Courage Vs Wealth

Mr. Benjamin paid all of his children's tuition. His daughter and sons all attended private elementary and high schools, prestigious private colleges, medical colleges and graduate schools. Mr. Benjamin paid for all of it - room, board, tuition, books and related expenses. Who is this man who demonstrated the ability to fund these enormous tuition bills - a highly paid physician or perhaps CEO of a major public corporation?

 

Before he retired, Mr. Benjamin was a school-bus driver who generated enough income to send his children to private colleges, medical school, and graduate school. He was frugal but being frugal is not enough to pay six-figure tuition bills.

 

When they were young, Mr. Benjamin realized that his children were extremely bright. He realized that each would greatly benefit from a top-quality education. So he constantly worried about funding that education with his low-paying job. Consequently, Mr. Benjamin began a 'self improvement' reading program. The central topic of it was investing.

 

Being a bus driver had one side benefit. It gave Mr. Benjamin several hours of free time each day. His fellow drivers often used this time for snoozing, reading newspapers and magazines, drinking coffee or chatting. Mr. Benjamin used his downtime more wisely. He read about various types of investments. Early in his self-study program, he discovered the truth about the long-run returns generated by corporate bonds, passbook savings accounts, treasury bills, municipal bonds, CDs, stocks, precious metals and real estate.

 

Mr. Benjamin concluded that after adjusting for inflation and taxes, only stocks paid a real return on one's investment dollars. However, his mother had always told him never to invest in the stock market. She was around during the stock market crash in 1929. But the 1929 downturn was included in Mr. Benjamin's calculations and he knew that in spite of the crash, the stocks outperformed all other investment alternatives in the long run.

 

Mr. Benjamin eventually became a serious investor in the stock market. Every extra dollar he and his wife would muster was earmarked for stocks but not just any stocks. Mr. Benjamin spent much of his free time studying specific corporations and their stock offerings. Over the years, he became an expert in his chosen vocation.

 

The result of Mr. Benjamin's self-improvement reading and investing program was that when he recently retired, the former bus driver had a net worth in excess of $ 3 million. That is $ 3 million after sending his children to the finest, most expensive schools in the country.

 

What is the point? Mr. Benjamin became financially independent because he had courage. It takes courage to invest in the stock market. The market guarantees nothing. It goes up and down! Often, people get in the market late and get out early and they lose a lot of money. Mr. Benjamin was always a long-term investor. He never let fear outweigh the knowledge he obtained from his reading program. When he bought a stock, he rarely sold it within ten years of his initial investment. In good times and bad, he held on to his picks. He frequently had some fears and concerns but dealing with fear in a positive manner is a foundation stone of becoming wealthy.

 

It takes courage to invest in public corporation as well as in one's own business enterprise. However, it takes even more courage to hold on to one's investments when the public mood is full of fear and panic. Without courage Mr. Benjamin's children would not be doctors today.

(Adapted from The Millionaire Mind)

Technical Vs Fundamental Analysis (By Farouk)

Through the years I had spent years investing my money in different asset classes around the world, I always met people who were either technical analysts or fundamental analysts, and even though these people have nothing in common, one thing was always common, technical analysts were always losing money and fundamentalists were always making money. Out of every 10 technical analysts I met one fundamental analyst, and to my surprise the only one smiling there on the trading floor was the fundamental analyst.

Fundamental analysis is based on researching the stock you are going to buy, knowing its financial position and estimating a value for it. Technical analysis is based on charting, where the only reason to buy a stock is finding a good signal in its curve.

Technical analysts

Technical analysts claim that human behavior can be easily predicted from charts, and while part of what they are saying is true, as a human behavior expert I can confidently say that charts are useless. Yes you can expect a stock price to go up because it broke through a strong resistance in the chart but you didn’t take into account that a new piece of information that is released the next day may have the power to reverse this signal.

Buying a company just because its chart looks good is way far from investing, it better fits under the act of speculating. If you don’t believe this now, then go invest your money using technical analysis only and when you lose your money come back and read about fundamental analysis.

Fundamental analysis

Fundamental analysis requires you to know the stock’s financial position, its sales, its net profit and lots of other figures that are directly related to financial performance. I guess you now know why technical analysis is very popular compared to fundamental analysis, simply because fundamental analysis requires more effort.

Buying a company because you know about its current financial position and its growth prospects is more likely to make you realize profits than buying a company that you know nothing about just because its chart looks interesting.

Technical and fundamental analysis together

You might think that I am against technical analysis but this is not true, the best way to invest your money in the stock market is not to use technical analysis only or fundamental analysis only but its to use them together.

You should first use fundamental analysis to determine which stock you are going to buy and after determining what to buy, you should then use technical analysis and charts to pick the right timing to buy it so that you can maximize your profits.

Investing Is Not What Most People Think

Many people think that investing is this exciting process where there is a lot of drama. They think investing involves a lot of risk, luck, timing and hot tips. Some realize that they know very little about this mysterious subject. So they entrust their faith and money to someone they hope knows more than they do. Many other so-called investors want to prove that they can outsmart the market. Actually, this is not investing. This is more like gambling or should be described as guessing.

"Investing is a plan, often a dull, boring and almost mechanical process of getting rich."

Robert Kiyosaki

So according to Robert Kiyosaki, the correct definition or attitude towards investing should be something stated above. Investing is simply a plan, made up of formulas and strategies or a system that will almost guaranteed for getting rich. Of course, there are always some systematic risks that are unavoidable. Thus, investing does not have to be risky, dangerous and exciting.

So it is just common sense for anyone wishes to achieve financial freedom to find a plan or recipe to be rich and follow it. Why try to make your own unproven recipe when someone else has already shown you the way?

In fact, following a simple plan to become rich is boring. Also, human beings are quickly get bored and want to find something more exciting and amusing. That's why very few people ever become rich. They start following a plan and soon they are bored. So they stop following the first plan and look for a magic way to get rich quick. Soon after, they are trapped and fall prey to the "Get Rich Quick Scheme".

Most people cannot stand the boredom of following a simple and uncomplicated plan. They repeat the process of boredom, amusement and boredom again for the rest of their lives. They think that if investing is not complicated, it cannot be a good plan. In fact when it comes to investing, simple is better than complex.

As an example, most of us have played Monopoly as children. The formula and strategy involved is simply buy four green houses and then exchange them for a red hotel. Believe it of not, playing Monopoly in real life were what some of the successful entrepreneurs were doing. Once they learnt the formula, the process became automatic. They could do it even when they were sleeping and without much thinking.

So just find one simple formula and follow it. Nobody needs to be a rocket scientist to be rich. All one needs to do is simply know what is wanted, have a plan and stick to the plan. In other words, all it takes is a little discipline.

Different Categories of Investors

What kind of investor do you want to be?

This may be the question bothering everyone who has the goal of achieving financial independence. However, are you mentally prepared to become an investor? Have you done your analysis and research before you get in the market?

In fact, a true investor is prepared for whatever happens. A gambler tries to predict what and when things happen. If you are prepared, there is a deal of a lifetime being presented to you everyday of your life! The following explains the different categories of investors exist in the market. Let's review them one by one:

The Accredited Investor

The accredited investor is someone with high income or high net worth. A long-term investor who has chosen for security and comfort may very well qualify as an accredited investor. Many highly paid employees or self-employed persons fit in this category of investor.

Individuals with the following amount of money can be classified as accredited investors:

• $200,000 or more annual income for an individual
• $300,000 or more for a couple
• $1 million net worth

The Qualified Investor

The qualified investor can be defined as the person who has money as well as some knowledge of investing. Qualified investors include most professional stock traders who are accredited investors and has invested in financial education. They have learned and understand the difference between fundamental and technical investing.

A fundamental investor searches for value and growth of a company by looking at the financial statement. The most important consideration for selecting good stock for investment is the future earnings potential of the company. Warren Buffet has been acknowledged as one of the best fundamental investors.

On the other hand, a well-trained technical investor invests on the emotions of the market and invests with insurance to hedge against catastrophic loss. The most important consideration for selecting a good stock is based on the supply and demand for the stock of a company. George Soros is often recognized as one of the best technical investor.

The Sophisticated Investor

The sophisticated investors know as much as the qualified investors but has also studied the advantages available through the legal system. They are familiar with the following specialties of law:

• Tax law
• Corporate law
• Securities law

While not a lawyer, the sophisticated investor relies his or her investment strategy on the law as well as the financial products in determining the potential returns. They often gains higher returns with very low risk by using the different disciplines in law.

The Inside Investor

Although an important distinction of the inside investor is the aspect of control over management of a company, the most imperative point is that one does not need to have a lot of income or net worth to become an inside investor. An officer, director or owner of 10% or more shares of the company is an inside investor.

Actually someone with the financial education but not the financial resources can still become an inside investor. This is where many people enter the world of investing today. By building their own companies, inside investors are building assets that they can run, sell or take public.

The Ultimate Investor

The ultimate investor is a person like Bill Gates or Warren Buffett. These investors build giant companies that other investors want to invest in. The ultimate investor is a person who creates assets that become very valuable that it is worth literally billions of dollars to millions of people.

Both Gates and Buffett became rich not because of their high salaries but because they built great companies and took them public. While it is not likely that everyone of us will ever build a Microsoft or Berkshire Hathaway, we all have the possibility of building smaller businesses and becoming wealthy by selling it privately or publicly.

[Other financial posts...]

AIG Fights For Survival

If we have learned anything over the last few days from the sudden demise of Lehman Brothers, it is that the markets are impatient and hate uncertainty, even if it leads to messy results.

American International Group (nyse: AIG - news - people ) is desperately trying to raise more capital to avoid meeting the same fate.

AIG has found a protector in the State of New York and its governor, David A. Paterson. Patterson, along with Eric R. Dinallo, New York’s superintendent of insurance, have made an exception to the rules governing the regulation of insurers that will allow AIG to tap into its own reserves that will perhaps enable it to obtain some sort of credit facility or additional capital. It will be used to help maintain the company’s credit rating. It may also be used as collateral.

AIG is in dire need of liquidity to tide it over until it raises additional financing.

New York’s governor has asked the Federal Reserve to provide short-term funding to AIG in order to send a strong message to Wall Street: The problems at AIG are not rooted in its fundamental business, but stem from a crisis of confidence. Should the Federal Reserve agree, it would be an unprecedented step, as it has never before provided liquidity to an insurer. Goldman Sachs (nyse: GS - news - people ) and JP Morgan Chase (nyse: JPM - news - people ) are also believed to be working together to try to arrange a $75 billion bridge loan that would involve a number of lenders.

Certainly, the Fed drew a line with Lehman, declining to provide actual support in terms of assuming potential losses. AIG knows that the government’s wallet has been slammed shut, so what it is seeking is a collateralized $40 billion bridge loan that would be paid back immediately upon it raising capital. A collateralized bridge loan would present no risk to taxpayers. The creation of a credit facility has also been discussed.

AIG is more than an insurance company. It is arguably the biggest player in the financial services industry. Most of the problems with its balance sheet were caused by AIG Financial Products Corp., a division that, like many investment banks, participated in financial risk-taking, including investments in credit default swaps written on collateralized debt obligations. These investments are now considered to be toxic. As of July 31, AIG’s total collateral related to this portfolio was $16.5 billion, and this figure is likely to climb.

If AIG fails, the implications would be truly extraordinary. It certainly won’t mean all of its underlying subsidiaries are unsound. The insurance divisions that make up its core would likely be salvaged, as they can be separated from the rest of the organization.

After the markets closed Monday, Fitch Ratings downgraded AIG’s long-term and short-term issuer default rating, as well as its senior unsecured debt and commercial paper program ratings. Fitch said AIG’s financial flexibility and ability to raise holding company cash are “extremely limited due to recent declines in the company’s stock price, widening credit spreads, and difficult capital market conditions."

Standard & Poor’s lowered its counterparty credit ratings (including long-term) and financial strength ratings on most of AIG's insurance operating subsidiaries. Moody's Investors Service downgraded the senior unsecured debt rating of AIG as well as the ratings of several AIG subsidiaries.

It would be in the interest of public policy for the regulators to separate the non-performing assets and problematic parts of the company from those that should and can continue. This would mean separating the insurance interests from the financial product divisions.

It wouldn’t make sense to let an insurer fail that is fully capable of paying claims and has adequate capital and financial strength. If there is an insolvency, it would be in the public’s best interest to allow the insurance entities to continue, however it will require a restructuring and even liquidation of the other assets within its portfolio. If that were not to happen, it would be destructive, as AIG is the largest commercial insurer in the U.S.

Should the company be split up, which is more than likely, it will probably hold onto its core property casualty business, spin off its auto insurance and life/annuities businesses, while selling its aircraft leasing division.

On Friday and Saturday, AIG was in discussions with Warren Buffett of Berkshire Hathaway (nyse: BRK - news - people ). Speculation was that they were negotiating a sale of the aircraft leasing division (Buffett owns NetJets). But at the same time, Berkshire Hathaway owns several large insurance entities, including Geico, so it may be interested in buying some of AIG’s insurance. It is doubtful, however, that Buffett would be interested in buying the whole enterprise.

A few minutes ago, CNBC's David Faber reported on the air that Buffett is "no longer" in talks with the insurer "about an investment or anything else."

"Don't count on Warren Buffett to "rescue" AIG as its white knight."

AIG [AIG 3.75 -1.01 (-21.22%)] is desperately trying to sell assets and raise new capital to avoid what would be a disastrous downgrade of its debt by the credit rating agencies.

Faber reports that people familiar with the situation tell him that talks between Buffett's Berkshire Hathaway and AIG did take place last Friday and Saturday, but there's been nothing since then and nothing is happening now on that front.

Faber says AIG is focusing its attention on getting billions in bridge financing from the Federal Reserve, to allow for massive asset sales.

Current Berkshire stock prices:

Class A: [US;BRK.A 125000.0 5100.00 (+4.25%)]

Class B: [US;BRK.B 4175.0 160.00 (+3.99%)]

The collapse of Lehman Brothers

Why has Lehman Brothers collapsed?

In short, other banks refused to trade with it. Without the ability to trade, and without investors prepared to bet on its long-term viability, Lehman effectively had no business.

Why would the other banks not trade?

It is a repeat of the Northern Rock debacle. Lehman, while it was a large and complex business trading in a web of assets, also supported 100% mortgage loans offered by specialist lenders to people with few visible means of support. When interest rates jumped, borrowers could no longer afford their monthly payments.

Like Northern Rock, it mattered less that 80% of its assets were rock solid if 20% were considered toxic. We don't know the exact proportions at Lehman and neither do the bank's trading partners, which is why they refused in growing numbers to do business or buy it once the bank was up for sale.

Could the US government have stepped in?

The US treasury has reached the limit of taxpayer funds it is willing to gamble on propping up investment banks. Henry Paulson, the treasury secretary, committed £3 trillion last week to saving Fannie Mae and Freddie Mac. If they had failed, the mortgage market in the US would have collapsed and hundreds of banks around the world that invested in US property would suffer huge losses.

Paulson bailed out Bear Stearns earlier this year, but he appears to believe a trading house like Lehman, which has little direct connection with retail markets and ordinary homeowners, could be allowed to go bust without causing the kind of systemic risk posed by Fannie and Freddie.

Why was Barclays interested?

Barclays joined the talks at the weekend to buy Lehman because it was interested in picking up the bank on the cheap. It is a re-run of the proposed deal for Northern Rock by Lloyds TSB at the time of its collapse last summer.

Lloyds TSB offered to buy Northern Rock and accept its liabilities if the government was prepared to set aside £30bn in discounted loans to support the takeover. Barclays asked Paulson for the same kind of guarantee. He refused. The main City regulator, the Financial Services Authority, was also believed to have expressed concerns to Barclays boss John Varley that it was unwise to buy a US investment bank at this time.

Will everyone at Lehman's get the sack?

The administrators, PricewaterhouseCoopers, said the bank was centrally run from New York and therefore all its main businesses across Europe are wrecked. That puts 5,000 people who are employed at the bank, largely in Canary Wharf, out of work.

Will the whole bank be liquidated?

Not yet. Chapter 11 administration in the US allows PwC to take its time while it tries to find buyers for the least affected businesses. The year-long protection offered by Chapter 11 shields a company from creditors while it is reshaped or sold as a whole or in parts.

PWC said a number of group companies remain solvent and will continue to trade. "These companies include Lehman Brothers Asset Management (Europe) and a series of special-purpose vehicles designed to manage portfolios of residential and commercial real estate assets and non-performing loans."

What are the risks for other banks?

Share prices have tumbled and are likely to fall further as investors take flight from a sector that appears to be run by a group of bankers who are in denial about the extent of their mistakes and the problems their firms now face.

A flight of investors will make their situation worse because they are to a great extent dependent on their shareholders for capital. The capital provided by shareholders is the bedrock for their lending and without it they cannot continue trading.

What is the position with Bank of America and Merrill Lynch?

In many ways the sale of Merrill Lynch to Bank of America is a more startling development in the year-long credit crunch than the collapse of Lehman. It is understood that once it was obvious Lehman's was going under, Merrill realised it was vulnerable. The "thundering herd", as Merrill is affectionately known, was approached by Bank of America earlier this year, but rebuffed takeover talks. Now it was Merrill that went cap in hand to the US's largest retail bank for a rescue deal. Sceptics say the deal does little to resolve the problems faced by both firms, which are heavily mired in the US sub-prime home debacle.

What's going on at AIG?

American International Group (AIG), which sponsors Manchester United FC, was hit hard by deterioration in the credit markets last week and yesterday issued a statement that said it was reviewing its operations. Its stock dropped 45% since the start of the week amid concerns about the security of its assets, many of which are linked to the financial turmoil on Wall Street. Over the weekend it crafted a $40bn loan facility from the federal reserve, which had obviously taken the view that AIG posed more of a systemic risk than Lehman.

Who's next?

Washington Mutual is named by several analysts as the next to find itself in serious trouble. It was the subject of a rescue led by private equity firm Texas Pacific group in the spring. But the billions poured into its coffers no longer look sufficient to satisfy investors and they are taking flight. It is possible shareholders will flee Bank of America, if they consider Merrill Lynch a bad buy.

Another victim could be the US mono line insurers, so called because they only insure the bonds of large companies, including mortgage lending institutions. Like AIG, the insurance cover they provide could be invoked by customers and, like a tsunami, overwhelm their finances.

In the UK, mortgage banks such as Halifax owner HBOS, Alliance & Leicester and Bradford & Bingley, could suffer further if investors switch to safer havens.

Will it make a recession worse?

Yes. The CBI predicts a "shallow recession" next year, but this now appears optimistic. If the last five years of our decade-long economic boom were characterised by reckless lending, then living standards, along with property prices, have a long way to fall.

We are all spending money we simply don't have and when we stop it will spell the end for many jobs in retail, hospitality and may other industries. A fall in the value of the pound will help exporters and that will offset the worst of the economy's problems. But without banks willing or able to lend money to millions of people, except at sky-high interest rates, a long and deep recession seems inevitable.

Short-Selling Will Short-Change You

Short-selling is the process of selling borrowed shares with the hope of buying them back at a lower price. To me, it’s a sucker’s bet. The odds are stacked against you. The likelihood of permanent loss of capital is greater than if you simply go long, and your potential gain is fixed. An unlevered short position has a maximum payoff ratio of just 2-to-1.

Throughout their careers, Berkshire Hathaway’s   (NYSE: BRK-A) (NYSE: BRK-B) Warren Buffett and Charlie Munger have typically avoided shorting stocks. If the world’s best aren’t doing it, odds are you shouldn’t be doing it, either. I know that as an ardent disciple of Buffett and Benjamin Graham, I will most likely go through my entire investment career without having ever shorted a single share.

But if you do short, understand that in the meantime, while you are waiting for your stock to drop, a host of market participants are working to push the stock up.

The overvaluation argument

The most common reason to short a stock is that it’s grossly overvalued. However, a company’s management team, through some very clever tactics, can increase the per-share intrinsic value of the business without adding any tangible value whatsoever.

Value investor Mohnish Pabrai provides a brilliant illustration in his book Mosaic: Consider a company that has land worth $100 million and no other assets or liabilities. Further assume that the company’s market cap is $1billion, or 100 million shares trading at $10 a share. At that share price, the company is being valued at 10 times the intrinsic value of the land. Management then decides to issue a secondary offering of 500 million shares at $10 per share. The new balance sheet looks like this:

• Cash: $5 billion (offering proceeds)
• Land: $100 million
• Total assets: $5.1 billion
• Market cap: $6 billion

So what once appeared to be a great short candidate selling for 10 times intrinsic value — 1,000% overvalued — is now selling for about 17% above intrinsic value. As Pabrai eloquently put it, "The shorts just got hosed."

The inevitable short squeeze

Most market participants operate within a very emotional state of mind constantly dictated by fear and greed. When the slightest tinge of bad news surfaces, fear overcomes the markets and stock prices begin to tank. Hoping to cash in, people begin short-selling, in hopes of profiting on the way down. Once a heavily shorted stock begins to rise, short-sellers begin buying back shares to close out their positions. The heavy buying pushes the stock way up, and when it’s all over, only the luckiest of short sellers will have made a profit. This silly type of investing relies more on luck than anything else for a potential profit.

The idea that short-selling is a smart way to hedge a portfolio rarely ever makes sense, either. With thousands of publicly traded equities available today, one can construct a well-hedged portfolio composed entirely of long positions. Pabrai, who has been running his hedge fund for almost nine years now, has never shorted a stock, yet has returned more than 27% net annualized to his investors over that time. I can’t think of a single short seller who has come close to that level of sustained performance.

Successful investing requires patience and discipline. Short selling forces you to watch the ticker tape each day in hopes that your timing was right. And unlike a long position, a short position that moves against you will at some point require the addition of capital to meet margin calls. Before you know it, your investing activities are being dictated by the movement in the short position, and any disciplined approach has been tossed out the window.

Beat the Stock Market by Ignoring It

You know what you’re supposed to do. Waiting for "fat pitches" is just as smart as walking away when you’re winning big at the casino. But if you never seem to be able to do either of those things, consider another way to beat the stock market: Ignore it.

Short end of the stick?

Think about your relationship with the stock market. Does it get the better of you, or do you get the better of it? Do you find yourself cursing Wall Street on a regular basis? Do you feel like Mr. Market walks all over you? Maybe it’s time to take control in this relationship and show the stock market who’s boss.

Many magazine articles have pointed out that Warren Buffett doesn’t have a computer, a Bloomberg terminal, or a Quotron matchine (back when they were still used). If an investor whose net worth fluctuates by hundreds of millions of dollars on a daily basis ignores the stock market, perhaps that’s a big hint for the rest of us as well.

Break up to make up

Fools should also refuse to have anything to do with Mr. Market unless he buys your friendship. If you read Warren Buffett’s shareholder letters, you’ll notice that the Oracle of Omaha is perfectly content to ignore Mr. Market for weeks, months, and even years.

In fact, Buffett’s only interested when Mr. Market gets extremely depressed, willing to part with his crown jewels for a song. Mr. Market’s bipolar disorder allowed Buffett to buy shares of stellar performers like M&T Bank (NYSE: MTB) and Torchmark (NYSE: TMK) at around nine times earnings, and Wells Fargo (NYSE: WFC) at a stunningly low five times earnings.

Compounding: a snowball rolling down...

Probably there isn't any other subject in the (financial) world that gets that little attention, and is that important at the same time... as compounding. Albert Einstein (1879-1955) called it the 'Eighth Wonder of the World'. Warren Buffett has been said to agree with him. And probably you should too!

Compounding is one of the most powerful principles in our universe. Almost everything you see around you is the result of a compounding process.

The human brain is programmed in a linear way. We are too much focused on the short run, on annual or even quarterly returns. Most of us are underestimating the effects our short term focus will have over time.

Our unconscious mind is much more suitable for calculating e.g. the total time of ten biking trips of two hours each, or to say 'run' when we would see a smilodon walking on the street... than to calculate the end sum of a specific amount of money invested growing exponentially at a specific rate, for a certain period of time.

The more you think about compounding, the more you discover its true and remarkable power. Maybe you will even start to see the compounding process as an organic process, as a living creature! Hopefully you will not only see the remarkable consequences, but also act on this knowledge. Quite probably you will - as you see yourself the differences of applying this process to your investments and your life.

Three elements

With compounding there are three components to be distinguished. These are:

1) The amount of money you start with (this doesn't not only hold true for investing!)

2) The returns (annual growth rate)

3) Time (the number of year's available)

First, as you may expect, it's better to start your compounding journey with a considerable amount of money. This was in effect the situation of Warren Buffett or Joel Greenblatt as they started their careers. Because they didn't have much money themselves, they attracted money to their hedge funds they started at a young age. (Buffett probably wouldn't call his early partnerships this way, but nonetheless his fee structure was quite hedge-fund like).

Instead of a big amount to start with, it's also recommended to add money to your compounding-'friend' on a regular basis: this will further 'fertilize' the accumulation process. As I said before, this process doesn't hold true for investing only. It's a process that can be put into action in all kinds of ways. So, after finishing this article, you can read it again... and every time you see 'money', read 'effort' instead!

The second component of compounding lies in the returns. As we have seen before, a high return will bring in wealth over time. And probably this is also the strategy used behind most of the other 'normal' millionaires in the world: they didn't start with a lot of money, but as their stock investments (or their businesses) compounded over time, they suddenly 'discovered' that they too had joined the club of millionaires.

The third and last component of the compounding process is simply time. As your money is doubling every x years, it is very logical that the more time you have, the more often your money can double (for 'effort': think of scalability). So, especially younger people can profit from compounding: they still have a lot of time, a critical resource and component of the compounding formula.

To reach the billionaire status, you actually need all of these components. Although Buffett always told he started with only $100 dollar, he in fact started a partnership with a hedge-fund like fee structure. And with these fees Buffett was able to generate quite an amount of money, in just a few years.

So, from that moment on, Buffett was 'fully loaded' with all the essential compounding ingredients. A lot of money to start with, a long investment horizon (over half a century!) and the knowledge to generated structural, high returns.

And as we look to Joel Greenblatt, and besides of him a lot other billionaires, we see exactly the same: they had all components of the compounding formula in place. Although, in some of these billionaire-cases the starting capital was at the moment just 'a really good idea', the only thing they had still to do was to convert it, into money (or freedom).

The Rule of 72

The 'Rule of 72' is a simple, but nonetheless very handy rule to calculate the number of years it takes to double your money. This is how it works: divide 72 by your expected annual returns and the number of years it takes your money to double follows.

So, if you expect an annual return of 12%, it takes 6 years to double your money (72 / 12 = 6).

With this simple formula you can also calculate the 'required return': if you know how many years you have to double your investments, but don't know the return which is required for that.

For this, you divide 72 by the number of years. If you have 10 years to double your money, you need a 7.2% annual return (72 /10 = 7.2). Only 5 years available? Your required annual return would be 14.4% (72 /5 = 14.4).

Final thoughts

Maybe you don't have a lot of money to start with or don't possess the substitute for it (a really good business idea), but you can still profit from the compounding formula! Also the possession of two of the components of the compounding formula will most likely direct you to impressive results. Just make sure to earn a satisfactory return, add money along the way and let the compounding formula do the rest.

Over time you will really see the value of your investment portfolio accelerate. Personally, I like to compare compounding with a snowball. A snowball rolling down the slope of a mountain. A rather remarkable slope... as the end of this slope is further away then you can imagine!