The Joys of Compounding

On January 18, in 1963, a 32 year old Warren Buffett sent his annual letter to the limited partners of the Buffett Partnerships. The compound annul return for the limited partners that had been there from the start, five years ago, the return was 21.1%. The cumulative return for limited partners over the five years was 215.1%.

Gross of the management fees that he took as the general partner, Warren Buffett had compounded capital at 26% per year. In the letter, Buffett wanted to better educate his partners of the powers of compounding. In a section that he called “The Joy of Compounding”, he writes the following:

I have it from unreliable sources that the cost of the voyage Isabella originally underwrote for Columbus was approximately $30,000. This has been considered at least a moderately successful utilization of venture capital. Without attempting to evaluate the psychic income derived from finding a new hemisphere, it must be pointed out that even had squatter’s rights prevailed, the whole deal was not exactly another IBM. Figured very roughly, the $30,000 invested at 4% compounded annually would have amounted to something like $2,000,000,000,000 (that’s $2 trillion for those of you who are not government statisticians) by 1962. Historical apologists for the Indians of Manhattan may find refuge in similar calculations. Such fanciful geometric progressions illustrate the value of either living a long time, or compounding your money at a decent rate. I have nothing particularly helpful to say on the former point.

The following table indicates the compounded value of $100,000 at 5%, 10% and 15% for 10, 20 and 30 years. It is always startling to see how relatively small differences in rates add up to very significant sums over a period of years. That is why, even though we are shooting for more, we feel that a few percentage points advantage over the Dow is a very worthwhile achievement. It can mean a lot of dollars over a decade or two.

– Warren Buffett, 1963 Letter to Partners

Here’s the accompanying table:

All of Warren Buffett’s annual letters to partners are a treasure trove for any aspiring investor. You can find a compendium of the Buffett Partnership Letters over at CSInvesting.org.