Suppose you were building a house.
Wouldn't it be great if you could build the foundation... and have the foundation automatically build the floors? And have the floors spontaneously generate the walls? And have the walls automatically grow the roof?
Once you laid the foundation, your only remaining job would be to do nothing...to sit and wait for the house to finish building itself.
The dream of a foundation that builds a house is a perfect description of what happens when you harness the greatest wealth-building power there is...a power that Albert Einstein called, "the greatest mathematical discovery of all time."
Einstein was talking about the power of compounding.
If you want to know how Warren Buffett turned $105,000 into a $50+ billion fortune, the answer is compounding.
All he did was decide ahead of time what were the best companies in the world. Then he waited until their stock prices fell because of a market collapse or a scandal. Then he bought. The rest, as they say, is history.
Time and compounding did all the rest of the work. Buffett was wise enough – and as an investor, passive enough – to let compounding do its work. As he once said, "I make money while I sleep."
Most people with small amounts of money to invest think they need to double their money every year to become wealthy. So they take big risks. This usually causes them to take big losses. Big losses cut into their available investment capital...and the effects of compounding are weakened.
Some small investors think it's necessary to win lottery-like returns, making thousands or hundreds of thousands or even millions for each dollar invested.
But that's simply not true. If you start today with $10,000 and average 20% a year for 20 years, you'll have over $380,000. Add $2,000 a year to the pot, and you'll wind up with $756,751 after 20 years. Granted, 20% a year is not easy to achieve. But even if you only make 10% a year, you're still going to become very wealthy over the long term.
So here’s how you double your money every year:
Buy a high quality business or asset at the moment of greatest pessimism and hold it for the long term.
That's what Warren Buffett has done his whole career. That's why he says his favorite holding period is forever. For just one example, Buffett has said he would never think of selling his shares of Coke.
Warren Buffett bought Coke shares twice: once in 1988 for $5.22 per share and again in 1994 for $21.95 a share.
For every $5.22 share Buffett bought in 1988, he now owns 16 shares, due to four 2:1 stock splits. For every $21.95 share Buffett bought in 1994, he now owns four shares due to two 2:1 stock splits. Today, Buffett owns over 400 million shares – worth over $15 billion.
That’s great, but it’s not the whole story. Buffett is now getting around 50% of his purchase price back in dividends each year. He's compounding money at an enormously high rate.
Don't let the stock splits confuse you. They don't change anything. Coke has a great business, and it has raised its dividend consistently.
I leave it to you to decide if Coke is a buy.
So the How to I promised in my title is simple, but perhaps not easy for the average impatient investor. You merely have to exercise a capacity that almost no investor is willing to use in a world where almost no one really thinks long term anymore: patience.
Buffett's strategy and his stellar results jibe perfectly with the great tax advantages of being a buy-and-hold investor. You can wind up with several times the amount of wealth on a safe, cheap investment, simply by never selling.
Good investing,