Buffettology: More to investing than returns

September 21st, 2011

Most of us want our investments to offer returns similar to the ones generated by the legendary Warren Buffett. To that end we try to learn from his investment style to get superior returns. But the question is, does one have to look at parameters beyond just returns to become wealthy?

Even if one generates returns comparable to Buffet, there is a possibility of one remaining poor or not being able to build enough wealth.

The magic formula

Consider some facts about the Oracle of Omaha. While Buffett was little over 11 year of age, he bought three shares of Cities Service Preferred for himself and while in high school  invested in his father’s business. Buffett filed his tax return at the age of 14. From his early days he tended to save. According to one estimate by the time he finished college, Buffett had accumulated more than $90,000 in savings measured in 2009 dollars.

Nine women or nine months

Buffett has always emphasised on giving time to your investments to grow. Even if one buys the right stock at the right price, the fortunes are made in time.

As Buffett explains in his 1985 annual letter to shareholders,  “No matter how great the talent or effort, some things just take time: you can’t produce a baby in one month by getting nine women pregnant.”

These words explain the power of compounding and the time that it takes before it starts to kick in. Compounding is simple and I know most of us understand the concept very well. However, we need to implement it in its true essence. Hope some these examples should be worth noting.

At 16 per cent annual returns, it takes five years for Rs 100 to become Rs 200. But if one holds the same Rs 200 for another five years it becomes Rs 440.

Differentiating factor

Like early investing, how much one invest is equally important. A Rs 100,000 compounded over the next 10 years with the annual returns of 20 percent would just total little over Rs 6 lakh. However a Rs 10 lakh invested today compounded with the same rate and over longer periods say 30 years would be worth about Rs 24 crore. This is a huge difference. The point I am trying to make is even if we exhibit the best stock picking quality, returns alone may not lead you to the pot of gold.

The widening gap between poor and rich

Here’s another example. Say investor A invests Rs 10 lakh and investor B invests Rs 1 lakh. Today the difference between both investors in absolute terms is Rs 9 lakh. If both of them remain invested and their money grows at a rate of 20 per cent per annum by the end of 30 years, the wealth of A would be Rs 23.7 crore compared to that of B at Rs 2.37 crore. This is a difference of over Rs 21.3 crore as against the current difference of Rs 9 Lakh between investors A and B.

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