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Compounding. This is a financial term that means making money tomorrow on money you make investing today. Money grows exponentially, they call it. It grows faster than in a straight line as it compounds over time. Starting investing for retirement 30 years before your retirement date is four times as good as starting 15 years before your retirement date.
Start early. Use the magic of compounding. With a little bit of interest and a lot of time, compound interest can help grow a portfolio significantly. Compound interest is reinvesting earned interest back into the principal of an investment. As you reinvest interest on top of interest, your investments can grow over time.
that let's say today today you deposit $100 in that bank account. If we wait 1 year and you just keep that in the bank account, then you'll have your $100, you'll have your $100 plus 10% on your $100 deposit. 10% of 100 is going to be another $106. So, after a year, you're going to have $110. $110. So, you can just say I added 10% to the 100.
And then after 2 years or a year after that first year after 2 years, you're going to get 10% not just on the $100, you're going to get 10% on the $110. So, you're going to get 10% on 110 is you're going to get another $11. So, 10% of 110 is $11. So, you're going to get 110 That was you can imagine your deposit entering your second year, and then you get plus 10% on that, not 10% on your initial deposit.
That's why we say it compounds. You get interest on the interest from previous years. Suppose there are two investors who have a starting balance of $10,000 each. They both decide to buy the exact same investment on the same date. And they both plan to hold their investments for 30 years. But one investor plans to withdraw the interest at the end of each year.
While the other plans to reinvest the interest and let it compound. Let's fast forward 30 years to see the difference in potential returns. In this example, let's suppose that the investment earns 7% per year. The investor withdrawing interest every year would have earned $700 per year. Over 30 years,
the earnings would have totaled $21,000. But let's see how much of a difference reinvesting the interest could have made. The investor who reinvested the interest would have possibly earned $66,123 over the 30-year period. This is more than triple the returns of the other investor. This example illustrates the power of compound interest.
Let's look at another hypothetical example to understand how important time is to compounding. Suppose two investors have portfolios worth $100,000 each. The portfolios hold identical investments. Each year, both investors save and invest an additional $10,000. And let's assume with compounding, their portfolios grow 7% per year.
One investor needs the money to retire in 15 years. The other will need the money to retire in 30 years. Let's see what a difference 15 years can make. At the end of 15 years, the investor's portfolio would have grown to $527,193. Now, let's see how much the other investor would have earned. As you can see, the additional 15 years of compounding resulted in their portfolio growing to $1,705,833.
That's over three times the return of the other investor. The final step is to avoid one of the biggest obstacles many investors face, taking excessive risks that can lead to large losses. After all, compounding only works if you're earning on your investments. Of course, consistently earning a profit is easier said than done because investments sometimes make money and other times lose money.
You can't guarantee your investments will make money, but you can avoid taking excessive risks that may lead to large losses. Measures such as allocating your portfolio across different asset classes and diversifying your portfolio within each asset class can help reduce some of the risk in a portfolio.
However, asset allocation and diversification do not eliminate the risk of loss. To potentially help avoid large losses, resist the temptations of taking excessive risks or not taking any risk and staying on the sidelines. Because when it comes to compound interest, slow and steady can be a highly effective approach.
My advice for a seeker of compound interest that works ideally is to reduce your expectations. Cuz I think it's going to be tougher for a while. And it helps to have realistic expectations. Makes you less crazy. And I think that You know, they say that common stocks probably aftermath of the Great Depression, which was the worst in the English-speaking world in all of those years, to the present time, maybe an index has produced 10%.
But that's pre-inflation. After inflation, maybe 7% or something. And the difference between 7 and 10 in terms of its consequences are just hugely dramatic over that long period of time. And if that's 7 in real terms, but may but it achieved starting in a perfect period through the greatest boom in history, starting now, it could well be 3% or 2% in real terms.
And when we get chances to deploy the capital, we we've always tried to make any entity, whether it was the partnership originally or the or Berkshire now or Blue Chip Stamps when we owned it or or even diversified retailing, we we wanted them all to be compounding in effect be compounding machines.
That's why people gave us capital. That's why we put our own capital in. And if we failed that I we feel like we really felt like we'd failed it. It didn't make any difference how much money we made from fees or anything like that. We we we knew what our yardstick was.
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