The STRIDE Blog

Understanding the Benefits of Compound Interest

stride-buffet-compound-interest-featured.jpgDid you know that when Warren Buffett was 50 years old, he had only 1% of the wealth that he has today? It’s the truest example of the benefits of compound interest.

We know what most of you are thinking: “It took a lot more than compound interest for Warren Buffett to get where he is”. You’re not wrong, he also had a exceptionally strategic long-term approach to investing and always looked for hidden value that he could buy on the cheap. But, compound interest was his foundation stone, and catapulted his efforts into the sky.

“Reinvesting your earnings and growth in capital transforms money into a tool for further earnings and growth in capital. The law of compounding transforms time into one of your greatest assets. It is not to be underestimated.” Scott Nursten

While it’s not a specific principle of STRIDE’s 3D VI strategy, compound interest is the hidden gem behind our strategy. Because, the principles themselves are built on the value of long-term compounding interest. As I said in my last blog, once you’ve analysed that a company is a good value investment, you shouldn’t need to worry about market fluctuations, and 10 years down the line you can exit to enjoy the wonderful provision of compound interest. 

Okay, What is this Compound Interest?

Let’s start with a practical definition from Investopedia of calculating compound interest:

“Compound Interest = Total amount of Principal and Interest in future (or Future Value) less Principal amount at present (or Present Value)

                                = [P (1 + i)n] – P

(Where P = Principal, i = nominal annual interest rate in percentage terms, and n = number of compounding periods.) If the number of compounding periods is more than once a year, "i" and "n" must be adjusted accordingly. The "i" must be divided by the number of compounding periods per year, and "n" is the number of compounding periods per year times the loan or deposit’s maturity period in years.”

What this equation means, though, is that you earn interest on your interest… which is fantastic, because it’s like a self-fulfilling prophecy. Your capital grows because of interest, which then increases your interest earned, which in turn increases your capital, and so the process goes on. It’s a concept to be taken by value investors because the benefit lies in a long-term investment, and we all know that time should be a value investor’s best friend.

A Case Study of Compound Interest Investing

We’ve already heard that Buffett's investment strategy only began to see benefits once he’d passed 50 years, so how would we have fared in that time? Let’s imagine you’d invested $100 with Buffett’s Berkshire Hathaway in 1964, and left it to compound over 50 years.

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The growth in both capital and interest is exponential. In 50 years, your investment would have grown to just short of $800,000… but note that there’s no sudden increase over one or two years. It takes at least 10 years for you to see the exciting benefit of compounding your investment, and if you look over the full 50 years it’s simply astounding. We aren’t implying that there aren’t other factors at play, but the foundation that creates this exponential rise is compound interest.

If you’d like to read more about STRIDE’s approach to value investing, download our eBook, A Practical Guide to Value Investing: Running Your Portfolio.

Your Practical Guide to Value Investing III

Topics: Value, 3D Value Investing, Valuation

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3D Value Investing: Triangulating The Best Investment Targets

3D Value Investing uncovers the best businesses for investment, the fair value of those businesses and the best times to buy in and sell out. This approach to long-term investing results in higher returns with lower risk.

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