5 min read Investing

Time: Warren Buffett's Best Kept Investing Secret

Time: Warren Buffett's Best Kept Investing Secret
Photo by Sonja Langford / Unsplash

Warren Buffett is often credited as one of the greatest investors of our time. As a value investor, he looks for stocks that he can buy at a discount that have a strong competitive advantage, high barrier to entry, and solid principles - among other things. Some of these companies include Coca Cola (KO) and Apple (AAPL). What if I told you, none of these qualities he looks for in companies is what gave him his $100 Billion plus net worth, but instead it was something we all can't seem to get enough of - time.

The Importance of Time

Now, don't get me wrong. Picking good companies is important. Getting good returns is also important. But, people drastically underestimate the power of compounding over a long time horizon compared to a good return or good stock pick here and there. To illustrate this let's look at some examples. Each investor below will start with $100 and will get a 20% annual return. The difference will be how long they invest for.

  1. Investor A gets a 20% return for 30 years.
  2. Investor B gets a 20% return for 50 years.
  3. Investor C gets a 20% return for 82 years.

How much more money would investor C have than the other 2? 2x more? 10x more? 50x more?

The answer is actually almost 350 times more. $23,737.63 vs $910,043.82 vs $311,072,898.53).

How Warren Buffett did It

Now, back to Warren Buffett. Investor C is Warren Buffett (except he has a 19.8% annual return1). Buffett was able to get really good returns for an extremely long time. He started investing at age 11 and is still investing now at age 93. Even if he got just 10% returns for those 82 years, it would be worth more than a 20% return for 45 years. (about how long the average investor invests for. Age 25 to 70 before retiring and shifting to some less risky assets like cash and bonds.) This shows time has much more of an impact on your end balance than returns do.

It's All About Compounding

Compounding is what allows time to be so impactful. It is a simple concept but so powerful. Essentially, if you start with $100 and earn a 10% return, you'll have $110. That is a gain of $10. The second year you are starting with $110. If you earn another 10% return, you will make $11 and have an ending balance of $121. The same 10% return makes you $1 more the second year. The more time you have, the more your money will compound. There are many free calculators that allow you to see how much compounding can help you.

Tips to Succeed

Here are a few quick tips to allow you to utilize time and compounding in your investing journey like Warren Buffett has.

Start Early

If you are fortunate to be reading this at a young age, start now. Even a few dollars a month can really add up over 50 or 60 years. If you're on the older side and have yet to start, the time to start is now.

Avoid Losses

Let's take 2 more investors starting with $100.

  1. Investor D gets a 10% return annually for 30 years.
  2. Investor E gets a 15% annual return but every 8th year gets a -30% return (-30% returns in years 8, 16, and 24).

Which investor would have more at the end of the 30 year period?

The answer is investor D ($1,744.94 vs $639.18). This shows that getting consistent returns is better than getting mostly really good returns and few really bad returns.

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This is different than investing in an index where the years following a big drawdown would likely result in a few years of really large gains due to the drawdown being some macro economic event (like COVID). Think of this example like picking a bad stock or losing on an options trade. There is no bounce back on that same stock.

Avoiding losses is fairly easy to do. You can do this by not investing in single stocks and instead using index funds which are much less prone to a large drawdown without a recovery.

Don't Interrupt the Compounding

You don't want to take money out of the market when it's down or try to time the market because this hurts your compounding. You might think the tax hit isn't that much from selling a stock or you'll get out of the market right before a big loss or invest at the bottom of a bear market, but chances are you'll be unsuccessful and miss out on returns. A great recent example of this is COVID. The market dropped quick but we had a quick recovery as well. If you sold off as the market was dropping, chances are you would not have gotten back in the market in time and missed out on a lot of gains. Selling near bear market lows and buying in a bull market is sure to hurt your returns.

COVID-19 cases in U.S. vs S&P 500 return. As cases went up, so did the market. It is very hard to time the market. https://www.researchgate.net/figure/Plot-of-S-P-500-Composite-index-and-number-of-COVID-19-cases-in-the-US-Sources_fig1_361556622

Conclusion

This post shouldn't come off as a slight to Buffett. Buffett is an incredible investor and has make great investments for a long time. I am simply illustrating the amazing power of time as it relates to investing. There are some other really fascinating reasons for Buffett's success. If you want to see those posts be sure to become a member.

References

1Buffett earned an average annual return of 19.8%.

Benjamin Carlson

Benjamin Carlson

Software Developer, creator, and writer living and working in CT.
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