We love to monitor the blog of Chris Mayer, co-founder & Portfolio Manager at Woodlock House Family Capital, and author of 100-Baggers. In his latest post, Mayer explores the beauty of compound investing.
Albert Einstein called compound interest the eight wonder of the world.
When applied to investing, it’s allowing the companies you own to reinvest earnings over and over again, and to let the stock grow unimpeded.
Mayer lays out the compelling returns that can be achieved over time just by doing nothing, and dispels a myth about when to buy a stock.
by Chris Mayer
“The first rule of compounding: Never interrupt it unnecessarily.” – Charlie Munger
I love this Munger quote. I may have it pinned on my wall. (Right next to another Munger quote I have on my wall: “The goal of investments is to find situations where it is safe not to diversify.”)
I thought about Charlie’s first rule of compounding the other day when a friend asked if I trimmed a position that has run quite a bit this year. I haven’t touched it.
Why not? Shouldn’t I trim when something becomes “expensive”? Shouldn’t I put the money in something “less expensive”? Isn’t that what “active managers” do?
I suppose, if I were Superman and I could leap tall buildings at a single bound, then I could make such deft moves without error.
But in the real world, making this a practice leads to a dizzying daisy chain of decisions that create lots of opportunities for making mistakes. (Besides making the IRS happy).
More important, however, is Munger’s point. Everyone seems to acknowledge the power of compounding.
If you earn 20% per year for 25 years, you’ll wind up with about 100x your money — the coveted 100 bagger.
But people forget the math of this is heavily back-end loaded. After 20 years, you have ~38x. After 10, about ~6x.
So, you don’t want to interrupt that compounding lightly. You better have a pretty darn compelling reason to sell a winning business just because the stock doubled in a year and looks “expensive.”
Otherwise, your sale is going to look really costly some years later.
Trimming is one of those things that sounds so sensible, so smart. It also satisfies that itch to “do something.” Yet, if you own a really good business and take the long view, you’re probably better off leaving it alone.
There is a similar idea to trimming that sounds smart, but doesn’t hold up if you’re a long-term investor. It goes like this: “X stock is too expensive, I need a 10% [or 20%] correction before I buy.”
If you’re a long-term investor, 10% or 20% is a rounding error.
Let’s say I find a business I really like. It checks all my boxes. The stock is $10 today and I think it will be worth $50 in a decade. But, shucks, I got a buy price sitting at $9 or $8. So, I’m just going to wait for it to hit my buy price.
Does that sound wise? What would Munger say? Remember, you can always buy more if the stock goes down. Don’t be penny-wise and pound-foolish as they say.
If my potential return is such that paying $8 or $9 or $10 is the make or break on whether I buy it, then I tell myself go look for a better idea. Again, I’m speaking from the perspective of a long-term owner of businesses.
And I don’t have to own many; 10-12 will do. If you’re flipping stuff, then the difference between $8 and $10 is the difference between eating and going hungry. But if that’s how you invest, you’re probably not reading this blog.