Why We Play For Doubles
How Understanding Compounding Will Change Your Life
Compounding is a simple concept, but difficult to internalize. It’s hard to conceptualize exponential growth. So it’s easy to underestimate the power of compounding.
Take 30 seconds to answer the following question: What is the difference if you invest $1 Million dollars for 30 Years at 7% vs 15% returns? (no calculators allowed!)
Approximately:
$10 Million?
$21 Million?
$37 Million?
$60 Million?
If you answered (d) $60 Million, Congratulations, You’re right!
At 7% you would have roughly $8 Million ($1,000,000 * 1.07^30).
At 15% you would have roughly $66 Million ($1,000,000 * 1.15^30).
A difference of a whopping ~$60 Million!
Can you Double Your Money 6 Times?
Ok, so growing your investment by 66X is daunting. To make it more manageable, I like to think about this in small steps. I like to think in doubles: How many times would you need to double your money to get to 66X?
The answer is about 6 times! (2^6=64).
Why 15%?
A 15% return means you need to double your money every ~5 years.
Achieving 15% returns is hard. It’s an ambitious goal.
However, even falling a little short of this produces wonderful results over 30 years.
But Wait... That’s Just From One Investment!
Wait what?
The above is just from a one-time investment...but you can invest every month or every year or every two years…
Think about that for a minute:
If you invest $100/month for a year ($1200 total), that will turn into $20,000 in 30 years (assuming a 10% annual return).
If you invest another $1200 the following year, that’s an additional ~$18,500 in 29 years.
If you invest another $1200 the following year, that’s an additional ~$16,800 in 28 years.
And so on...
After 30 years you would have invested $36,000 ($100/month)... but that would have turned into almost $220,000!
Here is what you would have if you invested a few hundred dollars a month, and doubled your money every 5-7 years (aka 10-15% annual return).
Now imagine what this number balloons into if you save more.
That’s why we play for doubles.
You may be asking…well that assumes the market will continue to go up over time. That isn’t true. Because we are investing in individual companies, not the “market”. That said, a rising market surely makes it easier.
Warren Buffet, the world’s most successful investor, explains why we CAN expect the market to keep going up during the next 30 years. He believes the determining factor is the following: as long as GDP growth is higher than population growth (GDP per capita growth), the markets should increase over time. Here’s his reasoning: https://time.com/5087360/warren-buffett-shares-the-secrets-to-wealth-in-america/
Remember:
Total Return = (Amount Invested) * (1 + Rate of Return) ^ (Number of Years)
The result depends on three factors:
Amount Invested
Rate of Return
Timeframe
Although you cannot control the rate of return, you can control what you invest, and for how long.
The sooner you start, the better!