Warren Buffet has an interesting principal he follows.
At the end of each year, a company gets to decide what to do with their earnings. Some companies issue a portion of the money to their shareholders; this is called a dividend. Most investors love it, in fact some design their portfolios to exclusively invest in companies that provide annual dividends. Warren on the other hand? He HATES investing in these companies.
Why? When you receive a dividend, you realize gains, which means you have to pay taxes each year.
Warren would rather the money was reinvested into the business to help it grow.
First off, this allows him to avoid taxes for as long as he can. But if we remember the rules of compounding, it allows his money to stay in the system and work even harder. Warren wants to be taxed only once, at the very end when the journey is over, not throughout.
But once your money is in, we want to optimize towards growth – this means paying as little as possible.
“The objective is to buy a non-dividend-paying stock that compounds for 30 years at 15% a year and pay only a single tax at the end of the period. After taxes this works out to a 13.4% annual rate of return.
Charlie Munger, 1998
If you invested $10,000 with Warren Buffett, at his annual rate of return of 23%, the following chart shows you the amount you’d have in 30 years, based off if you paid taxes each year versus allowed the money to keep compounding.
Assumes 23% compounding annual rate, blue line allows money to compound, red line removes taxes at 35% rate each year It’s worth noting that these are extremely high rates of return, and the average investor can expect to get closer to 8% ARR
Breaks vs BRAKES
Breaks are healthy – they allow us to recover and admire our results.
Trouble comes when we allow a short break to turn into hitting the brakes (that is, stopping completely).
Here’s what what I mean:
Health – When we feel physically in shape, we decide to stop exercising – a few days becomes a few weeks
Learning – When we believe we’ve mastered enough, we decide to stop learning – binge reading becomes binge television
Relationships – When we sense our connections are strong, we decide to stop building them – personal texting becomes singular social media posting
Warren’s principal reminds us of the power of pausing too often or for too long.
Once you stop showing up, you stop gaining.
Keep It Going
You’ve decided to start (that’s great!), but don’t underestimate the importance of continued hustle. The laws of compounding don’t care if you’ve had a bad day, or it’s a busy week.
When we decide to follow through, we continue to gain, period.
So wherever you are, keep it up, and just like Warren you too will enjoy the aggregation, not of a single year, but an exponential 30 years.
Getting up when others won’t is what makes all the difference.
And who knows, that determination might be worth an extra $2.8M dollars, in whichever domain you’re compounding.
There’s a divide on the horizon, and it’s unlike ones we’ve seen in the past.
When we use the word “divide” to describe a phenomenon, it usually refers to access; one group of people has access to a resource, while a second group does not. We’ve seen this around the world with clean water, education, and nutritious foods. If you happen to be born in a country that doesn’t have one of these resources (or a limited supply of one), you’re at a disadvantage and there’s not much you can do about it – tough luck.
But today we’re looking at a different divide, one which I believe will be synonymous with the 21st century. It has to do with access, but in a completely new way.
I call it, “The Next Divide” and it’s a digital one.
Chapter 1:Active vs Passive
Are you using your phone, or is your phone using you?
We live in an amazing time. Your phone can retrieve endless quantities of entertainment, social connection and knowledge.
Consider for a moment that you’re able to travel back in time to 1980. You encounter your 1980’s doppelgänger self and you do your best to explain smartphones in 2019.
Let’s face it, we tend to spend a large portion of our time surfing our phones without meaningful intent. This isn’t completely our fault, it more has to do with the implicit relationship between you and your phone.
While your phone offers you endless possibilities, it comes at a cost. Instead of money, most apps demand something else: your time and attention.
New-age business models
Internet companies (and many smartphone apps) make money by keeping you on their products longer. They do this by monetizing their products through online advertising, which directly correlates with engagement and time spent on their website. The more they know about you, the better they can convert your data into cash.
Question: What happens when our most valuable businesses operate in this way?
Answer: Our most brilliant data scientists and software engineers are being taken from every other industry to work on the same objective: keep you online longer.
According to Tristan Harris, a “design ethicist,” the problem isn’t that people lack willpower; it’s that “there are a thousand people on the other side of the screen whose job it is to break down the self-regulation you have.”
While you’re scrolling through Instagram, there are thousands of MIT, Harvard, and Berkley engineers running multivariate tests, all to determine the best way to break down your self-control and keep you on their app longer.
Personally, I find myself being used, all the time.
Last week, I decided to open Instagram to see what my friends were up to. My intention was to scroll for 5 or 10 minutes, but 30 minutes later I caught myself mindlessly watching puppy video clips. The power dynamic shifted because I was no longer making the choices.
For the first five minutes, I was in control of the content, but soon after Instagram took over by deciding what to put in front of me. Facebook had been battling for control over my attention, and it had won.
Digital and online for that matter, isn’t a story of all negatives, there are positives too:
When I was 18 I received a guitar as a gift. Before then my involvement in playing instruments was limited, however learning guitar was a cool aspiration I’d always had. Unlike generations before me, I shrugged off formal training, and instead took to YouTube for lessons.
Between the hundreds of videos and endless practicing, I learned how to play guitar and still do today. Sure, that took discipline; I played for at least an hour everyday after school, but there were far less distractions back then.
This is just one small example; there are millions of people who have elevated their musical ability through the type of lessons the internet can provide. If you take a step back and consider this idea, you’ll recognize that people are applying it to all areas of expertise (ie: coding, art, history, the list goes on).
So ask yourself, who really has the power in your tech relationship? And further, are are you trading your asset (time and attention) at a positive return? Or perhaps the technology has the upper-hand?
Summary: The 21st Century has created a new tier of human potential, but the question is…
Chapter 2:Which Group Are You In?
While technology is accelerating our ability to achieve amazing intellectual, creative and productive feats, it’s ability to distract us is accelerating at an equal clip. You can’t go a day without being inspired, yet so distracted at the same time. It’s these conditions that make the digital divide possible.
Sometimes success is 3% brains and 97% not getting distracted by the internet.
Shane Parrish
The digital divide will create two groups:
Group 1 is able to control their focus and leverage technology to improve themselves, and moreover, reach greater potential.
[Technology] is a great way to automate a habit. You can save for retirement with an automatic deduction from your paycheck. You can curtail social media browsing with a website blocker.
Technology can transform actions that were once hard, annoying, and complicated into behaviors that are easy, painless, and simple.
It is the most reliable and effective way to guarantee the right behavior.
James Clear
Meanwhile, Group 2 is trading their time for mindless surfing. Their behavior is not only distracting themselves from the world around them, but it’s also causing them to achieve less.
And technology can rewire our brains.
The Sleeping Scientist
We each have a little scientist named Hank, who manages a lab within our brain. It’s Hank’s job to control your focus, and he does this by balancing your distraction liquid 24 hours a day, 7 days a week.
There’s a constant replenishment of distraction at all times; your thoughts wander as new stimuli enter and exit your external environment.
Some people are born with more liquid than normal, others develop habits which increase their exposure over time. Ultimately, you train your Hank to manage his beakers in the best way possible. My personal favorite strategy is meditation.
But the crux of the problem is that digital applications are training your Hank to be irresponsible. Have you ever sat down to work on something, only to find yourself distracted 10 minutes later? What about open your phone to do something, and then completely forget?
That’s your Hank falling asleep in the lab, and when Hank doesn’t pay attention, he causes leaks and spills.
Here’s what distraction looks like:
Small naps lead to extreme compounding. . One laboratory spill leads to a broken beaker, which leads to less liquid control in the future. Lab explosions move from a rarity to a constant affair in your head.
So over a short period (1-2weeks), the difference is marginal. However as the time series extends further, the differences become insurmountable.
I’ve written about the power of compounding many times; Albert Einstein dubbed it as one of the greatest wonders of the universe. Talk about a bold statement, especially from a man who revolutionized modern day physics (and astronomy).
Summary: Whether you’re in Group 1 or Group 2, will become a life-changing characteristic.
Over the next ten years, this macro trend will lead to enormously disparate outcomes. Great or terrible, it all depends on which group you fall into.
Chapter 3: The AI Revolution
We’ve now established that access (per the traditional sense) isn’t the problem; each group can connect to the internet at relatively similar speeds. Instead this divide focuses on the way in which people leverage the internet (use the resource).
Enter Artificial Intelligence, aka: the great accelerator.
AI is a comprehensive subject, so I’m going to over-simplify a bit here. If afterwards readers have greater interest in the mechanics, I can write up a separate blog post. But for now, let’s just say there have been some major advancements in the field.
Once of the largest breakthroughs is around this idea called deep learning.
Previously you could only train a computer to follow a set of rules (or simple algorithms). You would tell a machine that if it hears the phrase, “Knock, Knock” it needs to answer, “Who’s there?” Any variations from “Knock, Knock” and the computer not be able to respond.
Now, with deep learning, we can give the computer a massive set of data (in this case jokes) and train it to learn humor. Scientists watch it learn in real time and correct it whenever it makes a mistake. After lots of data and repetition, it eventually “learns” the idea.
Mechanically the computer forms connections just like how our brains do. These are called neural networks, and to get a better visualization of how these systems work, you can check out the Tensorflow Playground.
What does this mean for the Digital Divide?
AI is (already) learning your behaviors, tailoring content, and therefore be able to break you down significantly further.
Remember those thousands of MIT graduates running multi-variate tests? Now imagine if they programmed a super-computer with more power and genius level pattern recognition. They will now discover things about you that were unfathomable with humans experimenting alone.
Summary: AI is forming a massive crater in the ground, and it is going to push the two groups further apart.
It will be on us to make sure there are enough formidable bridges to provide opportunity for those stuck on one side, however more likely than not, AI Valley will destroy your hopes of crossing… if you wait too long.
Conclusion: Big Distractions or Big Dreams?
I believe these gaps will be filled over time, but it’s going to take time and large innovations in technology.
Right now companies are making money off of your time and attention, so there’s no incentive to turn a passive person into a more active person. Yet, if we want to grow to our total potential, we need to flip the script and change the way we use our attention ourselves.
Which side of the digital divide will you be on?
The earlier you decide, the more you’ll gain.
“Don’t be on your deathbed someday, having squandered your one chance at life, full of regret because you pursued little distractions instead of big dreams.”
Last week Jack Bogle passed away. A true financial great, Jack made some of the most pivotal contributions to finance and investing throughout his career. Don’t just take my word for it, even other legends agree:
“If a statue is ever erected to honor the person who has done the most for American investors, the hands down choice should be Jack Bogle.
In his early years, Jack was frequently mocked by the investment-management industry.
Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me.”
In this writeup, I outline my favorite Jack Bogle lessons, all of them have applications outside of money management and may be applied in wider ways across your life. The quotes within are taken from, “The Bogleheads’ Guide to Investing“
Compounding Interest
The best gains in life grow in a compounding fashion; returns continue to grow on top of prior returns. The amounts your money can earn in Year 1 will be far smaller than year 2, year 3 or year 5.
A comparison of two investment accounts. The first starts with $10 and grows by $1 everyday. The second starts with 1 penny and doubles everyday. The penny will be worth more by day 13, and by day 16 (shown above) the compounding account will be worth 13x that of the linear one.
“It may not seem like a big deal, until you realize that every time the money doubles, it becomes 4, then 8, then 16 times your original investment.
Start with one penny and double it every day, on the thirtieth day it compounds to $5,338,709.12.”
LESSON: Most people search for linear gains. Instead, set your pursuits on investments that can yield compounding results.
If your young, your greatest advantage is starting earlier than your competition. “The best time to plant a tree is twenty years ago. The second best time is now.” The old proverb goes. At face-value, a few years doesn’t sound like much, until you account for compounding interest.
If you contribute $1,000 each year into an investment account, which compounds at 7% each year, above is the final balance you’d have by age 67, based off what age you start.
“Let’s assume a child is born today. For the next 65 years, she or her parents will deposit a certain amount into a stock mutual fund that pays an average annual return of 10 percent.
How much do you think they need to deposit each day in order for her to have $1 million at age 65? Five dollars? Ten Dollars?
In fact, a daily deposit of only 54 cents compounds to more than $1 million in 65 years.
It really helps to start early.“
LESSON: The most important thing you can do is start today. Forget about the marginal progress you’ll make on Day 1, it’s the fact that you got off the couch and began that matters most.
The common-person thinks the only path to wealth is to generate more income. While making more money can help, there’s a second part to the equation, one which is often times ignored: minimizing costs.
“Reducing your spending [costs] is financially more efficient than earning more money.
For every additional dollar of earnings you plan to save, you will likely have to earn $1.40 because you have to pay income taxes.
However, every dollar unspent can be invested [immediately for compounding gains].”
LESSON: While most people focus on gains, you should also consider the power of subtractions. You don’t need to add another book to your reading list, you need to remove one not servicing your needs.
Index Fund vs. Fund Managers
Choosing a single winner is far harder than it may appear. While markets are meant to show the “real value” of an asset, it’s nearly impossible to predict their future value. You’ll fare much better by holding the entire market; when the economy wins, you win too.
The fastest way to get rich in the stock market is to own the next Microsoft. The fastest way to lose all your money is to own the next Enron. Identifying them in advance is impossible.
However, you don’t have to identify them in advance to make a healthy return on your investment. If you buy an S&P 500 index fund, your investment is highly diversified and its performance will match that of 500 leading U.S. corporations’ stocks.
Over 10 years, the average expert-picked stocks were up an annualized 8% compared to the market index return of 9.5%.
A 1.5% difference may not seem like much, but compounded over a lifetime it makes a tremendous difference.
LESSON: Don’t waste your time trying to find a needle in a haystack. Sure you may get lucky sometimes, but odds are you’ll fare better by holding a small piece of everything. Worry about getting the market (macro) right, not the stock (micro).
If you’re reading this article, I need to thank you.
Thank you for becoming a fan, sharing with friends, and for all of the encouragement along the way.
Building a subscriber base is a lot like weight lifting.
Let me explain…
The first time you hit the gym, your muscles aren’t very strong. Something as light as 25 pounds, really feels like 100.
Well, that’s the same thing that happens when you start anything new. I’ll use this blog as an example, but odds are, you’re also working on something you’re excited about too. Take this framework and fit it into whatever constitutes as your blog.
If you plot difficulty over your most ambitious goals, they get more achievable over time. It takes a while to establish a base, but once you do, the next goalpost becomes easier. Much like when you hit the gym, the first set of weights feel way heavier, but if you stick with it, your muscles build and those once heavier weights become your warm-up exercise.
It has this funny compounding effect; where your progress keeps doubling, yet, it continues to get easier. Your ability to impact keeps growing too. Suddenly lifting 100 pounds feels less than your original 50 pound rep on day one.
This blog is still in its earliest infancy. We’re deciding which exercises make sense and when to fit the gym into the busyness of life. We have to zoom in really close to see the location.
This past month, you’ve seen me lace up my sneakers and hit the gym. After a month of checking out the equipment, I’ve decided to put a new workout plan in place. That’s right, channeling my inner Kanye =)
Monday Tidbits are staying, but I’m switching around the article content.
I want to go deeper on these topics and add more visuals (similar to this week). Who knows, maybe there will be video content too or a podcast for the train ride or drive. But basically, the articles won’t come everyThursday.
If you’ve enjoyed anything so far, or thought this week was cool, I think you’ll love what’s coming next.
The destination may change but who cares?
Changing the workout routine keeps life interesting.
Ninety-Percent of life is about showing up… on time
Compounding interest is perhaps one of the most important and powerful discoveries of our time.
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
– Albert Einstein
Einstein wasn’t just referencing money when he said those wise words; in nearly every domain of life, compounding can either make or break you. If for example, you only get 1% better everyday for a year, versus 1% worse, you’ll be over 1000% better by end of year.
When you break it down, success is actually played at the margins; it’s about getting slightly better each day over a long period time, instead of dramatically better in one fell swoop. [James Clear on Marginal Gains]
The classic example is saving for retirement. When you start early and stay consistent, accumulating a large nest egg becomes much easier. With an Employer Match, a 20 year old could invest as little as $5 each day to retire a millionaire by 67 (The Impact of a Starbucks Latte).
If you imagine compounding as a Dr. Seuss-like machine, there are two ingredients going in to create varying levels of “Success” that come out the other side: TIME (when you start) and INVESTMENT (deliberate practice).
Here’s the best part about it, you control both inputs. Given the first example (1% better), you can see that, if time is on your side, you actually don’t need to invest nearly as much. However, the longer you wait, the more you’ll need to catch up. If you contribute $1,000 each year into an investment account, which compounds at 7% each year, below is the final balance you’d have by age 67, based off what age you START:
If you start at age 5, you’ll be a millionaire. Say you wait until half way through this chart (31 years old) to begin, you’d end up with a mere 17% of the total opportunity.
Perhaps the more powerful input you control is how early you start, not how much you invest.
Intellectual Compounding told by greats
“An investment in knowledge pays the best interest.”
-Benjamin Franklin
Most people know about financial compounding, but few recognize intellectual compounding. That is, the same exponential curve can apply to your growth as a thinker, an entrepreneur, or any related skill. If we were to plot how much you push yourself to learn, we see the same 1% better trend lines. By learning everyday, you become better at learning new things and adapting to your environment; it’s not a linear relationship, but instead an exponential lift.
“Read 500 pages every day. That’s how knowledge works. It builds up like compound interest.”
-Warren Buffett
The prolific speaker, Tony Robbins, has also acknowledged this phenomenon. When Tony started his career, he wasn’t nearly the presenter he is today. In fact, Tony says one of his co-workers was much better than him, which made Tony wonder why. What was difference between them? Did his co-worker have a gift that Tony was incapable of? Not even close. Tony realized he was only giving 1 presentation a week, whereas his co-worker was giving about 3 a week. So to be better, Tony quit his job and started giving 3 presentations a day. In about 2 months time, Tony gave the equivalent number of presentations that the other guy would give for the rest of the year.
Tony massively elevated his deliberate practice, but he also started early. While his fame emerged after his first book release at age 28, his first job as a motivational speaker was at age 17 – a full 11 years earlier.*
“The most important thing to do is start investing now so you can unlock the power of compounding.”
-Tony Robbins
We typically over-praise the individual versus their positive habits, environment, or commitment to growth. Whether you’re starting a business, a new job, or working towards an ambitious goal, compounding is the secret sauce that gets less attention. When we think of becoming great in any domain, we usually think about working harder and longer than the proverbial other guy. Instead, we should be thinking about starting one day earlier than ‘the other guy’.
Timing needs a higher priority
Working hard is the easier part; it’s not difficult to wake up an extra hour earlier or stay at the office after hours if it’s something that you find deep purpose and potential in. Figuring out when to start though, that’s hard.
“Bookstores have an entire ‘how to’ section but not a ‘when to’ section… [Yet] timing… can be everything.”
Perhaps we can simplify this though; start now. There are probably millions of great ideas waiting to be unlocked, but we’re too afraid or too slow to start. When you understand compounding, you give timing the attention that it deserves. Successful people understand this and it’s why, when they get asked about their biggest regret, many of them answer that they wish they had started sooner.
One of my favorite high school teachers used to say, “Ninety-Percent of life is showing up on time.” He would go on long tangents about the value of time, whenever someone arrived late to class. Ironically, we’d end up spending anywhere from 5 to 15 minutes of class time listening to him dissect the topic. To him, it was imperative to show up, but the more important point was to be on time.
Reflecting more than a decade later, I believe he understood something much deeper about timing. If you want to be the next Mozart, you can’t wait 30 years to begin learning piano, you need to show up when the opportunity first strikes. When you’re late to start, you miss much more than just the opening credits of a movie; you miss the character development, the plot, in fact, you never reach the conclusion. Using compounding interest, a late entry could reduce your returns by 100x; that’s the chance to learn, grow, or become your best self.
To take advantage of our total potential, we need to be on time.
Every morning around the country coffee-fanatics line up in droves, waiting for that favorite cup of Joe. Not only can the wait be long, but it can be more than $5 a cup! Which should beg the question… how much does your morning cup really cost?
On one side, we have people who get the occasional coffee every month. On the other side, we have the group that can’t go a day without their orange mocha frappuccino (you know who you are)… let’s look at the daily coffee camp.
To start, if you’re buying a $5 cup each day of the week, you are spending $1,825 each year. If that doesn’t sound expensive enough, consider the income you need to earn to sustain this morning ritual. Using a 15% marginal tax rate, you must earn $2,098 each year. To someone who makes $50,000 a year ($24 / hour) that’s 87 hours or two weeks of working each year!
Kicking the habit or making it yourself would put $1,825/year in your pocket – sounds simple, minus the potential coffee withdrawals. But what if we took this to the next level?
Investing the savings into retirement accounts
If you dumped that $1,825 into retirement on January 1st of each year, here’s what your estimated balance would look like over time:
Assumptions: 7% annual rate of return, lump sum invested on Jan 1 of each year, return calculated without fees
That’s the power of compounding.
But since we’re talking about retirement, it’s only fair we discuss the employer match. Here, an employer may match the dollars you contribute towards your 401k. There are limitations to the amount they might match (check with your HR department), but let’s assume they’ll match the $1,825 dollar-for-dollar.
Now your investment becomes $3,650 each January 1st, and the results are staggering.
Assumptions: 7% annual rate of return, lump sum invested on Jan 1 of each year, return calculated without fees. Employer matches $1,825, investment becomes $3,650 each year
If a 22 year old beginning their career made this one change in their daily routine, they would have roughly $744K by age 62, and they’d break $1M by their 67th birthday.
Saving the equivalent of a daily Starbucks latte could allow working Americans to retire on schedule.
Even if you don’t have or aren’t taking advantage of an employer-sponsored 401K or match, looking to cut a small habit is worth considering. Redirecting even a handful of dollars a day can go a long way. It’s worth noting, the retirement problem in America is very complex. There are, of course, other factors contributing to the broader issue; but this is for the individual to consider.
When small, everyday habits compound, they create extraordinary gains.
Habits are at the center of everything we do. Everyone has experienced this situation; you’d like to workout more often, but things come up and you never end up at the gym. Perhaps you find there isn’t enough time to get to the things you care about and love. Why? You may feel as though your decisions and routines are repetitive; like you’re driving your car on autopilot. We fail to recognize that we control the habits that we form and, thus, the direction of the car.
“We first make our habits, then our habits make us” -John Dryden
While not everything is within your control, existing habits can stop you from reaching your goals. Be an informed driver and decide the route you want to drive based on the conditions; not on the routine.
“It’s the daily practice of all the monotonous, little, boring things like brushing your teeth that matter the most. There’s no single event. There’s no one thing I can tell you you have to do. It’s an accumulation of lots and lots of little things, which any one by themselves [are] useless, yet together add up.” -Simon Sinek
When it comes to money, turning a small expense into a small savings could make you a millionaire. The same exponential return is seen across other areas of your life.
Want to become more insightful?
Read about a new subject for 15 minutes each day
Want to raise your EQ?
Meditate for 5 minutes each day
Want to become a more empathetic leader?
Put down your smartphone before stepping into meetings; give your reports 20 minutes of undivided attention each day
Similar to retirement investing, small habit changes will be subtle at first, but they add up and compound over time. It’s with patience and commitment to betterment, that we can achieve slow, yet incredible gains.
What’s your Starbucks latte?
Whichever area it falls into, it may just make you a millionaire.
