equally important.”---Charlie Munger
So our 14-year-old must never interrupt the compounding IRA, never make withdrawals or cash out, to achieve the eventual bonanza result.
Moreover, if the annual $1000 deposit can be faithfully replicated each and every year, the account will grow to over three million dollars at the first mandated RMD, assuming a 10% annual return.
Secret IV “Live Long and Prosper”---Star Trek’s Vulcan Farewell
“Growth is driven by compounding, which always takes time.”---Charlie Munger
“The real action from compounding takes place in the final twenty years of a lifetime.”---Warren E. Buffett
Warren Buffett once pointed out, in an annual Berkshire Hathaway letter, that if Queen Isabella had not financed Columbus’ expedition, but invested that $30,000.00 at 4% interest, if she were alive today she would be a trillionaire.
That grants a whole new meaning to Mr. Spock’s timeless farewell, “Live Long and Prosper.”
That is, “Live Long and Prosper…Thereby.”
Secret V Front-Load Compounding for Best Results
“The first $100,000 is a bitch, but you gotta do it. I don’t care what you have to do---if it means walking everywhere and not eating anything that wasn’t purchased with a coupon, find a way to get your hands on $100,000. After that, you can ease off on the gas a little bit.”---Charlie Munger
Because compounding takes time, and the biggest returns come after time, it behooves us to make large deposits at the beginning of our lives, despite the fact that it is precisely when it is toughest to accomplish.
That’s not easy. But as Charlie Munger teaches:
“Anyone who thinks it’s easy is stupid.”---Charlie Munger
Secret VI Management Fees Compound, Too
“If returns are going to be 7 or 8 percent and you’re paying 1 percent for fees, that makes an enormous difference in how much money you’re going to have in retirement.”---Warren E. Buffett
“I put two children through Harvard by trading options. Unfortunately, they were my broker’s children.”---Jason Zweig
Compound interest’s “cloak of invisibility” cloaks money managers’ fees as well.
An annual fee of 1% sounds minimal but compounded over time it is vast.
If, as in Warren Buffett’s example, you were to invest $10,000 per annum in a nontaxable retirement account and earned 8%, you would have $3,140,862 after 40 years.
Surrendering a mere 1% annually to a broker or money manager would reduce that sum to $2,348,307!
Nearly $800,000 or ¼ of your retirement lost to the exponential blind spot!
How else can you reduce brokerage fees?
Buy and hold. Don’t trade. Reinvest dividends fee-free.
Berkshire Hathaway, notably, does not pay taxable dividends. They reinvest their profits and dividends for you, tax-free, unless and until you sell, if you ever do.
See also, “The Great Exponential Blind Spot”.
Secret VII Credit Card Debt Compounds On You
“If I owed any money at 18% the first thing I’d do with any money I had would be to pay it off. It’s going to be way better than any investment idea I’ve got.”---Warren E. Buffett
“It’s way easier to stay out of trouble than to get out of trouble.”---Warren E. Buffett
“People should avoid using credit cards as a piggy bank to be raided.”---Warren E. Buffett
According to a recent study the average American credit card balance in 2024 is $8,674 and rising.
The average interest rate on credit cards is now over 24%.
The average American will pay $649,067 in interest over their lifetime.
Some interest payments are justified: home mortgage and student loans.
Credit card debt at 24% is not.
But it flies right past humanity’s exponential blind spot.
Here’s Warren Buffett at the Nebraska Educational Forum in 1999 with a timeless lesson on credit card debt:
Secret VIII Compound Tax-Free
“In this world nothing can be said to be certain except death and taxes.”---Benjamin Franklin
Benjamin Franklin knew not tax-sheltered retirement and college savings accounts, but in an age of income taxation he would doubtless welcome both.
So should you.
Better reap profits in an IRA than share them with the IRS before they’re compounded and grown.
Secret IX Get Rich Slowly
“The desire to get rich fast is pretty dangerous.”---Charlie Munger
“We get these questions from the enterprising young. You look at some old guy who’s rich and you ask, ‘How can I become like you except faster?’”---Charlie Munger
“The big money is not in the buying and selling but in the waiting.”---Charlie Munger
Exciting money is fast money.
Watching paint dry, grass grow, or even water boil is dull and boring.
But wealth grows slowly, by accumulation and compounding, over a lifetime.
That is not how we have evolved to want things.
“Nobody wants to get rich slowly.”---Warren E. Buffett
“We want the world and we want it…now!”---The Doors
A sudden flood of money can be as destructive as a literal flood.
Look at lottery winners. Their stories are online. Many are broke, bankrupt, divorced, unemployed, swindled and depressed just a few years later.
Observe trust fund babies. Often unmotivated and entitled.
Found money corrupts because it was never earned.
It’s so easy to spoil anyone. Indeed, any animal.
The spoiled are a trial for everyone, including themselves.
Money earned, invested and compounded teaches respect for work and money.
“If you would know the value of money, go and try to borrow some.”---Benjamin Franklin
If you earn and compound money over a lifetime, not only will you have independence and comfort in old age and the ability to improve the lives of your children, but you will enjoy the pride of accomplishment, in what you have built.
Secret X Get Rich Surely
“The world is full of foolish gamblers and they will not do as well as patient investors.”---Charlie Munger
Every investor dreams of the lead pipe cinch: the perfect trade that brings enviable riches, wide acclaim and sustainable wealth.
Is it out there?
Maybe.
But a lifetime of trading rarely matches the returns of long-term investment.
Wouldn’t you rather grow rich in certainty, through a diversified, compounded portfolio blossoming into wealth as you reach retirement?
The great Jack Bogle recommended to his Vanguard fund shareholders that they invest steadily in his index funds over a lifetime, never opening a statement until retirement. Then have a cardiologist in attendance when at last they view their most recent statement and fathom the enormity of their compounded wealth.
The Great Secret: Everything Compounds
The power of compounding is not limited to finance. It is a power in all of life. Trust compounds. Friendship compounds. Love compounds. It weaves what Charlie Munger calls “a web of deserved trust” in which we should all seek to live and work.
The greatest cinematic exposition of compounded virtue and deserved trust is the climax and conclusion of that Christmas evergreen, “It’s A Wonderful Life”:
Best wishes for a joyous holiday season.
Full disclosure: grateful Berkshire Hathaway shareholder
