The Secret to Profitable Investing

When the student is ready, the teacher will appear - Lao Tzu

This is one of my favorite quotes and I thought it was important I started with it because I 1st came across what I'm about to share with you 7/8 years ago, but it only started resonating with me 4 years ago. So, don't worry if this message doesn't make sense to you just yet. As the quote says, when you're ready for it, the knowledge will find you as it did me.

The "secret" is compound interest.

Let's start with the final story from last week's article.

Ada and Ade are 25-year-old twins who just finished their master's degree. They both landed jobs immediately. Ada started contributing $50 a month to a stock mutual fund and continued doing so for 8 years until she found more pressing uses for her money. Ade didn't start investing until he was 33 (the same time Ada stopped). He contributed $50 each month, like Ada, to the same fund for 37 years till he turned 70.

In total, Ada contributed $4,800, while Ade contributed a whopping $22,200. Assuming they both earned 10% a year, at age 70, who will have the most money?

It's Ada.

45 years after they finished their masters, Ada will have $291,133 compared to Ade's $234,933.

Time is the most impactful thing to have when investing

You may be thinking, this doesn't make sense. How did Ada end up with more money than Ade? She put in less than a quarter of what Ade invested, she only had 8 years head start, and she stopped contributing after those initial 8 years.

Compound interest is not intuitive

Linear thinking is so much more intuitive than exponential thinking.

If I asked you to calculate 5+5+5+5+5+5+5+5+5+5+5 in your head, you can do it in a few seconds (it's 55) but if asked to work out 5x5x5x5x5x5x5x5x5x5x5, you'd struggle if you're not a genius (it's 48,828,125).

The counterintuitive nature of compounding makes even the smartest of us to underappreciate its power.

But to the question, how did Ada outperform Ade?

• By the start of year 9, Ada had $7,309 invested (from her $4,800 capital plus $2,509 she had earned in interest) earning interest for her while Ade was starting with 0

• While Ada did not contribute anymore, the interest she was earning on her initial capital was more than Ade's contributions. Look at Ade's contribution column vs Ada's interest column below. In year 1, while Ade was contributing $600, Ada's capital earned $765.35 in interest. Ada's interest was basically her contribution

• Money invested earlier is worth more than money invested later because the money invested earlier has more time to earn interest and for that interest to earn interest and so on. $1 invested in year 1 of a 45-year investment horizon will earn interest in year 2-45, and the year 2 interest plus year 1 capital will earn interest in year 3-45, and year 3 interest plus year 2 interest plus year 1 capital will earn interest in year 4-45 and so on. While the $1 invested in year 45 will only earn interest in that year. Compare Ade's accrued interest to Ada's accrued interest in year 5. Ade had $904 while Ada had $4,700! Link to compound interest calculator

Let's see how this has worked in real world examples

Warren Buffett started investing when he was 11 years old with $115. By the time he was 30, he had a net worth of $1m, or $10.3 million in today's dollars.

What if Buffett didn't start investing until he was 30? What if he started with $25,000?

And let's say he still earned the extraordinary investment returns he's been able to generate (22% per year) but retired from investing at 60, his net worth would have been $17.3 million at retirement. Which is still a lot of money but 99.9% less than what he's worth today.

The "secret" to Buffett's success is that he's been a phenomenal investor for almost a century (82 years).

His skill is investing but his secret is time.

While Buffett is the richest investor today, he's not had the best returns. Jim Simons, head of Renaissance Technologies (a hedge fund) has compounded his money at 66% annually since 1988. Buffett has only achieved about a 3rd of his returns.

Simons' net worth as I write is $30.7 billion. He is 75% less rich than Buffett.

Why the difference, if Simons is such a better investor?

Time.

Simons found his stride when he was 50 years old. He's had less than half as many years to compound as Buffett.

If Jim Simons had earned his 66% annual returns for the same 82-year time span as Buffett, he'd be worth ---wait for it--- 46 septillion 90 sextillion 240 quintillion 113 quadrillion 452 trillion 380 billion dollars ($46,090,240,113,452,380,000,000,000)

RIDICULOUS!

Warren Buffett's $121bn fortune isn't due to just being a good investor, it's due to being a good investor since he was a child. Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him.

Ok, that was a lot. Let's come back to earth.

Flash back to March 2020, a 50-year-old man reached out to me with a seemingly simple question, "how can I have a billion naira by the time I want to retire (in 10 years)".

My answer was simple. After crunching the numbers, I said he needed to invest 3 million naira every month without fail at 20% annual return to get there in 10 years.

That was an incredibly high return to require for 10 years. For context, the S&P 500 returns around 10% every 10 years. So to require double the returns of the "best" 500 companies in the US while also contributing large amounts every month was a tough ask.

But assuming he had Buffett's investment prowess and could deliver 20% return consistently, if he had come to the same resolution at:

• Age 40: he'd need to invest only 350k every month to achieve the same goal at 60. About 10% of what he needed to deposit at 50 just because he was 10 years early
• Age 30: he'd need to invest 45k every month to achieve the same goal
• Age 20: he'd need to invest 6,500 every month
• And if he had started at the same age as Buffett, 11, he'd need to set aside "just" 850 every month

Final Thoughts

Good investing isn't about earning the highest returns, because the highest returns tend to be one-off hits that are incredibly difficult (virtually impossible) to replicate.

In any given year, there is at least one asset that grows 10 times. It could be crypto, stocks, commodities, etc. Only very few people ever hear about the 10x asset till after it's done its thing.

The secret to profitable investing isn't finding the investment that will 10x this year. It's about earning pretty good returns which can be repeated for the longest period of time. That's the secret of profitable investing, TIME. Learn how to start here.