Buffett Letters Vault

Compounding

3 min read

Compounding

Definition & Origin

Compound interest is the core engine of Buffett’s investment philosophy - interest generates interest, and income generates income, forming exponential growth. Buffett has been using compound interest tables since his first partnership letter in 1957 to convince partners to understand the power of long-term investment.

Key Points

  • Time is the fuel of compound interest: The longer the holding time, the stronger the compound interest effect
  • Both starting point and velocity are important: Buffett emphasized that he “started from a very young age”
  • Avoid interrupting compound interest: Frequent transactions and taxes can interrupt the compound interest process
  • Scale is the enemy of compound interest: The larger the amount of funds, the more difficult it is to maintain a high compound growth rate.

Case Studies

  • Coca-ColaDividend: Dividends were US$75 million in 1994, growing to US$704 million in 2022 - the same investment, dividends increased nearly 10 times
  • Berkshire overall: From $19 per share in 1965 to over $600,000 in 2024 – the power of 60 years of compounding
  • See’s Candies: US$25 million acquisition, which has since contributed more than US$2 billion in pre-tax profits to Berkshire

Common Misconceptions

  • Not just a mathematical formula: Compound interest requires the right business and the right holding mentality
  • Does not equal high rate of return: Stable medium rates of return with long-term compound interest are often better than fluctuating high rates of return
  • The impact of taxes is underestimated: Taxes must be paid every time a gain is realized, and deferring taxes is itself a form of compound interest.

Evolution of the Idea

  • 1956-1969: Compound interest is a tool for measuring performance. Buffett used the compound interest table to convince his partners
  • 1970-1989: Compound interest becomes the standard for stock selection - look for “companies that can make compound interest run automatically”
  • 1990-2009: Compound interest growth rate declines, Buffett admits that scale is the enemy of compound interest
  • 2010-2025: Compound interest becomes a philosophy - not just investment, but the underlying logic of life

Quotes from Buffett

“Life is like a snowball. The most important thing is to find wet snow and long slopes.”

“I am successful because I started at a very young age and I never stopped learning.” ——2024 Shareholder Letter (2)

“Taxation is the biggest enemy of compound interest.”——1989 Shareholder Letter

Letters Mentioned

Compound interest is mentioned in 64 letters and is one of the concepts that appears most frequently throughout Buffett’s entire investment career.

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