This is How Compounding works - MUST WATCH | Mohnish Pabrai | Stocks | Investment

Summary

The speaker emphasizes the profound impact of compound interest, illustrating its power with historical examples and math calculations. They recount Warren Buffett's story of Manhattan's sale by the Min Indians for $24, demonstrating how that amount could have grown to trillions with a 7% annual return. The talk also touches on the importance of starting to invest early, using the example of a librarian who saved $4 million and the potential of an 18-year-old saving a small amount annually. The message is clear: understanding and leveraging compounding can lead to significant wealth accumulation over time.

Takeaways

• 🧮 **Understanding Compounding**: Einstein considered compounding as the eighth wonder of the world, highlighting the importance of grasping the power of compound interest and its mathematical implications.
• 📈 **Rule of 72**: The rule of 72 is a simple way to estimate how many years it takes for an investment to double, given a fixed annual rate of interest.
• 🏖️ **Historical Investment Example**: Warren Buffett used the example of the sale of Manhattan by Native Americans to illustrate the potential of compounding over time, had the $24 been invested at 7% annually.
• 💸 **Impact of Time and Rate**: Two key factors in compounding are the length of time and the rate of growth. Even a modest rate can lead to significant results over a long period.
• 👴 **Longevity and Compounding**: The longer one can compound their investments, the greater the potential wealth accumulation, which is why Buffett values longevity in the context of investment growth.
• 🎓 **Educational Importance**: The speaker emphasizes the importance of being able to perform compounding calculations mentally, as it has significant practical implications.
• 👨‍💼 **Real-life Story**: The story of a librarian who left a sizable donation upon his death demonstrates the power of consistent saving and compounding, even on a modest income.
• 💼 **Career Earnings vs. Compounding**: A person starting with a minimum wage job but saving and investing can end up with a substantial net worth due to the effects of compounding over 50 years.
• 👧 **Youth and Investing**: Starting to save and invest at a young age, such as during an internship, can lead to a substantial accumulation of wealth by retirement age due to the magic of compounding.
• 🚫 **Avoid Early Withdrawals**: The script advises against taking early withdrawals from retirement accounts like 401(k)s or IRAs, as it can lead to significant value destruction over time.
• 📊 **Mathematical Fluency**: Having fluency in the mathematical concepts related to compounding is crucial for understanding and utilizing its power effectively.

Q & A

What did Einstein reportedly call compounding?

Einstein is said to have called compounding the eighth wonder of the world, highlighting its significant impact on growth over time.

Why is it advantageous to understand the power of compounding?

Understanding the power of compounding is advantageous because it allows individuals to perform mental calculations related to financial growth, which can lead to better investment decisions and wealth accumulation.

What historical example was used to illustrate the power of compounding in the script?

The script uses the example of the sale of Manhattan by the Min Indians to the Dutch for $24 in 1626, and how that amount could have grown to trillions if invested at a 7% annual interest rate.

According to the script, what is the estimated wealth of the entire planet?

The script estimates the entire wealth of the planet to be 300 trillion dollars.

What is the estimated wealth of the United States mentioned in the script?

The script estimates the wealth of the United States to be 80 trillion dollars.

What is the Rule of 72, and how is it used in the script?

The Rule of 72 is a mathematical rule used to estimate the number of years required to double the investment at a given annual rate of return. In the script, it is used to demonstrate how the $24 invested at 7% interest rate would grow over time.

What is the significance of the number 2^10 in the script's explanation of compounding?

The number 2^10, which equals 1024, is used in the script to illustrate the concept of exponential growth, showing that an investment would increase by a factor of 1,024 in 100 years if it were to double every 10 years at a 7% interest rate.

How much would the $24 invested in 1626 be worth today if it had been compounded at 7% annually?

According to the script, if the $24 from 1626 had been invested at a 7% annual interest rate, it would be worth approximately 12 trillion dollars today.

What is the importance of starting to invest at a young age, as illustrated by the script?

The script emphasizes the importance of starting to invest at a young age because the longer the investment has to grow, the more significant the compounding effect, leading to substantial wealth accumulation over time.

What is the significance of the librarian's story mentioned in the script?

The story of the librarian who left $4 million to the college where he worked is significant because it demonstrates the power of consistent saving and investing over time, even with a modest income.

How does Warren Buffett view the concept of compounding?

Warren Buffett views compounding as a critical element in wealth accumulation. He is known to have understood the concept at a young age and has used it to build his wealth over many decades.