How To Compound Wealth

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Includes: QQQ, SPY, VOO
by: Bogumil Baranowski

Summary

Learn to be patient.

Start immediately.

Earn, save, invest.

The first $100,000 is the hardest.

Never lose money.

If we can only shift our mindset from getting rich overnight to compounding wealth over a lifetime, everything changes and our odds of success dramatically rise…

Learn to be patient

I recently had the opportunity to spend a few nights among the California redwoods - those giant trees from the sequoia family. More than a decade ago, on my first big trip when I moved to the States, I visited Sequoia National Forest. The recent visit was a great opportunity to reacquaint myself with these magical, magnificent trees that dwarf regular pines. As you can imagine, it takes ages to grow this tall; the lifespan of these conifers is counted in the thousands of years. John Steinbeck called them “ambassadors from another time,” and wrote that “the feeling they produce is not transferable. From them comes silence and awe.” I couldn’t agree more.

After I returned to New York, I decided to get some seeds of those magnificent trees and watch them grow in a small pot. Though I planted them promptly, the seedlings have yet to appear. Nevertheless, I await them patiently. They remind me of how, as a child, I used to plant pines, birches, oaks, and maple trees with my parents. There is no better way to learn patience than by planting a tree, and there may be no better tree to teach you patience than one of the oldest, longest-living tree species in the world.

Whether you are starting out with $1 or taking on the challenge of managing newly acquired or inherited wealth, there is nothing more important in compounding wealth than patience.

Start immediately

As the famous Chinese proverb reminds us: “The best time to plant a tree was 20 years ago. The second-best time is now.” This reminds me of a beautiful oak tree that my great-grandfather planted with his classmates in 1917, which represented a turning point in Poland’s history. The country had just regained its independence after the 123-year partition among the three big European powers of the time: Hapsburg Austria, the Russian Empire, and the Kingdom of Prussia.

It’s been 101 years since that oak was just a little seedling. It witnessed the Nazi occupation, 45 years of Communist rule, Poland’s reopening to the world, and joining the European Union… my grandparents' school days, my dad learning to ride a bicycle, and me learning to walk.

Of course, we all wish our ancestors had planted trees to give us shade today, as much as we wish they had started compounding capital long before we were born. But we can start now, and though we may not reap all the benefits, those who come after us will.

Earn, save, invest

I don’t believe in miracle stocks. I do believe that if you follow certain steps, you can’t help but do very well by compounding your wealth over the long run. To grow the capital, you need to continuously and regularly underspend what you earn. If you are living off the capital, underspend what it earns for you.

You can leave your cash idle over long periods of time, but bank interest will only get you so far. You will be better off by becoming an investor in businesses. Stocks are nothing else but small pieces of businesses. If you have plenty of time, experience, and the appropriate skills, you can turn into a stock picker yourself -- otherwise you can turn to trusted professional guidance from an advisor or choose to use passive index funds that give you broad exposure to all kinds of stocks at a low cost.

The longer your investment horizon, the less you have to worry about market timing. You can spread your contributions out over years, even decades. Compounding wealth is not about finding the hottest stocks and getting in the market at the right time. It’s more about long-term consistency – which may sound as boring (or as fascinating) as watching a sequoia tree germinate and grow into a plant!

The first $100,000 is the hardest

Few brilliant minds can explain complex ideas with as much ease as Charlie Munger. Janet Lowe, in Damn Right!: Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger, writes:

Munger has said that accumulating the first $100,000 from a standing start, with no seed money, is the most difficult part of building wealth. Making the first million was the next big hurdle. To do that a person must consistently underspend his income. Getting wealthy, he explains, is like rolling a snowball. It helps to start on top of a long hill—start early and try to roll that snowball for a very long time. It helps to live a long life.

Have you ever rolled a snowball? It takes forever to grow it from nothing to any decent size, but once it’s big (say, half the size of a 7-year-old boy), it catches so much snow so fast that it’s almost impossible to keep it rolling.

Charlie Munger is right, the first $100,000 might be the hardest. But that shouldn’t stop you; what’s to come should inspire you to keep going. If you are already starting with meaningful capital, let time work in your favor, and don’t assume yet that hardest part is behind you. Keeping it may prove to be as challenging as making it in the first place.

Never lose money

Growing up, I had the rare opportunity to watch a newly reopened stock exchange in Poland go through short-term booms and busts that produced quick riches and even quicker financial busts. Years that produced 100% gains or 50% declines were nothing uncommon in an emerging market following a 50-year long hiatus since the beginning of WW2. I also saw the destructive forces of hyperinflation.

Later, I witnessed the dotcom boom and bust. If that wasn’t enough, soon after I started my career in investing came the Great Recession, bringing the worst time for stocks since the 1930s Great Depression. Those experiences made it very clear to me that not losing money is as important than making money – if not more so.

Any investment decision, whether it pertains to an individual stock or to an industry or to the market as a whole, starts for me with a good understanding of how I can lose money. Experience has taught me that if I avoid investments that carry an obvious chance of losing my entire stake, the money-making aspect of compounding will take care of itself.

No time like the present

Be patient, start now, get over the hurdle of the first $100,000, underspend, invest and never lose.

Discipline is essential in compounding your wealth, and there are three inputs at play: capital, time, and rate of return. Nothing helps grow capital more than consistency both in underspending and investing. Nothing helps extend your time more than starting early and thinking in terms of multi-generational compounding of wealth. Finally, nothing improves the rate of return more than avoiding losing money.

I’d better go water my giant sequoia seedling, and let you start on your path!

Happy Investing (from the California Redwoods)!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.