The secret to Warren Buffett's wealth creation

Aug 22, 2019

Warren Buffett is an excellent writer. No one can dispute that. His letters to his shareholders are insightful, informative and an absolute delight to read.

In his immutable style, he even addressed the investors of Buffett Partnership in a similar fashion. I recently came across a very old letter and was not surprised to see him evangelize on the merits of compounding.

Read these two examples.

Queen Isabella’s funding of Christopher Columbus’s expedition to find a new route to Asia, was approximately $30,000; a moderately successful utilization of venture capital. The $30,000 invested at 4% compounded annually would have amounted to something like $2 trillion by 1962.

The Manhattan Indians unloaded their island to notorious spendthrift for $24 in 1626. Minuit received 22.3 square miles which works out to about 621,688,320 square feet. In 1965, he figured the land value to be a little less than $12.5 billion. However, the Indians have only had to achieve a 6.5% return to obtain the last laugh on Minuit. At 6.5%, $24 becomes $42 billion in 338 years, and if they just managed to squeeze out an extra half point to get to 7%, the present value becomes $205 billion.

Buffett is a great believer in compounding. Hence statements such as "about 99% of Buffett's wealth was earned after his 52th birthday", can be utterly  misleading.

MILIND KOHMARIA, a Certified Financial Planner and a Network FP ProMember, sought to put it all in perspective. He decided to look under the hood when it came to the power of compounding in Buffett’s life. He hunted for data, captured it brilliantly, and presents his narrative below. 


The first time I set eyes on the last four bars of the above graph, I was taken aback. They represent data for a specific age - 59, 66, 72 and 83. Which means that those four bars cover 24 years!

Looking at that steep climb, I must admit that it came across as a slight misrepresentation of data. So, I decided to verify it by obtaining the actual number for each and every single year.

I hunted online and reached out to peers. I was astonished to note that the numbers were not as easily available as I assumed they would be.

I decided to approach it from another angle, by looking at the historical data of the richest people across the globe. Buffet has been featuring among the top in the list for a long while.

What better source than the Forbes Billionaires List. To my pleasant surprise, data of the richest people in the world is available right from 1982 to till date.

It took me a couple of hours to gather the data and put it on a graph. The result is worth a very good look.

My initial apprehension about the slight misrepresentation of data was proved wrong. It turned out to be a very significant misrepresentation.

Warren Buffet - Bar Graph

We are looking at a graph representing more than 70 years here.

I also opted to present the data in a line graph to starkly portray the volatility of Warren Buffet's net worth.

Warren Buffet - Line Graph

Look at that closely.

In 2008 see the net worth plummet. Buffet's portfolio declined from $62 billion to $37 billion. That is a 40% plummet during the subprime crisis!

The message here is - when the stock market corrects, even the best investors' portfolios follow suit.

It is the long tenure that capitalizes on the magic of compounding to pay handsome returns. Do good returns matter? Of course they do. But to create wealth, it is compounding that banks on longevity.

Let me pose a simple question.

Warren Buffet made his first investment at the age of 14. Had he started investing late, say after 5 years, what is the kind of money he would not have made?

The answer. The wealth bars missing would be the last five!

I rest my case.

May I boldly suggest that compounding is the secret sauce to Buffet's wealth creation, coupled with the grit to stay on during market upheavals.

My advice: Watch the documentary Becoming Warren Buffet.

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