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TimeValue Software Blog

The Impact of Compounding

By Martel Pellerin

In reviewing the 2017 Berkshire Performance summary, you would be amazed at the impact that compounding has over a number of years. In their report, they show three return calculations: the Berkshire per share “book value” which was a 19.1% compounded annual return, the Berkshire per share “market value” which was a 20.9% compounded annual return, and the S&P 500 compounded annual return of 9.9%. These were from August 31, 1964 to December 31, 2017.

If you invested $100,000 in 1964, the returns generated a cash equivalent of $2.5 billion with the 20.9% return, $1.1 billion with the 19.1% return, and $15.4 million with the 9.9% return. What is astounding was the impact of the 1.8% difference between the 20.9% and 19.1% return over the 53 years of $1.4 billion.

If you are interested in doing these calculations in TValue, set the compounding to Annual and enter an Invest event on 08/31/1964 of $100,000. Then enter a Return event on 12/31/17 with “U” for Unknown for the amount. If you want to see the annual compounding affect, put a zero payment each year for the 53 years and you can see the money grow.

Definitely a fun exercise to do but, more importantly, it clearly shows the substantial impact of compounding over time. It can be material.