The Sunday Times 03 June 2018
In November 1626, Peter Minuit, representing the Dutch West India Company, purchased the island of Manhattan from the native Americans for some beads, cloth, and trinkets worth about 60 Dutch guilders, which was estimated as the equivalent of $24 at the time.
When people hear this story they say the Dutch swindled the local native community, paying them a pittance for what is now the epicentre of world finance, the richest and most famous of the boroughs that comprise New York City.
But was it really such a bad deal?
When we consider money we tend to think of it in nominal terms – the euros and cents in our bank accounts. But what if the native Americans invested the money and earned a reasonable return; what would it be worth today?
There’s a simple rule in maths called the rule of 72 which computes how long it takes for a sum of money to double. So you divide 72 by the rate of return, and the answer is how long it takes for it to double. So at a 7.2% p.a. rate of return, the sum doubles every ten years (72 divided by 7.2).
So in 1636, the native Americans would have $48 at this rate of return; $96 in 1646 and so on. Every century then, you get roughly 10 doubles, or 1000 times the sum i.e. add three zeros (it’s actually 1024, but the maths is easier if we simplify).
So in 1726 they would have had $24,000. In 1826, $24m. In 1926, $24bn. And in 2026, it would be $24 trillion. We haven’t reached 2026 yet, so if we take one double away, its 2016 equivalent would be $12 trillion.
The total net worth of the entire United States is estimated at $123 trillion according to Wikipedia. I don’t know what Manhattan is worth, but it’s unlikely that 20 square km of America accounts for one tenth of the total country’s wealth. So maybe the native Americans didn’t get such a bad deal after all.
The long term return on the US stock market has been c. 10% p.a. going back to 1900 according to several reputable sources. Maybe future returns will be lower, who knows. The rate of return we can quibble about, but the central point here is that compounding is one of the most important ideas to be fanatical about.
One person who discovered the importance of this at a very early age and was completely obsessed by it was Warren Buffett. At age 11 he said he wanted to be a millionaire by the age of 30. And that he did achieve.
Buffett today is worth an estimated $81bn. According to Morgan Housel, a staggering $80.7 billion of this was accumulated after his 50th birthday (he is now 87 years old)
In a thought experiment, Housel wonders what if Buffett got serious about investing when he was age 22 – just out of college – instead of age 11? Assuming his net worth at age 30 was still in the impressive 90th percentile he would have been worth about $24,000 at age 30, after adjusting to reflect 1960s era inflation.
If, at age 30, Buffett was worth $24,000 instead of the $1 million he actually accumulated, and went on to earn the same returns, he would be worth $1.9 billion today; 98% lower than his actual net worth.
The punchline is that 97.6% of Buffett’s net worth can be directly tied to the base he built in his teens and 20s. As Housel says, “without the capital base he built before he could grow a beard, you’d probably never have heard of him.”
There are hundreds of books documenting the success of Buffett and how he amassed such a fortune. Arguably, the most practical takeaway from his success is, to start investing before you leave primary school. I think this analysis skims over the fact that Buffett has an astonishing investment track record, but having written enough times on this, we will take it as read.
As the father of 11 year old twins, I’ve struggled to create a sense of fanaticism about compounding in my own children. Though I have to admit that I believe a lot of this to be innate anyway – we can help at the margins in terms of the nurturing a sense of it, but most of it comes from within.
A nice idea proposed by one of my work colleagues is to promote the idea of saving by having three jars for money; one is a savings jar, one a spending jar and a 3rd jar for charity. They agree a split between each and then apportion money earned (or gifted) between them. I’ve let early enthusiasm for the idea wane a little recently, but initially found it to work quite well.
Whatever route one takes, I think the important part is the initial decision and action, and the earlier the better. Some historians claim that the native Americans, with whom Minuit made the deal, were actually from Long Island and never owned the island of Manhattan. Selling something you don’t own is one approach to making a fortune!
In the interests of staying on the starboard side of the law however, the stock market has proven to be a very powerful (and legal) way to compound wealth.
Gary Connolly is Managing Director of iCubed. He can be contacted at email@example.com or on twitter @gconno1. iCubed Training, Research and Consulting, trading as iCubed, is regulated by the Central Bank of Ireland.