Critical Chance

Category: Investing

  • The Power of Consistency

    The Power of Consistency

    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.

    Buffett principal #2: Never take your money out

    The Aggregation of Gains

    The first rule of compounding is to start as early as you can. 

    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.

    Post inspired by:

    Buffettology: Unexplained Techniques That Have Made Warren Buffett by Mary Buffett

  • The Great Jack

    The Great Jack

    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.”

    Warren Buffet, Berkshire Annual Letter 2016

    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.

    Related: The Impact of a Starbucks Latte

    Start Early

    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.

    Related: Ninety-Percent of life is about showing up on time

    The Power of Subtracting

    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).

    RIP Jack, you will be missed.