Sunday 13 September 2009

Let time work to your advantage

Choosing good companies at fair prices seldom has produced losses for investors willing to wait patiently for the stock price to track the growth of the company.

"Time is the friend of the good business, the enemy of the poor," Buffett has said many times.

Strong enterprises see their intrinsic value rise consistently, lifting the stock every step of the way. Over a period of 5 years or more, there should be a very close correlation between the change in the value of the company and the change in the stock. Watching great companies increase their sales and earnings consistently is a dream come true for an investor.

The power of compounding begins working its magic as the years progress and allows your net worth to gather momentum and increase (in dollar value) by greater and greater amounts.

What happens to money that is allowed to sit and grow at different rates? Two principles should be readily apparent:

1. Time has a tremendous effect on terminal wealth. The longer that money can compound, the larger the sum will be.

2. The rate of return attained acts as a lever that magnifies or minimises your ultimate wealth. Adding just a few extra percentage points a year to your overall returns can have unfathomable consequences to your wealth. An investor who compounds $1 at 6 percent annual rates has $5.74 in his pocket at the end of 30 years. The same investor who can find ways to obtain higher returns (the purpose of posting all these materials here :-) ) walks away with much more. If you can obtain a 10 percent annual return, your $1 compounds into $17.45 in 30 years. Compounding $1 at 20 percent annual rates compounds into $237.

The mathematics of compounding excited Buffett in his earliest years, and stories abound of how he memorised compounding and annuity tables to help him calculate an investment's merit and to keep his personal portfolio on a straight upward track.

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