Warren Buffett is said to have had a “marital debate” with his late wife Suzy about Suzy’s plan to spend $20,000 to renovate their decades-old home. Was Buffett’s objection based on his inability to afford the renovations? Hardly. As one of the world’s richest men, he could spend that amount daily on his home and not even make a dent in his wealth. Did he disagree with Suzy that their surroundings needed some freshening-up? Probably not, given that home interior styles have such a short shelf-life, their home probably needed a little updating. What then was his objection? Warren knew that once the $20,000 was spent, it was dead money.
To understand the wealth-building principles of Warren Buffett, it’s important to understand how Buffett relates to money. Buffett sees each dollar as a seed that can be planted to grow more dollars. With his investments generating a compound annual rate of return of 22% for the past 40+ years, Buffett also recognizes that he’s not your average Johnny Appleseed. Buffett is a master capital compounder. That $20,000 did not appear to him, thru his capital compounding lens, as $20,000. Rather, it most likely looked like $7,000,000 to Buffett. Yes, seven million dollars.
How do you view your expenditures? If you are like most people, you look at them as the face value of the item’s cost, not in opportunity lost. What do I get today, not what I’m giving up tomorrow. Indeed most often, people look thru the lens of affordability and deservability when making purchases. What if, instead of an item’s cost being listed on its price tag, the lost future wealth of making the purchase was listed instead? Would you think differently about the purchase? An illustration may help:
What about buying a $100 golf club instead of investing that sum over 30 years? The future wealth lost of that purchase at a 15% return would be $6,621. At 20%, it would be $23,737 and at 30% it would be an astounding $261,999.
What about buying $5 in lottery tickets each week instead of investing the same amount for 30 years? At a 15% return the lost wealth would total $17,215. At 20% it would be $61,717 and at 30% it would be a remarkable $681,198!
Now back to that $20,000 on home renovations. If Buffett had spent that sum instead of investing it, the lost future wealth at a 15% return would have been $1.3M. At 20% return, it would have been $4.7M and at a 30% return, the lost future wealth would have eclipsed $52M.
No wonder Buffet objected. That’s a mighty expensive couch!
Modern financial literature is loaded with examples on the importance of compound interest with regards to saving. However, compound interest operates in both directions. Money compounds away from you as fast as it compounds to you. Buffett knew he could make a 22% return with that $20,000. And if you think Buffett didn’t make most of his money via compounding, think again. Buffett earned the majority of his wealth very late in life as the result of massive compounding.
If you knew that you could compound your money at 10% or greater each year, would your money look like seeds to you? Had you invested in an index fund that simply mirrored the S&P 500 over the past 100 years, your money would have compounded at around 10% annually. Money can grow on trees.
Unlike teenagers, money does what it is told to do. You direct it towards savings and investment or towards spending and waste. Which direction is your money headed today?
Be free. Nothing else is worth it.
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