“My wealth has come from a combination of living in America, some lucky genes and compound interest.” – Warren Buffett
Warren Buffett, chairman of Berkshire Hathaway, Inc., is currently the third wealthiest individual in the United States with a fortune estimated at around $80 billion. Of the trifecta that Buffett cites as the source of his wealth, we’d like to focus on the third factor, the only one you can directly control – the power of compounding interest. Like a snowball gaining mass as it rolls down-hill, compounding can be a powerful force in helping investors build wealth.
One anecdote that Buffett uses to illustrate the power of compounding is the tale of Spain’s Queen Isabella, who funded Christopher Columbus’s voyage of discovery to the New World. When Buffett first relayed this anecdote in 1963, he noted that had Isabella instead invested her $30,000 at an interest rate of 4 percent, Spain could have had more than $7 trillion in wealth (today that figure would surpass $23 trillion).
Investors would be wise to emulate Buffett. The most important things an investor can do in the quest to accumulate wealth is to invest early and consistently. A young worker starting out at age 25 will likely have at least a 40-year career. If that worker puts aside $5,000 every year and earns a compound annual return of 5 percent, the cumulative value of the investment by age 65 will exceed $600,000. Compare that to another who delayed saving until age 45. If they put aside $15,000 annually and earned the same 5 percent compound return, by age 65 they would end up with less than $500,000. Such is the power of compounding; even tripling the amount saved won’t make up for the shorter period of investing.
Beyond starting early, the other key for successful investing is to invest consistently rather than try to time the market. An investor who bought an index fund tracking the S&P 500 at the top of the last market cycle in October 2007 and held that investment through the downturn would have waited roughly five years to get back to break-even. But, by the end of 2017, they would have realized a compound annual return of more than 7 percent, turning the original $100,000 investment into more than $212,000. Another who invested the same amount at the same time but panicked, sold near the bottom in March 2009 and sat out of the market for a year before reinvesting, would have ended up with only $125,000 by the end of 2017. When it comes to long-term investing, slow and steady really does win the race.
John O’Rourke is First American Bank’s Private Banker and Wealth Advisor for South Florida. As a relationship manager for high net-worth individuals and their companies, he assists clients and family members with a variety of banking and wealth advisory needs. If you have any questions or comments, contact John at Jorourke@firstambank.com. First American Bank Not FDIC Insured, Not Bank Guaranteed, May Lose Value.
