I'm a professional trader. I know a lot of people who have put up massive returns for 10+ years. But not one is in Warren Buffett's league.
Why?
Buffett can take advantage of the eighth wonder of the world. None of us can.
The eighth wonder of the world is compound interest.
Imagine that you make 20% per year. If you have a little bit of money, 20% won’t give you a lot of money after just one year. But if you reinvest your profits, you have 20% more money every year. Over time you build up a lot of money — for example, $1,000 invested at 20%/yr for 30 yrs becomes $250,000. Buffett has been at it for more than 50 years; after 50 years, that $1,000 would become $9 million!
The magic of Buffett’s strategy is its ability to scale. When Buffett makes 20%, he can do it on $150 thousand or $150 million or $150 billion. This is not true for ordinary traders!
When buyers come into a market the price is pushed up. Then, when they sell to take their profits, the price is pushed down. The more money you have to move around the more impact you have on the market, so you must buy at higher prices and sell at lower prices — that is, your profit margins fall.
So where do the biggest investors put their money?
If Buffett wants to deploy $100 billion of capital without spooking his stocks’ prices, there aren’t a lot of different companies he can consider. He can choose Coke versus Pepsi, Goldman Sachs versus Bank of America, IBM versus Apple. And guess how many other A-list investors are looking at those same stocks?
An ordinary person can look at 5,000 stocks, but Buffett can only look at 50. And he’s looking at the 50 with the most eyes on them.
The traders who put up massive annual returns aren’t limited like this. Today my biggest profit was in an obscure Chinese shipping company. Not a regular in the CNBC headlines? That’s because it could fit inside Coca-Cola one hundred times over and nobody would notice. Guess how many people with Warren Buffett’s elite skills were competing with me? Zero.
Then it gets even worse!
Buffett has 400 million shares of Coca-Cola. Yesterday the stock traded only 22 million. So even if he could take every single share sold, it would take him a month to get out of his position. At his scale, Buffett has to spend months or years just putting his money into a stock, then he has to wait years for it to make a move, then he has to spend months or years getting out. And if it ever turns against him, sorry, he’s stuck holding onto that loser.
Let’s compare that with the kind of trading that produces 100%+ returns. Of my 10 best trades of the last year, I didn’t hold a single one for more than three hours of the trading day. While writing this, Sprint and T-Mobile had news, and I got in and out of an entire position in under sixty seconds. So not only is Buffett constrained to the 50 (or so) most crowded stocks in the market, his fund is this lumbering giant that can’t make a move before the traders running nimble money have already booked their profit.
I guarantee you that if Warren Buffett were not constrained by scale, he could put up percentages every bit as gaudy as traders like me. He prefers to make billions.
The eighth wonder of the world is compound interest.
Let’s run some simplified numbers. Imagine that a hotshot trader makes 200% returns every year on his $1,000,000 account, which would be an elite level of success to say the least. The only caveat is that he has to take his profit out every year because the trades can’t scale up any further. He would make $2 million per year — good money if you can find it. After 30 years he would have $60 million in total profits.
Now let’s imagine we invested that money with Warren Buffett instead. Say that instead of 200% he can make 20%, but he can scale indefinitely. That first year, a $1,000,000 account would kick off $200,000, just a fraction of the hotshot trader’s payday. But after 30 years we wouldn’t have $60 million. Thanks to compound interest, we would have $250 million. And where the hotshot trader would have $100 million after 50 years, we would have $9 billion!
Now, you might be thinking: Wouldn’t the trader put those excess profits in outside investments and therefore have more money in the end? Sure, absolutely. But where would he invest that money — his own account, or Warren Buffett’s fund? So who’s the better investor: the guy with higher numbers on a stat sheet, or the guy that the other guy wants to invest his money with?
That’s the magic of compound interest. And that’s what makes Warren Buffett’s success so incredible: 20% that can scale beats 200% that can’t scale every time.
Thanks for Reading
0 Comments