How Staying Power Made Warren Buffett Billions
Buffett made around 20% per annum his whole career. Hwang did above 40%. Who is the better investor?
Warren Buffett has compounded his capital by approximately 20% per annum on average for his whole career.
20% is a far cry from Bill Hwang's investment record. Around 2013, Hwang invested around $500 million in his fund. By 2021, his fund was worth over $10 billion. This means that he compounded his capital at over 40% per annum!
Who is the better investor?
Looking at these numbers, most people would conclude that Hwang is a much, much better investor than Buffett.
But wait - we're missing an important detail.
In 2021, Hwang lost everything. It turned out that he built his fortune using debt, which magnifies both gains and losses. During the good years, he multiplied his money at amazing speeds. However, one bad year was all it took for him to be unable to pay off his debts, causing him to go bankrupt.
This means that Hwang's long-term compounding isn't actually 40% per annum. In reality, it's a full loss of negative 100 percent.
Who's the better investor now?
Staying power matters more than rate of return
Between 1926 and 1987, only 50 out of 744 months accounted for all USA stock market returns. Had you stayed fully invested during this time period, you would've compounded your capital at an average of 9% per annum thanks to these 50 months.
Our financial environment is volatile. Sharp gains and sharp losses are a part of investing life, and we can never predict what tomorrow will bring.
Because markets are so dynamic, your investing strategy must be able to survive all kinds of scenarios. If your investing strategy only works in specific circumstances, you're bound to get caught by a downturn sooner or later.
Most people in the markets emphasize gains. However, history has repeatedly shown that the best investors aren't necessarily the fastest compounders.
The one thing in common with all investing legends is staying power.
You don't need an excessively large rate of return to make a lot of money in a lifetime. Just hitting 8% per annum with an index fund, over 50 years you will multiply your initial capital 46 times.
What if you hit Buffett's 20% for 50 years? You'd multiply your capital by 9,100 times.
Because of compounding, you don't need to make massive gains every year to make a lot of money. Just stay in the game long enough and you're bound to do well. Slow and steady wins the race.
Remember that the only thing that matters in investing is the amount of money you make over your entire lifetime. A strategy that 1000x's your money in 3 years is worthless if it blows up on year 4, bringing you back to zero.
Safety first; profits second.
Staying power is about more than just a good investing strategy
You'll need more than just a safe strategy to have staying power. Having a good strategy is essential, but not enough.
Aside from having a good strategy, it's important to be able to follow through on it - especially during downturns.
We are all human. Fear and greed can make us do stupid things. From a value investor's perspective, you can feel afraid watching your companies fall in market price by 50%. You can also feel the greed of wanting to join your friends in making money from speculative assets.
Over the long run, following a good strategy despite our emotions telling us not to is the safest way to prevent loss. By definition, if we want to "buy low, sell high", we need to have the emotional fortitude to enter when the markets are at their scariest (low market prices), and to exit when it looks like only good things lie ahead (high market prices).
A good investment strategy is not just measured by its potential lifetime earnings. It's also judged by whether you'll be able to stick with it through euphoria and panic.
How to make your investing strategy stick
So let's say you have a great investing strategy. How do you override your emotions to follow the system no matter what?
To answer this question, let's reverse it: What causes people to fail to follow their systems?
The answer? Doubt. If you do not fully believe in your system, you give up on it when things get tough.
So now we know how to make our strategies stick. We need to reduce doubt. And one way to reduce doubt is to increase our understanding of why our strategy works.
As an example, I find value investing easy to stick with because its core philosophy makes sense:
- Stocks are businesses: A stock is a partial ownership in a real business that generates profits. These profits can be passed on to shareholders through dividends.
- Prices have nothing to do with the business: Price is just based on an agreed-upon price between a buyer and a seller. These market participants can be completely uninformed about the business. Price has nothing to do with the business's assets or profits.
- Therefore, cheap businesses can exist: There will be times when prices are low relative to profits, giving us a higher-than-usual investment yield.
Because I truly believe this is how the world works, I have the confidence to follow value investing strategies even when things look like they're going south.
This belief, for example, has given me the fortitude to enter the markets during the panic of the COVID crash of 2020. It's helped me to continue holding on to high-quality businesses as I watch some of my holdings drop 40% - all while sleeping soundly at night.
(Update from 2024: These investments from 2020 ended up beating the index.)
Mike Tyson once said: "Everyone has a plan until they get punched in the face". You're guaranteed to go through tough times in your portfolio at some point, so you must be ready to follow your plan when things go south.
Whatever investment or trading strategy you intend to pursue, learn why it works. If you know it inside out and believe in it 100%, you will have more confidence to stick to your plan no matter what happens.
Conclusion
Compounding can make you wealthy, but to make it work you need to stay in the game for a long time.
Given our changing economic environment, having a safe investing strategy is key. It's also important to learn about your strategy and why it works. This will allow you to stay in the game for a long time, which will ultimately allow you to achieve your financial goals.
References
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