“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things” - Charlie Munger.
There is a disputed quote from Albert Einstein that compound interest was the eighth wonder of the world. Whether he really said this is debatable but compound interest is indeed one of the most powerful force invented by man. And if you want to be rich, you should know how to master this force. With my second year as an investor over, it is time for me to analyse my own performance against the market. The US stock market S&P 500 index gained 15% since March 2017 while I gained 95%. This might look remarkable at first glance but this is not the whole story. I actually doubled my investments in nine months and then went up to 130% before going down to 80% before moving back up to present level. How I had nine fantastic months? Compound interest. How the last three months were not that good? Greed.
According to a legend when chess was invented in India, the man who invented the game presented it to the emperor and he liked the game so much that he wanted to thank the inventor. The inventor asked that on the first square of the chessboard was placed 1 grain of wheat. On the second, 2 grains of wheat. On the third, 4 grains of wheat. On every consequent squares, the number of grains was doubled until the 64th and last square. The emperor thought the deal was reasonable and accepted it. What the emperor failed to understand here was compound interest. Over each square, the number of grains was doubling, that is, it was being compounded by 100%. The number of grains on the last square is 2^63, that is, 9 223 372 036 854 775 808 grains. And the total number of grains on the whole chessboard is 2^64-1, that is, 18 446 744 073 709 551 615 grains of wheat, weighing about 1 199 000 000 000 metric tons (This is about 1 645 times the global production of wheat in 2014). If that legend was true, the inventor definitely bankrupted the whole empire and became the richest man on the planet. Now if instead of wheat grains, imagine you could do that with dollars. Imagine, if you started with 1 USD and you doubled that every year, you will be the richest person in history after 64 years. However, doubling your money in a year is hard but with the right investments in the stock markets you could expect gains of 10% every year on average. And if you are Warren Buffett, then gains of 20% are possible. As the graph below from MarketWatch shows, Warren Buffett gained the bulk of his wealth after he turned 60. Now at 88, Warren Buffet is worth 88.8 billions USD.
Over the last twelve months, the real power of compound interest worked on cryptocurrencies. As I have recently explained, I invested 10% of my portfolio in two cryptocurrencies, namely, Bitcoin and Ethereum and expected them to grow over several years. Unfortunately(or fortunately), the cryptocurrency market entered into a bubble and they were soon worth 50% of my portfolio. I decided that I could not let such a volatile and unstable market be the majority of my portfolio. Beside, I was gaining popularity on the social trading platform eToro and was consequently managing funds worth 400 000 USD for over 400 people. The fact that there were people who have trusted me with their money and were investing according to my advices compelled me to move away from cryptocurrencies before the bubble burst. I set a plan to gradually get out of this market. Unfortunately, at some point I turned greedy and decided not to go according to my plan but to wait a little longer before I exit. Well, the bubble burst and I eventually exited this market with less profit than I was expecting. Like Warren Buffett said, "I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful." I was fearful in the beginning when everybody was greedy and then I became greedy too and couldn't lock maximum profits. Anyway, 95% return in a year is still great and I have now seen the real power of compound interest. With the cryptomania over, I changed my strategy and they are already turning fruitful. As for my net worth, it is too early for me to make that public but I can share how distribution of my assets changed over the last few years.
You can see how quickly my little investment in cryptocurrencies grew and when I took my profits, instead of just cashing everything or buying something fancy that I don't need, I reinvested the profits. Now my investments in America's largest bank JP Morgan Chase & Co. (JPM) is worth more than my physical assets. At the same time, I have a large share of my portfolio allocated to two growing tech giants Apple (AAPL) and Amazon (AMZN). Likewise, I took some bigger risks with a big investment in Yandex (YNDX), which is Russia's largest search engine, expecting faster returns on my investments. The rest of my portfolio is diversified in various sectors including railroads, airlines, aviation, banks, insurance, reinsurance, fashion, automobile, oil refineries and more.
To sum up, the key to success, the key to building an empire can be summarised in just a few steps: 1. Find multiple stream of incomes. It can be your job or your business or any skill that you can be paid for. 2. Make sure you have a positive cashflow. It is worth waiting a few years or decades to buy something that you really need (for example, a private jet) rather than taking loans, which are liabilities, to buy something you don't really need. 3. Invest that cash depending on your risk tolerance and let compound interest do its job.
These three steps look so easy that you must be wondering why only a minority are rich and successful. It is because there is step zero and only a few are willing to take it: 0. Invest in yourself first. Educate yourself, discipline yourself and understand yourself and your goals before doing anything.