The only sure-fire way to build wealth

Writer Morgan Housel likes to tell the story of how Warren Buffett really got to become so wealthy. For the record, Buffett’s current net worth is an estimated US$121 billion, making him the world’s seventh richest person, according to Forbes.

Buffett is one of the greatest investors ever. Yet if you think that’s the only reason for his success, you’d be missing the full picture. They key to his wealth is that he’s been a phenomenal investor for more than three quarters of a century. If he’d started investing in his 30s and retired in his 60s, most people would never have heard of him.

Housel demonstrates this by running a thought experiment where Buffett started investing at age 30 with $25,000. And Buffett goes on to earn the extraordinary investment returns he’s been able to generate (22% per annum) but quits investing and retires at age 60.

In this experiment, what would be a rough estimate of his net worth today? The answer: US$11.9 million. An excellent number, though about 99.9% less than his actual net worth.

Instead, what Buffett did is that he started investing at the age of 10, and by the time he was 30, he had a net worth of US$1 million, or more than US$10 million in today’s terms, adjusted for inflation. And he didn’t retire in his 60s like most people do. He’s continued investing into his 90s.

In other words, the real secret to Buffett’s wealth hasn’t just his investing acumen, but the amount of time that he’s been investing.

Becoming a mini-Buffett

That’s what most people miss about the concept of compound interest – it isn’t just about the rate of return but time in the market. It doesn’t just apply to Buffett either.

With enough time, anyone can become wealthy. Don’t believe me? Let’s look at historical returns from the US stock market. Since 1900, that market has had annual returns of 9.5%. If you’d invested US$1,000 in the market in 1900 (equivalent to more than US$30,000 today) and stayed invested to now, that would have turned into US$88.5 million (note the charts below are to the end of 2022).

Source: Credit Suisse

I can guess that you’re thinking: “c’mon, James, this is totally unrealistic. I don’t have 123 years to let compound interest work its magic.” True enough.

Let’s then run the same returns over smaller timeframes. Say, the amount of time that Buffett has been investing – 83 years. The result is that US$1,000 would turn into US$2.57 million. A larger sum invested of US$50,000 would result in US$129 million at the end of 83 years. That’s nowhere near Buffett’s net worth yet it’s a tidy sum.

What about an even shorter time of 60 years? Assuming the same annual return of 9.5%, US$1,000 would turn into about US$292,000, or US$50,000 would become US$14.6 million.

This demonstrates the power of time in compounding money.

Potential objections

There are several possible objections to this analysis:

1. 60 years is still a long time to let compounding work.

Yes, that’s right. Though I hope the analysis shows the potential to build wealth if not within your lifetime, certainly within those of your children or grandchildren.

2. Using the US is disingenuous because America has had one of the best-performing markets over the past century.

This is true. Since 1900, the US has gone from being a middling power to becoming the world’s only superpower. This rise has been reflected in the performance of its stock market. In 1900, the US made up just 15% of the world equity markets. Now, it’s 58%.

Funnily, Australia has performed even better than the US in the long term, at least in nominal terms. Since 1900, the market here has achieved an annual return of more than 10% per annum.

Let’s take a country where recent history hasn’t been as kind to it. Over the past century, the UK has gone from a global superpower to a middling one. Its economic decline accelerated over the past 40 years with sharp falls in oil production in the North Sea, among other factors. Yet, its share market performance, though not as good as the US and Australia, has still been impressive.

Source: Credit Suisse

3. Returns won’t be as high in future.

That’s a guess. While it’s right that past performance isn’t indicative of future performance, long-term equity returns should continue to be favourable, especially in Australia.

4. It doesn’t account for inflation and costs such as brokerage and taxes. It also doesn’t include the benefits of franking credits in Australia.

Yes, these are all things that need to be factored in and applied to potential portfolio returns. 

5. It doesn’t include additions or subtractions to the initial amounts invested.

For simplicity’s sake, I've excluded that in this article.

Stop trying to beat time

Building wealth primarily depends on two things: the rate you can earn and the amount of time the money has to grow.

Most investors are obsessed with beating the market when time in the market is just as important, if not more so.

In markets as in life, time can be your most valuable asset.

James Gruber is an assistant editor at Firstlinks and Morningstar.com.au