According to Alice Schroeder’s The Snowball: Warren Buffett and the Business of Life, a young Buffett was sometimes heard muttering things to himself like, “Do I really want to spend $300,000 for this haircut?” (H/t to this Wall Street Journal article by Jason Zweig.)
Warren Buffett obviously never spent $300,000 on a haircut. The remark instead refers to the power of compound earnings over time, something Buffett later called “The Methuselah Technique”: The financial advantages of a long life, a high rate of return, and as Buffett wrote in his 1965 Buffett Partnership letter, “a combination of both (especially recommended by this author.”)
Of course he’s right: Where building wealth is concerned, time is your friend. Say you invest $5,000 and receive a relatively conservative 6 percent return. Over time, here’s are the gains on that $5,000:
Clearly time is your friend. But while money spent today is money that never grow in the future, Buffett’s $300,000 haircut overstates the premise.
If a haircut costs $30 (which, based on results, is clearly more than I’ve ever spent on a haircut), it will take 50 years at a 20.23 percent rate of return for my $30 to turn into $300,000. Generate that level of return over that many years… and by comparison, Buffett is just be a footnote in investing history.
That’s why a high rate of of return is also your friend. At 6 percent, my $30 turns into $552 after 50 years.
Not too shabby. But not $300,000.
The Power of Early Effort
While it’s fun to assume differently, most of us have relatively little control over the rate of our investment returns. Instead, we ride tides. Unless you’re incredibly savvy, the difference you’ll be able to make in your investment returns is likely to be small.
But what you can control is how much you save — and the faster you build your savings, the faster you achieve a critical mass of wealth and the greater the effect even marginal gains in investment return will have on your principal.
For at least the first 10 years, how much you save makes a much greater difference than how much you earn on those savings. When you have $5,000, earning 10 percent instead of 5 percent will only increase your savings by $250. But when you have $100,000, the difference in return is $2,500. The larger your egg, the greater the difference in incremental return — and the greater the compounding effect as each year passes.
So in that way, Warren is right: Money spent on a haircut is money he can never get back. Saving money on a haircut — actually saving and investing that money — is money he can turn ito hundreds or even thousands of dollars in the future.
But dive too deeply into that way of thinking and you can drive yourself crazy.
The Power of Solving for the Future
The point of Buffett’s Methuselah Effect isn’t to exhaustively consider every purchase.
Nor is it to stress, once you reach some level of financial success, over whether you’re managing your money to within an inch of its life so you can capitalize on that success. (One reward of success should be gaining the freedom to stop constantly worrying about whether you maximize that success.)
One key is to consider today in regards to tomorrow. Is spending money today more fulfilling than what you could accomplish years from now with that money years after it has compounded?
While that seems like a loaded question, sometimes the answer is yes.
The same is true for other choices. Hiring a great employee is a form of compounding; that one decision can pay dividends for years. So is finding the right location. Finding the right business partner. Finding the right vendors and suppliers. Spending a little more on equipment that will do the job both now and for years to come.
Expedient decisions are sometimes necessary, but whenever possible think in terms of compounding. What is the long term effect? How will this pay off not just today, but well into the future?
The biggest key is to start now: To start solving for the future by making decisions that take full advantage of the power of time and return.
Do that, and you won’t settle for hiring a decent job candidate. You’ll hold out until you find the perfect person to fill your opening.
Do that, and you won’t keep spending money on expedited shipping to meet delivery dates. You’ll spend a little money on fixing a process so that you don’t have to overspend on shipping.
Do that, and you won’t decide to put off developing a new service. You’ll start today, because waiting means it will take you longer to start earning revenue from that service. Worse, waiting increases the chances you’ll never do it at all.
Do that, and you’ll be much more likely to achieve your long goals, because your actions will consistently reflect your ultimate intentions.