This is How Warren Buffett Understands Compound Interest

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At 90 years old, and with a net worth exceeding $100 billion as of July 2021, Warren Buffett is the kind of investor who always manages to make headlines. The Oracle of Omaha is starting to wind down his financial and philanthropic activities; he recently resigned from his trustee position at the Bill and Melinda Gates Foundation, and he is no longer involved in the day-to-day operations of Berkshire Hathaway.

Buffett understands that he is at an age when he should be taking things easier; this is a man that has a great understanding of the inevitable passage of time, and we can safely say that he has mastered this understanding to perfection with regard to compound interest. Approximately half of the fortune Buffett has amassed since he started investing at the age of 10 can be attributed to his unrelenting dedication to compounding. When Buffett turned 65, an age at which most Americans start receiving their monthly Social Security checks, he was already worth $70 billion. Over the last two and a half decades, he has earned more than a billion each year, and this is an even more assertive argument in favor of compound interest investing strategies.

Financial analysts who have evaluated Buffett’s portfolio of investments estimate that his annual compounding rate to be less than 25%; while this may sound like a nice return on investment, it pales in comparison to what Jim Simons, the secretive hedge fund manager of Renaissance Technologies, has achieved since the late 1980s, which is closer to 66% per year. While Simons’ annual percentage yield from compounding is three times higher than Buffett’s, his net worth is about 70% lower.

Technically, Renaissance Technologies generates more profits than Berkshire Hathaway, but the latter company has been under Buffett’s management since the late 1960s. Buffett’s religious adherence to long-term investing and compounding is what gives him the upper hand every time. Long-term consistency and unwavering investing discipline are what sets Buffett apart. The 22% APY Buffett may not seem like much to day traders who can generate 100% profits in a single trading session, but day traders are the kind of investors who are not able to sustain profitable streak; in fact, they often go negative on their market positions, thus erasing their previous gains.

Emphasizing Strategy Over Returns

Patience is a virtue that Buffett has closely adhered to all his life. He knows that earning the highest possible returns on investment is not a sustainable effort, even though on the surface it seems as if it should be the best way to build a fortune. The problem with this line of thinking is that it runs counter to what good investing should be.

Earning good returns on an exponential basis is the best strategy any investor can realistically hope for, and the only way you can reasonably achieve this is with compound interest. The reason many people ignore the power of compounding is that they approach it as an abstract concept even though online compound interest calculators will tell you exactly how much you stand to make down the line.

Making monthly contributions to a high-yield savings account that compounds on a daily basis may not be sufficient to fund your retirement, but you should try to think bigger. You should try to emulate Buffett in the sense that he routinely deposits Berkshire Hathaway profits into his compounding portfolio.

There will be times when your earnings will surpass the interest rate paid by your compounding account, but you do not know how often this will be. As of July 2021, not many American savings accounts paid more than 1% worth of compound interest; this may seem like peanuts to an active Bitcoin trader who can ride market fluctuations to the tune of 10% in just a few hours, but this is a risky and speculative method of investing. These traders would be better off setting aside a working capital amount and depositing their trading profits into compound interest accounts.

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