A Marathon, not a sprint
Chapter 4 of Morgan Housel’s “Psychology of Money”, he highlights a critical truth about investing: success is not about chasing extraordinary returns but achieving consistent, sustainable ones. Compounding, the phenomenon where returns build upon themselves over time, is a powerful force that requires patience and discipline.
Using Warren Buffett as a case study, Housel demonstrates the magic of compounding. As of 2020, when this book was written, Buffett’s net worth was $84.5 billion. Astoundingly, $84.2 billion of that was accumulated after he turned 50, and $81.5 billion after his mid-60s. Buffett’s success is not just a product of skill but of starting early and allowing time to amplify his wealth.
By contrast, Jim Simons, a hedge fund manager with extraordinary annual returns—three times higher than Buffett’s—has a net worth of $21 billion (as of 2020). Simons started his investment journey much later, honing his craft in his 50s, which curtailed his ability to fully leverage compounding. This comparison underscores a key takeaway: the duration of compounding matters more than the rate of return.
Avoiding the Tragic Pitfalls
While achieving sky-high returns may seem appealing, they are often unsustainable and fraught with risks. Housel warns that the quest for massive, short-term gains can lead to financial disasters if these gains are not retained. Good investing is about ensuring returns are consistent and enduring, allowing compounding to "run wild" over decades rather than chasing fleeting success.
In chapter 5, Housel tackles the subject of getting wealthy vs. staying wealthy. The challenge of wealth isn’t just accumulating it—it’s keeping it. Housel explains that while getting wealthy may involve making good decisions, staying wealthy is about avoiding catastrophic mistakes. A single, devastating mistake—driven by greed, overconfidence, or fear of missing out—can undo years of progress.
To protect wealth, Housel advocates appreciating 3 things.
- More than seeking outsized financial returns, desire to become financially unbreakable
- Prioritize unbreakability over high returns. Rather than striving for spectacular gains, aim for financial strategies that can withstand adversity.
- Practically, have a comfortable emergency fund to withstand market downturns and unforeseen financial hardships. Also, have a sounding board, like a financial advisor to talk through with you your fears, emotions, and concerns to ensure you avoid a rash decision.
- Plan that your plan won’t go according to plan:
- Recognize that life doesn’t go according to plan. Build flexibility and a cushion into your planning.
- Discuss and consider what you would do if your plan derails, so you are prepared when hardships do occur.
- A “barbell” personality:
- Be optimistic about the future but paranoid about what could keep you from getting there.
- Don’t risk it all. Few gains are worth a complete financial wipeout. A cautious, measured approach ensures survival through both good times and bad.
The Takeaway
Housel’s lessons on compounding and wealth longevity are a reminder that financial success is not about speed or spectacular achievements but about consistency and endurance. By embracing the principles of time, patience, and risk management, investors can harness the full potential of compounding and build wealth that lasts.