Lecture1:TheJoysOfCompounding

Evolution:WhocoloredthemiceinArizona?
WarrenBuffett:ALearningMachinewhoranat19.6%for50years
MooresLaw:TheSecondHalfOfTheChessboard
Ourbraincan'tunderstandexponentialgrowth
Storyofanemperorwhoalmostlosthiskingdom
Howfoldingpapercangetyoutothemoon
HowmuchdidVCswhofundedthevoyageofColumbusearn?
CompoundingIsBackloaded
AlbertEinsteinUnderstoodItAll
DontLoseCapital
TaketheroadlesstraveledThinkLongTerm

If,insomecataclysm,allofinvestingknowledgeweretobedestroyed,andonlyonesentence
passedontothenextgenerations,whatstatementwouldcontainthemostinformationinthe
fewestwords?WithoutblinkingmyeyeIwouldpassonthedefinitiongivenbyBenjamin
Grahamwhoisthefatherofvalueinvesting.

Aninvestmentoperationisonewhich,uponthoroughanalysis,promisessafetyof
principalandanadequatereturn.Operationsnotmeetingtheserequirementsare
speculative.BenjaminGraham

Wewilldecipherthemeaningofthisdefinitionlaterinthecourse.FornowImgoingtoplaya
gamebycopyingthedefinitionbyhand.IntheprocessofcopyingIwoulddeliberatelymakea
singlecharactermistake.Thecopiedstatementwithasinglecharactermistakeisgivenbelow.


Lecture1:TheJoysOfCompounding

2
Aninvet
tmentoperationisonewhich,uponthoroughanalysis,promisessafetyof
principalandanadequatereturn.Operationsnotmeetingtheserequirementsare
speculative.Mycopywithasinglemistake

Thiscopiedtextisgiventomyfriendwhowillcopyitbyhandanddeliberatelymakeasingle
charactermistakeatadifferentplace.Hepasseshiscopytohisfriendandthiscontinues150
times.Thecopyproducedbythelastpersoninthechainwillappearasgivenbelow.

Bojowftunfoupqfsbujpojtpofxijdi,vqpouipspvhibobmztjt,qspnjtfttbgfuzpgqsjodjqbm
boebobefrvbufsfuvso.Pqfsbujpotopunffujohuiftfsfrvjsfnfoutbsftqfdvmbujwf.Copy
of150th
personwith150mistakes

IfIshowthelastcopytoastrangerandtellhimthatthereisarelationshipbetweenthisandthe
originaldefinitionproducedbyBenjaminGraham.Howwouldhereact?HewouldthinkthatIm
madandmostlikelyhellrunaway.

TherulesIusedtoplaythisgame,copyingwithamistake,iswhatevolution,inthenameof
mutations ,playedforthreebillionyears.Thediversityoflifeweseeallaroundusisaresultof
that.Whatsthisgottodowithvalueinvesting?HangontoyourthoughtsandIllmakeitall
clearbeforetheendofthislecture.

Evolution:WhocoloredthemiceinArizona?
InthedesertsofArizona,millionyearoldblacklavaflowsareinhabitedbyrockpocketmice.In
thisregion,themousecanbeseenintwocolorsdarkblackandsandycolored.Thedarkcolor
mousearefoundmostofteninblacklavarocks.Andwhitecolormousearefoundmostoftenin
sandycoloredhabitat.Takealookattheimagegivenbelow.Beforethelavaflowsallthe
mouseweresandycolored.Acuriousmindshouldaskcoupleofquestions (1)
howdidsome
micemanagetochangefromsandycoloredtoblack? (2)
howdidthemiceorganizeitself
accordingtoitssurroundings?


Lecture1:TheJoysOfCompounding

3
Forthemousetochangefromsandytoblackcolorthreethingsneedstotakeplace.Theyare
(1)mutations (2)
naturalselectionand
(3)
time.Letuslookateachoneofthemindetail.

Mutations: Inordertoreproduce,organismsmustmakecopiesoftheir DNA .Thecopyingof

DNAisacomplexbiochemicalprocesses.Andmistakeshappenduringthecopyingprocess.
Thesemistakesaremutationsandtheyarethesourceofallthevarieties(plants,bacteria,fish,
lion,monkey,andhumans)thatweseearoundus.ThegamethatIplayedabovecontainedone
kindofamistakeatypoorcopyingerror.ButduringaDNAcopyingprocessmanykindsof
mistakesarepossible.

IfwethinkofDNAasbeinglikeawrittentext,thenthecategoriesofmutationsarejust
likethefamiliarkindsofwordprocessingerrors.TheDNAofagivenspeciesranges
frommillionstobillionsofpermutationsofthefourlettersA,C,G,andT.Themost
commonmistakeisthesubstitutionofanincorrectletteratypo. Buttherearemany
otherkindsofeventsthatalsooccur,suchasdeletionsandinsertionsofblocks
ofletters.Copyandpasteerrorsalsooccurtheseresultinduplicationsoftext.
Groupsfromjustafewlettersonuptoentiregenes,orlargeblocksofgenes,are
duplicatedatasignificantfrequency.BlocksofDNAlettersarealsorearrangedby
inversionsandthebreakageandjoiningofpartsoftext.Asaresult,ineverynew
individual,therearesomenewmutations. TheMakingoftheFittest

Inamousethereisagenecalled MC1R andwhenmutatedturnsthecolorofthemousefrom

whitetoblack.Whatistheprobabilityofthisgenetomutate?Inagenetheplacewhere
mutationcanoccuriscalledasasite.Inamouse,onaverageamutationcanoccurin2outof
everybillionsite.TherearetwocopiesofMC1Rgene.AndeachMC1Rgenehas10sites.This
tellsusthatthereisabouta1in25millionchanceofamousehavingablackcausingmutation
intheMC1Rgene.ThisshowshowaccurateDNAcopyingis.Butitsnotperfect.

Total no of mutations for every 1 billion site =2

Total sites in MC1R gene that can be mutated = 20 (2 copies * 10 sites)
9
No of mutations that can happen in MC1R gene = [ 20 / 10 ]*2
No of mutations that can happen in MC1R gene = 0.00000004
One black mouse out of 25 million = 1 (25 million * 0.00000004)

Imaginethatthereare5,000whitefemalemiceinthepopulationandeachoneofthemis
capableofproducing5offsprings.Thismeansthateveryyeartherewillbe25,000offsprings
andin1,000yearsagroupofwhitefemalemicewouldhaveproducedoneblackmousejustby
randomchance.

ThelavainArizonawasformedover1.7millionyearsandduringthisperiodthemutationwould
haveproduced1,700blackmice.Ourevolutionaryclockis3billionyearsold.Sodontbe
surprisedof1.7millionyearsasitrepresentsonly0.056%ofthetotalevolutionarytime.

Lecture1:TheJoysOfCompounding

4
Mutationisarandomchanceoccurrence,rememberinthegameweplayedImadethemistake
deliberately.Aftercreatingavariationithandsoverthejobtonaturalselection.

NaturalSelection: Manythinkthattheentireprocessofevolutionisblind.Butthatsnotcorrect.
Themutationalprocessisblind,naturalselectionisnot.Iftheblackmousewasbornaround
blacklavarocksthenthepredatorslikeowlsandsnakeswillnotbeabletospotiteasily.Sothis
trait(blackcolor)givesitsurvivalandreproductionadvantage.Ontheotherhandifitwasborn
aroundsandyenvironmentthenitwouldhavebeenkilledbeforepassingitstraitstoits
offsprings.Thustheprocessofnaturalselectionactsasacoptofavormutationswhichsuitsthe
environment.

Time: Withoutmutationandnaturalselectiontherewouldbenovariationandorderlinessthat
weseeintheworld.Peopledonthaveproblemsunderstandingthesetwoconcepts.Buttheir
misunderstandingofevolutioncomesfromthetimefactor.Inordertounderstandthemassive
impacttimehadonevolution,letsgobacktoourmiddleschool.Ifyouwereawakeinmiddle
schoolmathematicsclassthenyoushouldnthaveanytroublerecognizingtheformulagiven
below.

Hopeyourecognizedcompoundinterestwithoutthinkingtoomuch.Compoundinterestisa
conceptfrommathematicsusedextensivelybybankers.WhyamIreferringtoittoexplain
evolutionwhichisafieldofbiology?Physics,mathematics,chemistry,biology,sociology,etc
arenomenclaturescreatedbyustoaidourbraintounderstandthembetter.

Butmothernaturedoesntcareaboutourcategorizationandcompartmentalization.Andshe
usestherighttoolsavailableatherdisposalaslongastheydontviolatethefirstprinciplesof
physics.
Thekeytakeawayisthatifyouwanttounderstandnaturebetterthenyouneed
tousetherighttoolsacrossdisciplines.

Letmederivethecompoundinterestequationinlaymantermssothatweknowtheinnardsof
theequationinsteadofjustknowingitsname.Letprincipal(P)is$100andrateofinterest(r)

Lecture1:TheJoysOfCompounding

5
perannumis6%anddurationofinvestmentinnumberofyears(t)is2andnumberoftimesper
yearinterestgetscompounded(n)is1.

F inalAmount = 100 + 100 * 0.06 + (100 + (100 * 0.06)) * 0.06

F inalAmount = 100 + 100 * 0.06 + 100 * 0.06 + 100 * (0.06)2
F inalAmount = 100 * (1 + 0.06 + 0.06 + (0.06)2)
F inalAmount = 100 * (1 + 2 * (0.06) + (0.06)2)
F inalAmount = 100 * (1 + 0.06)2
F inalAmount = P * (1 + r)t
F inalAmount = 100 * (1 + 0.06)2
F inalAmount = 112.36

Letsapplytheideaofcompoundinteresttounderstandhowtimeplayedacrucialrolein
changingthecolorofthemicefromwhitetoblack.Letusassumethattheblackmicehasa
survivaladvantageinblacklavarocksoverwhitemiceby1.9%.Survivaladvantageinnatural
selectionisakintointerestrateinfinance.Seehowideasinterplayacrossdisciplines.

Sincemutationhasalreadyproducedmanyblackmice,letusassumethatthereare9,992
whitemiceand8blackmice.Atthestartthepopulationwillhave99.92% (9992/10000) white
miceand0.08% [8/10000] blackmice.After500yearswithblackmicegrowingat2%therewill
be159,653 [8 * (1 + 0.02)500] blackmice.Andwithwhitemicegrowingat0.1%therewillbe
16,470 [9992 * (1 + 0.001)500] whitemice.Thiswillresultinpopulationhaving90.65%
[159653/176123] blackmiceandand9.35% [16470/176123] whitemice.

Eventhoughmutationandnaturalselectiongavevariationandorderlinessitstime,1.75million
years,whichplayedakeyroleinproducingsuchadramaticresult.
Thekeytakeawayisthat
eventinysurvivaladvantages(readitasverylowrateofinterest)willproducemind
blowingresultsifitsdoneoverlongperiodsoftime. Holdontothisideaandwellcome
backtoitlaterinthelecture.

Thereasonwhywehavetroubleunderstandingtimeisthatouraveragelifetimeisaround70
years.Thisisatinynumberwhencomparedto1.75millionyears.LaterinthelectureIllgive
someexamplestoprovethatourbrainthinkslinearlyanditsdefaultwiringisnotgoodenough
toseethepowerofexponents.

Lecture1:TheJoysOfCompounding

WarrenBuffett:ALearningMachinewhoranat19.6%for50years
Afterplayingthegameofcompoundingfor3billionyearsevolutionproduceduswithathree
poundjellybrain.Mostofuswithoutrealizingthetruepowerofourbrainletitattenuatewith
disuse.Butonemanknewitspowerandworkedhardatittokeepitsharpevenattheageof
eightyfive.HisnameisWarrenBuffett,whowasastudentofBenjaminGraham,Chairman&
CEOofBerkshireHathaway.Whatissospecialabouthim?

Overthelast50years,sinceBuffetttookoverthecompany,itspersharebookvaluehasgrown
from$19to$146,186.Hecompoundedthepersharebookvalueat19.6% [$19 * (1 + 0.196)50]
for50years.Ifonecompares50yearswithevolutionarytimescaleof3billionyearsthenit
wouldbeminisculearoundingerror.Whencomparedwiththeaveragelifetimeofhumans,70
years,wecanseethatBuffetttookhugeadvantageoftime.OninterestrateBuffettbeat
evolutionhandsdowninterestrateof19.6%vsmutationrateof0.000004%forpocketmice.


Lecture1:TheJoysOfCompounding

WhywereWarrenBuffettandhiscreation,BerkshireHathaway,sounusuallysuccessful?This
questionwasansweredbyCharlieMunger,ViceChairmanofBerkshireHathaway,in2007
DJCOmeeting.Read,reread,andreflectonMungersresponse.Theyaregoldennuggetsand
itcontainsalltheinformationthatoneneedstoleadarationallife.

AconfluenceoffactorsinthesamedirectioncausedWarrenssuccess.Itsveryunlikely
thatalollapaloozaeffectcancomefromanythingelse.Soletslookatthefactorsthat
contributedtothisresult:Thefirstfactoristhementalaptitude.Warrenisseriously
smart.Ontheotherhand,hecantbeatallcomersinchessblindfolded.Hes
outachievedhismentalaptitude.Thentheresthegoodeffectcausedbyhisdoingthis
sincehewas10yearsold.Itsveryhardtosucceeduntilyoutakethefirststepinwhat
yourestronglyinterestedin.Theresnosubstituteforstronginterestandhegotavery
earlystart.

Thisisreallycrucial:
Warrenisoneofthebestlearningmachinesonthisearth.
The
turtleswhooutruntheharesarelearningmachines.Ifyoustoplearninginthis
world,theworldrushesrightbyyou. Warrenwasluckythathecouldstilllearn
effectivelyandbuildhisskills,evenafterhereachedretirementage.Warrensinvesting
skillshavemarkedlyincreasedsinceheturned65.Havingwatchedthewholeprocess
withWarren,Icanreportthatifhehadstoppedwithwhatheknewatearlierpoints,the
recordwouldbeapaleshadowofwhatitis.

Theworkhasbeenheavilyconcentratedinonemind.Sure,othershavehadinput,but
Berkshireenormouslyreflectsthecontributionsofonegreatsinglemind.Itshardto
thinkofgreatsuccessbycommitteesintheinvestmentworldorinphysics.Many
peoplemissthis.LookatJohnWooden,thegreatestbasketballcoachever:hisrecord

Lecture1:TheJoysOfCompounding

8
improvedlaterinlifewhenhegotagreatidea:belessegalitarian.Of12playersonhis
team,thebottomfivedidntplaytheywerejustsparringpartners.Instead,he
concentratedexperienceinhistopplayers.ThathappenedatBerkshiretherewas
concentratedexperienceandplayingtime.

Thisisnothowwenormallylive:inademocracy,everyonetakesturns.Butifyoureally
wantalotofwisdom,itsbettertoconcentratedecisionsandprocessinoneperson.Its
noaccidentthatSingaporehasamuchbetterrecord,givenwhereitstarted,thanthe
UnitedStates.There,powerwasconcentratedinoneenormouslytalentedperson,Lee
KuanYew,whowastheWarrenBuffettofSingapore.

Lotsofpeoplearevery,verysmartintermsofpassingtestsandmakingrapid
calculations,buttheyjustmakeoneasininedecisionafteranotherbecausetheyhave
terriblestreaksofnuttiness.LikeNietzscheoncesaid:Themanhadalamelegandhes
proudofit.Ifyouhaveadefectyoutrytoincrease,youreonyourwaytotheshallows.
Envy,hugeselfpity,extremeideology,intenseloyaltytoaparticularidentityyouve
justtakenyourbrainandstartedtopoundonitwithahammer.YoullfindthatWarrenis
veryobjective.

Allhumanbeingsworkbetterwhentheygetwhatpsychologistscallreinforcement.Ifyou
getconstantrewards,evenifyoureWarrenBuffett,youllrespondandfewthingsgive
morerewardsthanbeingagreatinvestor.Themoneycomesin,peoplelookuptoyou
andmaybesomeevenenvyyou.Andifyoubuyawholelotofoperatingbusinessesand
theywinalotofadmiration,theresalotofreinforcement.Learnfromthisandfindout
howtoprosperbyreinforcingthepeoplewhoareclosetoyou.Ifyouwanttobehappyin
marriage,trytoimproveyourselfasaspouse,notchangeyourspouse.Warrenhas
knownthisfromanearlyageanditshelpedhimalot.2007DJCOMeeting

ThekeytakeawayfromWarrenBuffettisthatifyouwanttocreateahugeimpactinones
lifetime,likecreatingasuccessfulconglomerate,thenyouneedtocompoundatahigh
ratesforalongtime.

MooresLaw:TheSecondHalfOfTheChessboard
In1965GordonMoore,thenworkingatFairchildSemiconductor,wroteanarticletitled
CrammingMoreComponentsontoIntegratedCircuits.Inithemadeafamousforecastwhich
latercametobeknownasMooresLaw.Theforecastwhichhemadeisgivenbelow.

Thecomplexityforminimumcomponentcostshasincreasedatarateofroughlya
factoroftwoperyear. Certainlyovertheshorttermthisratecanbeexpectedto
continue,ifnottoincrease.Overthelongerterm,therateofincreaseisabitmore
uncertain,althoughthereisnoreasontobelieveitwillnotremainnearlyconstantforat
leasttenyears.MooresLaw

Lecture1:TheJoysOfCompounding

Thelinemarkedinboldmeansthattheamountofcomputingpowerwhichonecouldbuyfor$1
woulddoubleeveryyear.Howdidhedoonhispredictions?Hewastooconservativeinhis
predictionsandhislawheldupforfivedecadesinsteadofone.Overtheyearshislawwas
correctedtoaccountfordoublingofcomputingpowerevery18monthsinsteadofeveryyear.If
thechartshownbelowdidntgiveyougoosebumpsthenitmeansthatyoudontunderstand
logarithmswell.


Lecture1:TheJoysOfCompounding

10
IfyouhadstartedwithasingletransistorCPUin1965thenafter50yearsthetotalnumberof
transistorsinaCPUwillbearound10.82billion [1 * (1 + 0.5874)50 ].Thenumberoftransistors
doublingevery18monthstranslatestoanannualgrowthrateof58.74%.Evenageniuslike
Buffettcouldntcomeclosertothatrate.

Inordertoreallyunderstandtheimpactcreatedbydoublingoftransistors,visualizeanempty
chessboard.KeepapawninsquareA1andforeverydoublingmovethepawntothenext
square.Sincethenumberoftransistorsdoubledevery1.5yearsfor50years,youwouldhave
movedthepawntosquarethirtythree [50/1.5] .InfivedecadesMooresLawcoveredthefirst
halfofthechessboardandnowwereinthesecondhalf.

ManyindustriesandcompaniesgotdecimatedasMooresLawtsunamisweptacrossthefirst
halfofthechessboard.Theimpactcreatedbythetsunamiisbeautifullycapturedinthevideo
givenbelow.Clickonittowatchthevideo.


Lecture1:TheJoysOfCompounding

11

JeffBezos,founderandCEOofAmazon,understoodtheimpactofMooresLawandheused
thistsunamitoAmazonsadvantagebysurfingalongwithit.Read,reread,andreflectonwhat
hesaid.

Industrygrowthandnewcustomeradoptionwillbedrivenoverthecomingyearsby
relentlessimprovementsinthecustomerexperienceofonlineshopping.These
improvementsincustomerexperiencewillbedrivenbyinnovationsmadepossibleby
dramaticincreasesinavailablebandwidth,diskspace,andprocessingpower,allof
whicharegettingcheapfast.

Priceperformanceofprocessingpowerisdoublingaboutevery18months
(MooresLaw),priceperformanceofdiskspaceisdoublingaboutevery12
months,andpriceperformanceofbandwidthisdoublingaboutevery9months.
Giventhatlastdoublingrate,Amazon.comwillbeabletouse60timesasmuch
bandwidthpercustomer5yearsfromnowwhileholdingourbandwidthcostper
customerconstant.Similarly,priceperformanceimprovementsindiskspaceand
processingpowerwillallowusto,forexample,doevermoreandbetterrealtime
personalizationofourWebsite.

Inthephysicalworld,retailerswillcontinuetousetechnologytoreducecosts,butnotto
transformthecustomerexperience.Wetoowillusetechnologytoreducecosts,butthe
biggereffectwillbeusingtechnologytodriveadoptionandrevenue.Westillbelievethat
some15%ofretailcommercemayultimatelymoveonline. JeffBezos2000

WhathappensifMooresLawcontinuestooperateinthesamewayforthenext35years?If
thathappensthenthetsunamiwouldhavealmostsweptthesecondhalfofthechessboard.At
thatpointanaverage$1000laptopwouldbeperforming 1026 calculationspersecond.Andthis
wouldbeequivalenttoallthebrainsoftheentirehumanrace.Willhumansberelevantifthat
happens?

Todaysaveragelowendcomputercalculatesatroughly10tothe11th(1011
)ora
hundredbillioncalculationspersecond.Scientistsapproximatethatthelevelofpattern

Lecture1:TheJoysOfCompounding

12
recognitionnecessarytotellGrandfatherfromGrandmotherordistinguishthesoundof
hoofbeatsfromthesoundoffallingrainrequiresthebraintocalculateatspeedsof

roughly10tothe16th(1016)cyclespersecond,or10millionbillioncalculationsper
second.UsingthesefiguresasabaselineandprojectingforwardusingMooreslaw,the
average$1,000laptopshouldbecomputingattherateofthehumanbraininfewerthan
fifteenyears.
Fastforwardanothertwentythreeyears,andtheaverage$1,000
26
laptopisperforming100millionbillionbillioncalculations(10 )persecond
whichwouldbeequivalenttoallthebrainsoftheentirehumanrace.
Abundance

Iftheaboveparagraphdidntmakeyousweatthenyoushouldrereadit.IdontknowifMoores
Lawwillcontinuetooperateforanother35years.Butifithappensforanother15yearsthen
humansneedntapply forjobs.Andtheoddsofthathappeningseemsreasonable.Clickon
theimagetowatchthevideo.

ThekeytakeawayfromMooresLawisthatifyouwanttocreateagargantuanimpactin
lessthanacentury,likechangingthewayhumanslive,work,andthink,thenyouneedto
compoundatextraordinaryratesforaverylongtime.

InthetablegivenbelowIhavesummarizedwhatwelearntsofar.Inadditiontothat,wealso
learntthatcompoundingisusednotjustinfinancebutalsoinbiologyandtechnology.And
ideasinterplayacrossdisciplines.

Agent CompoundingFormula KeyVariablesUsed KeyTakeaways

Evolution:Mice [8 * (1 + 0.02)500] Longperiodsoftime.For Thekeytakeawayis

miceinArizonaits1.7 thateventinysurvival
millionyears.Evolutionasa advantages(readit

Lecture1:TheJoysOfCompounding

13

wholeused3billionyears. asverylowrateof
Intheformula,Iused500 interest)willproduce
yearstodemonstratethe mindblowingresults
effectsofcompoundingover ifitsdoneoverlong
longperiodsoftime. periodsoftime.

WarrenBuffett [$19 * (1 + 0.196)50] TimeandHighratesof Thekeytakeaway

return. fromWarrenBuffettis
thatifyouwantto
createahugeimpact
inoneslifetime,like
creatingasuccessful
conglomeratelike
BerkshireHathaway
whichisAmericas
5thlargestcompany
measuredbymarket
capitalization,then
youneedto
compoundatahigh
ratesforalongtime.

MooresLaw [1 * (1 + 0.5874)50 ] Timeandextraordinarily Thekeytakeaway

highratesofreturn. fromMooresLawis
thatifyouwantto
createagargantuan
impactinlessthana
century,likechanging
thewayhumanslive,
work,andthink,then
youneedto
compoundat
extraordinaryratesfor
averylongtime.

Ourbraincan'tunderstandexponentialgrowth

Thedefaultwiringofourbrainsupportslinearthinking.Anditsnotwellequippedtounderstand
sustainedexponentialgrowth.Weseverelyunderestimatehowbignumberscanget.Letslook
atthestoryofanemperorwhoalmostlosthiskingdomduetohisinabilitytothinkexponentially.

Storyofanemperorwhoalmostlosthiskingdom
th
ThegameofchessoriginatedinIndiaduringthe6 century.Thecleverinventortookhisgame
andpresentedhisinventiontotheemperor.Therulerwassoimpressedbythebeautifuland

Lecture1:TheJoysOfCompounding

14
difficultgamethatheinvitedtheinventortonamehisreward.Theinventorbeingacleverguy,if
nothecouldnthaveinventedchess,asked

AllIdesireissomericetofeedmyfamily.Sincetheemperorslargesswasspurredby
theinventionofchess,theinventorsuggestedtheyusethechessboardtodeterminethe
amountofricehewouldbegiven.Placeonesinglegrainofriceonthefirstsquareof
theboard,twoonthesecond,fouronthethird,andsoon,theinventorproposed,so
thateachsquarereceivestwiceasmanygrainsastheprevious. SecondMachineAge

TheemperordidntstudyMooresLawlikeyou.Sohisbraincouldntseethepowerof
compoundingathighratesofgrowth.Withoutthinkingfurtherheagreedtotheinventors
request.Iftheemperorrequestwerefullyhonoredthentheinventorwouldhavetakenhome
eighteenquintilliongrainsofrice 264 1 .Howmuchricewouldthatbe?Thatmuchricewould
dwarfMountEverestanditsmorericethathasbeenproducedinthehistoryoftheworld.The
emperorrealizedhisstupidityandhegottheinventorbeheaded.Ofthethreemodels[Evolution,
WarrenBuffett,MooresLaw]thatwestudiedwhichonedoestheemperorstoryrelateto?Ifyou
answeredMooresLawthenyourecorrect.

Howfoldingpapercangetyoutothemoon
Itstimetotestyourknowledgeoncompounding.Imaginethatyouhaveapieceofpaperwhich
is 103or0.001centimeters thick.Howmanytimescanyoufoldthispieceofpaper?What
happensifyoufoldit45times?Tryingtosolvetheproblembeforewatchingthevideo.Clickon
theimagetowatchthevideo.


Lecture1:TheJoysOfCompounding

15
Thecompoundingequationfortheaboveproblemwouldbe 351, 843kms = 0.001cm * (2)45 .And
ifyouweresuccessfulinfoldingthepaper45timesthenyoucouldhavegonetothemoonfor
$0.Ofthethreemodelsthatwestudiedwhichonedoesfoldingpaperrelateto?ItsMoores
Lawagain.

HowmuchdidVCswhofundedthevoyageofColumbusearn?
Onemoreproblemtotestyourskillsoncompounding.WeallknowthatColumbusdiscovered
Americain1492.Theventurecapitalistswhosponsoredthevoyagespent$30,000intheyear
1492.Ifthedescendentsofventurecapitalistswereoffered$17trillionin2015,currentGDPof
America,fortheirancestralforesight.

Whatistherateofreturnontheiroriginalinvestment? Beforesolvingtheproblemmakea
guessattherateofreturn.Aftersolvingtheproblemcomparetheresultswithyour
guess.

Therateofreturnwouldbe3.92%.Didyouguessitright?Iseriouslydoubtit.Thecompounding
equationforthisproblemwillbe $17trillion = $30, 000 * (1 + 0.0393)524 .Ofthethreemodels
thatwestudiedwhichonedoesthestoryofVCsrelateto?IfyouansweredEvolutionthen
yourecorrect.

CompoundingIsBackloaded
IgotthestoryofVCsfundingColumbusfromaletterWarrenBuffettwrotetohislimitedpartners
in1963.

IhaveitfromunreliablesourcesthatthecostofthevoyageIsabellaoriginally
underwroteforColumbuswasapproximately$30,000.Thishasbeenconsideredatleast
amoderatelysuccessfulutilizationofventurecapital.Withoutattemptingtoevaluatethe
psychicincomederivedfromfindinganewhemisphere,itmustbepointedoutthateven
hadsquattersrightsprevailed,thewholedealwasnotexactlyanotherIBM.

Figuredveryroughly,the$30,000investedat4%compoundedannuallywould
haveamountedtosomethinglike$2,000,000,000,000(thats$2trillionforthoseof
youwhoarenotgovernmentstatisticians)by1962. Historicalapologistsforthe
IndiansofManhattanmayfindrefugeinsimilarcalculations.Suchfancifulgeometric
progressionsillustratethevalueofeitherlivingalongtime,orcompoundingyourmoney
atadecentrate.Ihavenothingparticularlyhelpfultosayontheformerpoint.Buffett
1963

Rereadthelinemarkedinbold.Buffettwrotetheselinesfiftythreeyearsback.Inthefirst471
years,from1492to1962,theinitialinvestmentwentupfrom$30,000to$2trillion.This
representsjust11.76% $2trillion/$17trillion ofthetotalproceeds.


Lecture1:TheJoysOfCompounding

16
Inthenext53yearstheremaining15trillion,whichrepresents 88.24% ,wasearned.Inother
wordsthelast10%ofthetimeearnedaround90%ofthetotalreturns.Thekeytakeawayis
CompoundingIsBackloaded .Spendalotoftimetoburnthis,powerfulandcounterintuitive,
conceptintoyourbrain.

AlbertEinsteinUnderstoodItAll

WhenmostofthehumanswerestrugglingtomakeendsmeetaGermanborntheoretical
physicistfiguredoutthepowerofcompoundinterest.HisnameisAlbertEinsteinageniuswho
discoveredthemindbendingformula E = M C 2. Andhecalledcompoundinterestasthe8th

wonderoftheworld
.


Lecture1:TheJoysOfCompounding

17

AtthispointIhaveconvincedyouenoughaboutthepowerofcompounding.Itstimetoputour
knowledgeintoactionbyapplyingtheprinciplesofcompoundinginourdailylife.

DontLoseCapital

WarrenBuffettgavetworulesforsuccessfulinvesting.Theyare (1)
Don'tlosemoney (2)
Never
forgetRuleno1.Whydidhetalkaboutnotlosingmoneyinsteadoftellingustocompoundour
capitalatveryhighrates?Thisisbecausecompoundingworksagainstusifwelosecapital.As
theysayTofinishfirstyoumustfirstfinish.

Thekeyininvestingistostayinthegameforaverylongtimewithoutlosingalotofcapital.
Thisiswhatourmodels[Evolution,WarrenBuffett,MooresLaw]did.Theyplayedthegamefor
averylongtimewithoutlosingmuch.Thisisveryimportantininvestingasasinglebigmistake
couldknockyououtofthegame.Thechartgivenbelowillustratesthispointwell.

Lecture1:TheJoysOfCompounding

18

TaketheroadlesstraveledThinkLongTerm

ImetalotofsmartvalueinvestorsinIndia.AndoneofthemisVinayParikh,whoisthe
cofounderofJeetayInvestments.Hetoldmethatlifeisprobabilisticandtoleadarationallife
oneshoulddothingsthatstackupoddsintheirfavor.Andavoideverythingthatworksagainst
them.Whathetoldresonatedwithmeanditremindedmeofaninterviewgivenby AndrewNg .

Doyouhaveanyhelpfulhabitsorroutines?

Iwearblueshirtseveryday,Idontknowifyouknowthat.[laughter]Yes.Oneofthe
biggestleversonyourownlifeisyourabilitytoformusefulhabits.

WhenItalktoresearchers,whenItalktopeoplewantingtoengageinentrepreneurship,
Itellthemthatifyoureadresearchpapersconsistently,ifyouseriouslystudyhalf
adozenpapersaweekandyoudothatfortwoyears,afterthosetwoyearsyou
willhavelearnedalot.Thisisafantasticinvestmentinyourownlongterm
development.

Butthatsortofinvestment,ifyouspendawholeSaturdaystudyingratherthanwatching
TV,theresnoonetheretopatyouonthebackortellyouyoudidagoodjob.Chances
arewhatyoulearnedstudyingallSaturdaywontmakeyouthatmuchbetteratyourjob
thefollowingMonday.Thereareveryfew,almostnoshorttermrewardsforthesethings.

Lecture1:TheJoysOfCompounding

19
Butitsafantasticlongterminvestment.Thisisreallyhowyoubecomeagreat
researcher,youhavetoreadalot.

Peoplethatcountonwillpowertodothesethings,italmostneverworksbecause
willpowerpetersout.InsteadIthinkpeoplethatareintocreatinghabitsyouknow,
studyingeveryweek,workinghardeveryweekthosearethemostimportant.Those
arethepeoplemostlikelytosucceed.AndrewNg

Rereadthelinesmarkedinbold.Reflectonitforsometime.Isthereaconnectionbetweenwhat
VinayandAndrewsaid?Doyouseecompoundingatplayhere?Ifyeswhichofthethree
models[Evolution,WarrenBuffett,MooresLaw]doesitmapto?Thinkforamomentbefore
readingfurther.

Compoundingisatplayinbothcases.Letsassumethatyoudevelopseveralgoodhabitslike
reading,thinking,exercising,healthyeating,etc.Andthesehabitscollectivelyconferyouan
advantageof0.0001percent.Letsassumethatinyourlifetimeyouengagein150,000
activities.Yourlifetimeadvantageaddsupto 3.2million = 1 * (1 + 0.0001)150000 .Amazingisnt
it.ThemodelthisexamplerelatestoisEvolution.

Thinkofamanagerslifeasalongseriesofconnectedactivities,suchasassertions,
questions,paraphrases,andthelikeasmeaningfulspeechacts,tobeprecise.Ifa
managerparticipatesin,say,10meetingsaweekandcommits10suchspeechactsper
meeting,thenina50weekyearshewillengagein5,000suchseriallycorrelated
activities,andina30yearmanagerialcareer,150,000ofthem.

Now,ifshepossessesordevelopssomecharacteristicthatmakeshereven1per
centof1percent(0.0001)moreeffectiveatbringingaboutconstructiveeffectsby
whatshesaysandhowshethinks,thenovercourseofhercareerthatadvantage
willcompoundtoamultiplierof3.2106 thatis,heroveralleffectivenesswillgo
upbyafactorof3million! A1percenteffectivenessimprovementonaperinteraction
basiswillcompoundtoanunimaginablyhigh1.61048
advantageprovided,ofcourse,
thatsuchadvantagescompound. Diaminds

SomeoneaskedCharlieMungerthesecretsofgettingrich.Theresponsehegaveissosimple
butyetmindblowing.

Spendeachdaytryingtobealittlewiserthanyouwerewhenyouwokeup.Discharge
yourdutiesfaithfullyandwell.Stepbystepyougetahead,butnotnecessarilyinfast
spurts.Butyoubuilddisciplinebypreparingforfastspurts.Slugitoutoneinchatatime,
daybyday.Attheendofthedayifyoulivelongenoughmostpeoplegetwhatthey
deserve. Spendlessthanyoumakealwaysbesavingsomething.Putitintoa
taxdeferredaccount.Overtime,itwillbegintoamounttosomething.Thisissuch
anobrainer. CharlieMunger

Lecture1:TheJoysOfCompounding

20

IfyoufollowMungersnobraineradviceby (1)
savingmoney
(2)
startinvestinginataxdeferred
accountlike401K (3)
buyalowcostindexfundworksinbothUSandIndia (4)
focusonthe
jobathand(5)
gotobedalittlewisereverynightthanyouwereinthemorning.Thenyoucant
avoidbecomingrich.

Thechartgivenbelowillustratesthatsomeonecontributing$17,500tohis401kaccountevery
yearwillearn$3.2millionpretaxattheageof60.Ihaveassumed401kcontributiongrowingat
1%everyyear.Ifyouwanttobeapassiveinvestor,thisisallthereistoknowaboutinvesting.

ThekeytakeawayfromVinay,Andrew,andMungeristodevelopgoodhabitsearlyinlife
andthinklongterm.