July 6th 1962, Buffett writes to those in his partnership:
“During the first half of 1962 we had one of the best periods in our history, achieving a minus 7.5% result…”
Hard to believe that is coming from Mr. Buffett, but it’s true. To look at why a losing year could be deemed so great we need to get into Mr. Buffett’s head.
If you are subscribed to our newsletter (signup available off to the right, or at the bottom of this post) you have received, or will soon receive a newsletter showing the powers of compounding interest. Today we use Mr. Buffett’s performances early on in his career as an example of just how powerful of a force compounding interest is.
Some people just seem to be born with the ability to calculate the powers of compounding interest in everyday life, and Buffett is certainly one of those people. Even though he was a millionaire (factoring in for inflation) by the age of 25, he still refused to pay more for designer suits, drive fancy cars or even pay extra to get his hair cut at fancy barber shops. Early in life Buffett is quoted as asking himself; “Do I really want to spend $330,000 on a haircut?” Of course that is not what it was going to cost him that day, but Buffett figured that he could turn that small payment into a fortune by investing wisely in the stock market over the next several decades.
Buffett’s “Best period ever” in the first half of 1962 saw the Dow drop 21.7%, meaning Buffett outperformed the Dow by about 14.2%.
In 1962 Buffett’s partnership managed about $7.2 million in assets; let’s assume that that investment amount stays constant and Buffett never took another dollar to manage. What are the long term implications of Buffett’s performance in 1962?
First, let’s assume Buffett “only” loses 7.5% compared to the Dow’s -21.7% in 1962 and then Buffett’s returns earn a constant 6% compounded (equal to the market) for the next 40 years. This example shows the long term effects of Buffett’s outperformance for just this ONE year. Of course Buffett managed to outperform the market for decades….but we will look at the implications of that later.
| Year | Buffett’s Return | Buffett’s Total | Dow’s Return | Dow’s Total | ||
| 1961 | – | $7,200,000 | – | $7,200,000 | ||
| 1962 | -7.50% | $6,660,000.00 | -21.70% | $5,637,600.00 | ||
| 1963 | 6% | $7,059,600.00 | 6% | $5,975,856.00 | ||
| 1964 | 6% | $7,483,176.00 | 6% | $6,334,407.36 | ||
| 1965 | 6% | $7,932,166.56 | 6% | $6,714,471.80 | ||
| 1966 | 6% | $8,408,096.55 | 6% | $7,117,340.11 | ||
| 1967 | 6% | $8,912,582.35 | 6% | $7,544,380.52 | ||
| 1968 | 6% | $9,447,337.29 | 6% | $7,997,043.35 | ||
| 1969 | 6% | $10,014,177.52 | 6% | $8,476,865.95 | ||
| 1970 | 6% | $10,615,028.18 | 6% | $8,985,477.90 | ||
| 1971 | 6% | $11,251,929.87 | 6% | $9,524,606.58 | ||
| 1972 | 6% | $11,927,045.66 | 6% | $10,096,082.97 | ||
| 1973 | 6% | $12,642,668.40 | 6% | $10,701,847.95 | ||
| 1974 | 6% | $13,401,228.50 | 6% | $11,343,958.83 | ||
| 1975 | 6% | $14,205,302.21 | 6% | $12,024,596.36 | ||
| 1976 | 6% | $15,057,620.35 | 6% | $12,746,072.14 | ||
| 1977 | 6% | $15,961,077.57 | 6% | $13,510,836.47 | ||
| 1978 | 6% | $16,918,742.22 | 6% | $14,321,486.66 | ||
| 1979 | 6% | $17,933,866.75 | 6% | $15,180,775.86 | ||
| 1980 | 6% | $19,009,898.76 | 6% | $16,091,622.41 | ||
| 1981 | 6% | $20,150,492.68 | 6% | $17,057,119.75 | ||
| 1982 | 6% | $21,359,522.24 | 6% | $18,080,546.94 | ||
| 1983 | 6% | $22,641,093.58 | 6% | $19,165,379.75 | ||
| 1984 | 6% | $23,999,559.19 | 6% | $20,315,302.54 | ||
| 1985 | 6% | $25,439,532.75 | 6% | $21,534,220.69 | ||
| 1986 | 6% | $26,965,904.71 | 6% | $22,826,273.93 | ||
| 1987 | 6% | $28,583,858.99 | 6% | $24,195,850.37 | ||
| 1988 | 6% | $30,298,890.53 | 6% | $25,647,601.39 | ||
| 1989 | 6% | $32,116,823.97 | 6% | $27,186,457.48 | ||
| 1990 | 6% | $34,043,833.40 | 6% | $28,817,644.92 | ||
| 1991 | 6% | $36,086,463.41 | 6% | $30,546,703.62 | ||
| 1992 | 6% | $38,251,651.21 | 6% | $32,379,505.84 | ||
| 1993 | 6% | $40,546,750.28 | 6% | $34,322,276.19 | ||
| 1994 | 6% | $42,979,555.30 | 6% | $36,381,612.76 | ||
| 1995 | 6% | $45,558,328.62 | 6% | $38,564,509.52 | ||
| 1996 | 6% | $48,291,828.34 | 6% | $40,878,380.09 | ||
| 1997 | 6% | $51,189,338.04 | 6% | $43,331,082.90 | ||
| 1998 | 6% | $54,260,698.32 | 6% | $45,930,947.87 | ||
| 1999 | 6% | $57,516,340.22 | 6% | $48,686,804.75 | ||
| 2000 | 6% | $60,967,320.63 | 6% | $51,608,013.03 |
Buffett’s results in 1962 alone would result in over $9 million dollars more 40 years later!
This is why Buffett’s main investing rules are:
Rule #1: Don’t lose money.
Rule #2: See rule #1.
Losing money hurts, but where it really hurts you is the long term implications and the loss of the compounding power that they money could have had. This is one of the main reasons I have been turned on to low cost, intelligent investing by the likes of Graham and Buffett. When I first started investing I purchased a few stocks that I thought would be good investments (really, I had no idea what I was doing). These stocks were in the news, vastly overpriced and had terrible balance sheets. But I was naive and just listened to the “experts” on TV about how the stocks were going “to the moon!”.
I ended up losing nearly $5,000 very early on in my investing career. Doesn’t sound like a lot, but I wasn’t making or saving a lot of money. Looking back, that money could have still been working for me compounding and growing, but instead it rode some company’s shares down to nearly $0. It would have more than doubled by now if it was just in a general S&P 500 index fund, and would have great compounding affects later in life. But if that is what it takes to learn a lesson, I guess it is worth it.
But back to the issue at hand… Don’t lose money, Buffett’s #1 rule.
Don’t take the rules too literally; Buffett is a perfect example that everyone is going to have a loss. But what if you can limit those losses to “only” 7.5% when the market is down 20+%? The long term compounding effects of that are astonishing!
This is why intelligent investors diversify their portfolio, stay away from frothy “bubble” stocks and invest for the long term compounding gains offered by the market.
To see the power of this over the long term, here is Buffett’s partnerships performance year by year (up to 1968) and then the cumulative compounded performance over the same period compared to the Dow.
(Click images below to enlarge)
There is no better testament to the long term results of investing wisely than Buffett. Will any of us achieve the magnitude of results he did? I think it is safe to say probably not. But we can certainly use his lessons and examples to show how patience and discipline can reward an investor over the long term. If I could have saved $5,000 a decade ago, that could easily have meant $50,000 more at the time of retirement.
But my loss, and Buffett’s gain can be a great lesson to beginning investors. You can Begin To Invest wisely today by making an effort to avoid unnecessary expenses, avoiding the bubbles and investing with patience and disciple. That is the recipe for long term success in the markets.
